Top Six Considerations When Buying a Hotel or Motel
Buying a hotel or motel requires specialized planning and regulatory compliance. In addition, there are several proven methods of marketing your hospitality services that a potential owner should consider before buying a hotel or motel.
Are you an aspiring hotelier? The hotel industry, and the hospitality industry in general, can be incredibly costly. Deciding to purchase an existing hotel or motel, start a hotel construction project, or plan large-scale renovations can be a significant financial decision that takes a great deal of forethought and planning. Current hotel owners may be looking for financing in order to undertake large-scale renovations or prospective owners may be looking to build or purchase a new hotel. When shopping for hotel lending options, geography, target clientele, property valuations, and financing are all concerns before ultimately investing in such a property.
1. What’s The Difference?
Hotels and motels are very different investments as commercial real estate. Not only do they traditionally have different locales, but they also attract different types of customers, who have varying lengths of stay and lifetime value (LTV). Your choice between a hotel and motel should be guided by your business plan and line of credit.
A traditional hotel not only has medium to short-term lodging but also many amenities, such as a pool, complimentary breakfast, room service, workout facilities, front desk/concierge, etc. Rooms are located inside the hotel where you must pass through a lobby. Hotels are often times located inside of cities, near business centers, airports, and city-centers.
Motels can provide short-term to long-term lodging to guests with limited or no amenities. These typically have minimalistic rooms that are located directly off of parking areas. Motels are typically located off of highways or other motorways. For this reason, motels are geared towards guests who are en route to a destination.
Deciding to invest in a motel or a hotel can be a daunting decision, however, deciding your target clientele and ideal location first can help in narrowing down your options. Once you have these decisions made, the choice should become clear.
2. What Should I Consider Geographically?
Location is extremely important when considering investing in commercial real estate, specifically hotels or motels. There are many things to consider when investing in a property such as a hotel, however, possibly the most important is understanding the real-estate value of the area over time. Ideally, you will choose an area that will appreciate over time. This would look like future development in areas surrounding the hotel. Additionally, you should take into consideration the ease of potential re-branding, property improvements, and renovations. Ultimately, you will want to take this into account when calculating your loan-to-value ratio when you explore financing options.
Hotels exist in many different environments and serve different purposes. For example, a hotel in a population-dense city may be able to attract a variety of guests, depending on the hotel itself. However, a hotel in a more remote vacation area could attract an entirely different type of guest. Motels are traditionally located along motorways. For this reason, they are more frequently located in between or outside of cities. When looking at a site to purchase a hotel, place, price, physical environment, and people should be considered. That being said, the physical location, along with the prices of other accommodations, food, etc. all influence the type of person that will be surrounding your hotel.
3. What Should I Consider With My Target Market?
When making purchasing decisions, your ideal clientele should be kept in mind. Identifying consumer personas is an important part of the process. Understanding the segmentations of your consumer will help you satiate the consumers’ needs and desires with your limited resources. Segmentation happens by finding a group of metrics that will be used to group consumers. Your firm should optimize its controllable marketing variables, which are heavily influenced by the geographical region of your hotel or motel in order to get to your ideal level of sales in your target market.
4. How Do I Value a Commercial Real Estate Property?
There are three main methods that you can use to determine the value of the property you are looking at. These main approaches are valuing the piece of commercial real-estate on the basis of income capitalization, sales comparison, and cost.
Income Capitalization Approach
This approach values a property using its net return (also known as ‘present worth of future benefits’). The net return would be calculated by adding up the income and expenses and anticipated proceeds from the future sale of the property. These figures can be used to show market value through a capitalization process and an analysis of discounted cash flows. This method is typically the preferred approach for valuing income-producing properties because it reflects the thoughts of a knowledgeable buyer with investment-styled thinking. This approach is very popular among knowledgeable buyers because it puts emphasis on the most important thing to consider when investing in property, return on investment (ROI).
Sales Comparison Approach
This approach operates off of the assumption that a knowledgeable buyer will pay as much, if not less, than the cost of acquiring another property that provides similar utility. In order to be able to compare two properties, a supportable common value will be necessary to reflect the differences in a similar metric. This technique is often troublesome due to the lack of information on sales data. The sales comparison approach is useful in showing a range of metrics from past sales and in establishing indicators of pricing momentum. However, this is typically used to establish broad metrics used to judge the property.
Some typical metrics include revenue per available room (RevPAR), which is a pretty standard performance metric used in the hotel industry. It is calculated by multiplying a hotel’s average daily room rate (ADR) by its occupancy rate.
The cost approach compares the cost of the property to the cost of building a new property with similar utility. The value of the property is found by calculating the cost of replacement and subtracting any depreciation, like deterioration, functional and economic obsolescence. The amount of depreciation should be added to the value of the land to reach an estimated total value. This valuation approach can be reliable with new properties, but as the building ages and deteriorates, the loss in value can be difficult to accurately gauge. The cost approach does not take into consideration economic or income-related factors, such as future net income and ROI. Because of this, the cost approach is not given much weight in the hotel valuation process.
When deciding what valuation process to use, it is important to understand your motivations for investing in the hotel in the first place. Many buyers prefer the income capitalization approach because it focuses on creating a return on your investment. However, it is also important to consider other metrics, like property value and depreciation costs. When comparing properties, you can use historical sales data to make a comparison. It’s recommended to use at least two valuation approaches at a time in order to get a better understanding of your potential investment.
5. How Do I Get A Hotel Loan and Motel Loan?
Deciding how to secure motel or hotel financing can be an overwhelming decision with all of the potential options. Luckily, there are many motel and hotel lenders that are willing to work with hospitality institutions to figure out loan terms that work.
Conventional Bank Loans
A conventional bank loan or a commercial real estate loan is a business loan from any lending entity for the purpose of purchasing, building, or restoring a commercial property. Commercial real estate is a property that is used in commerce, i.e. office spaces, warehouses, production facilities, store-fronts, etc. This is an important distinction from residential properties. These types of loans typically have the following characteristics: No limit on loan sizes, 5%-7% interest rates, and a repayment term up to 25 years. These loans are best for borrowers with strong credit and an existing relationship with their bank.
Merchant Cash Advance
Also known as a Business Cash Advance, is a very common short-term financing option that isn’t technically considered a loan. This agreement says that the hotel/motel will sell their future revenue in exchange for an upfront sum of cash to be used towards refinancing, construction, or renovations. This is perfect for a hospitality company that has good cash flow and needs money quickly by providing an immediate loan-to-value.
This is a standard for hotels or motels located in rural areas through the Guaranteed Loan Program of the US Department of Agriculture. These properties must be in USDA-designated areas and benefit the local community somehow. A USDA loan doesn’t actually have a maximum amount, however, it depends on your debt and housing ratios. The USDA allows a 29% housing ratio and a 41% total debt ratio. These two ratios will tell you the maximum amount you will be allowed to borrow.
These conventional loans are offered by banks or other lenders in collaboration with the Federal Government’s Small Business Administration. The SBA backs a large portion of the mortgage.
SBA 7(a) Loans for Commercial Real Estate
The Small Business Administration (SBA) offers commercial mortgages backed by the SBA through its business loan program called the SBA 7(a). These types of loans are often used by businesses to purchase or refinance hotel properties up to $5 million and in order to borrow funds needed for working capital. The typical characteristics for this type of loan are as follows: A loan size up to $5 million, SBA interest rates between 7.25% to 9.75%, and a repayment term of up to 25 years. These loans are best for small-scale commercial real estate projects.
SBA 504 Loans
This SBA 504 Loan (Also known as Certified Development Company program) is designed to provide financing towards the purchase of fixed assets, typically being real estate buildings or machinery at below traditional market rates. This loan program works by distributing the loan among three parties….. In an SBA 504 Loan the business owner puts a minimum of 10%, a bank puts up 50%, and a Certified Development Company puts up the remaining 40%. The maximum loan size is 5$ million, the interest rates range from 4.5% to 6% on CDC loans and 5% to 12% on bank loans. This is typically used for large projects that are unable to obtain conventional financing.
Large Balance Motel Commercial Loans
This loan program is designed for average and above-conditioned properties located in medium and above market sectors. This is traditionally used for the acquisition or refinancing of a motel property. The minimum loan size is $500,000 with year fixed rates of 3,5,7, and 10. This loan can be amortized for 15, 20, 25, and 30 years. This loan uses the piece of commercial real estate as collateral.
Small Balance Motel Commercial Loans
This is similar to the previous large balance motel loan, but the greatest difference is that the maximum loan size is $1,000,000. Stated Income Commercial Loans are available for most commercial property types in the medium and large market sectors.
Commercial Mortgage-Backed Security Loan
Commercial mortgage-backed security (CMBS) loans, also known as a Conduit Loans, are debt-obligations that are backed by the cash flows from pools of mortgage loans, which is a type of asset-backed security. Mortgage loans are purchased and bundled up by banks which represent claims on a principal and interest payments made by the borrowers on each loan within the pool. The minimum loan amount for something like this is typical $2 million and can be amortized over 25-30 years with a large payment due at the end of the term.
6. What Type Of Financing Should I Choose?
Traditionally, motels are found in more rural areas that are accessible in transit off of roadways. For this reason, it could be beneficial to use a USDA loan that supports rural agricultural areas (these areas typically support populations of 50,000 or less). Additionally, depending on the size of the motel, the large and small balance motel loans are widely used in financing the purchase or refinance of motels.
Hotel financing typically happens through strong banking relationship with lenders and a good credit score, which can allow you to obtain a conventional bank loan. These terms range from 3 to 10 years with amortization up to 25 years. This is better for boutique hotels working with qualified buyers. A CMBS Loan is best for large franchise hotels or resorts, like a Hilton. These loans have a fixed interest rate, a standard amortization period of 25 to 30 years and sometimes have an optional interest-only period. SBA loans are typically used for purchasing, construction, renovation, or sometimes the refinancing of hotels. USDA loans can be used with hotels located in rural areas because they can help bring more business to the community and create jobs.
Summing Up: Financing a Hotel vs a Motel
As with anything else, there are pros and cons to financing a hotel versus financing a motel. Additionally, there are many avenues to take when looking for financing for your commercial real estate project. It is extremely important to consider your business plan, size, location, and target market before making any finalized decisions on a specific building or plot of land. However, once this is decided, understanding your own credit limits, bank relationships and timeline for financing should be taken into account when finalizing a financial plan for this project. Fortunately, there are so many financing options that there is almost always a best fit for the specific project at hand.