Buying a hotel or motel is always a large and complicated transaction. Every hotel is different, and buyers must seek to understand a property’s potential in the context of dynamic market conditions. It is critical to do extensive due diligence on any hotel or motel purchase.

Here are 4 things you must consider before buying a hotel or motel.

1. Understand The Key Financials Of The Hotel Or Motel

When you are analyzing a hotel or motel for purchase, it’s essential to understand the key financial measures of hotel performance. Be sure to request or calculate them for the hotel or motel you are considering buying.

  • Average Daily Rate is the average rate paid by guests at the hotel. You can calculate it for a specific period of time by taking the total revenue of the hotel during that period and dividing by the number of rooms sold during that period. This number may feed your cash flow projections and is a major driver of occupancy, so it is important to understand the average rate your guests are paying.
  • Occupancy Rate reflects the occupancy of the property. This is calculated by dividing the number of rooms sold by the total number of rooms in the hotel or motel. From this, you can calculate the Market Penetration Index by dividing your occupancy rate by the market occupancy rate and multiplying the result by 100. If the result is over 100, the hotel is performing well for its market in terms of occupancy.
  • Revenue Available Per Room (RevPAR) is a performance metric specific to hotels and motels and Revenue Generated Index. It is calculated by multiplying a hotel’s Average Daily Rate by its Occupancy Rate. A higher RevPAR is usually a good thing because it means a hotel’s Average Daily Rate, Occupancy Rate, or both are high or increasing. However, don’t use RevPAR in isolation because it fails to consider the scale of the hotel.
  • Average Length of Stay is an important metric for any hotel manager because fewer turnovers means lower operational costs and labor. You calculate it by dividing the occupied rooms by the number of bookings for a specific period of time. A higher Average Length of Stay can point to higher profits.
  • EBITDA stands for Earnings Before Interest Tax Depreciation and Amortization. It is a measure of operational profitability for hotels and other types of businesses. It is sometimes used as a proxy for cash flow or profit, but it is not quite the same. It is calculated as Total Revenue – Total Expenses (excluding interest, tax, depreciation, and amortization). EBITDA is important in the hotel industry because it reveals to buyers, investors, and lenders the amount of cash flow available to cover operational expenses and pay interest on the loan.

If you take the time to understand these metrics, you be able to gain a nuanced perspective of the underlying financials and performance of a particular hotel or motel. This list is not exhaustive. You should be sure to do your research, including requesting financials and tax records, inventory records, leases, contracts, warranties, and environmental studies.

2. Consider How This Hotel Or Motel Creates Synergies With Your Other Assets

A synergy is the concept that the combined value of two assets may be greater than the two assets separately. If you are buying a hotel or motel and already have other hotels or motels, you may be able to realize synergies in the transaction. For instance, you may be able to share staff between the properties or even merge back office functions like payroll. These steps can save your business money and promote efficiency, and should be factored into your projections.

3. Find a Good Lender and Understand Their Requirements

Be sure to explore all of your options for hotel loans before picking one.

In addition to ensuring that the cash flows of the hotel can cover the loan payments, a lender may have numerous restrictions and requests regarding the financing required for a hotel purchase. Make sure to understand your lender’s preferred Debt Service Coverage Ratio, which is Net Operating Income / Annual Debt Service. Net Operating Income is Total Revenues Minus Total Expenses. Debt Service is the cash required to make interest and principal payments on a loan. Most commercial real estate lenders want this ratio to be 1.4+ for hotels and motels.

If the hotel you are purchasing has a franchise model, make sure you know your lender’s policies about working with franchised hotels. Your lender may require a so called “Comfort Letter,” which addresses the lender’s rights in the event of a default. The lender may require a Hotel Management Agreement, which stipulates certain things about the hotel should be run and managed. The lender may also require that you maintain a certain capital reserve in a lender controlled account. Be sure to seek out a lender that is familiar with these types of loans.

4. Pick the Right Bid Price

The most important part of buying a hotel or motel is determining how much to bid. In order to determine the right price, you have to take into consideration many factors, including the property’s current performance, the surrounding market, and the future outlook. Determine your price using expected future revenues and expenses using realistic estimates. Perform a discounted cash flow analysis or hire someone to do it for you, and examine nearby comparable hotel sales. The price will depend on the market conditions and your unique situation.

Do Your Homework and Partner With the Right Experts

When considering any hotel or motel purchase, it pays to do your homework and be selective. Along the way, be sure to seek out experts and partners such as an attorney, accountant, and experienced lender to assist you with the transaction.

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