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HowtoTestHotelFeasibility
BySteveRushmore,Sep26,2011 SteveRushmore'sAugust2011columninLodgingHospitalitymagazine. Whendesigningahotel,thearchitectanddevelopmentteamneedtocreateaprojectthatisultimately economicallyfeasible.Unlessthehotelsownerisegodrivenratherthaneconomicallymotivated,most investorsarelookingforareturnontheirinvestedcapital.Sincefeasibilitymeansdifferentthingstodifferent people,andasahotelconsultanthavingpreparedthousandsoffeasibilitystudies,Ihavebeenaskedto providemyperspectiveonthistopic. TheprocessIliketousefordeterminingwhetheraproposedhoteliseconomicallyfeasibleistocomparethe totalprojectcost(includingland)withthehotelsestimatedeconomicvalueonthedateitopens.Afeasible projectisonewheretheeconomicvalueisgreaterthanthecost.Accuratelyestimatingthetotalprojectcostis arelativelysimpleprocessforthearchitectanddevelopmentteam.However,determiningtheeconomicvalue ismuchmorecomplicated. Thefirststepinthevaluationprocessistoperformamarketstudywherethelocalhoteldemandisquantified andallocatedamongtheexistingandproposedsupplyoflodgingfacilities.Theallocationofroomnight demandisbasedontherelativecompetitivenessofallthehotelsinthemarket.Theendresultisaprojection ofdemandcapturedbytheproposedsubjecthotel,whichisthenconvertedintoanestimateofannual occupancy.Asimilarprocedureisusedtoprojecttheaverageroomrate. Thesecondstepistoprojectthehotelsoperatingrevenueandexpensesbasedonthepreviouslyestimated occupancyandroomrate.Thisresultsinanestimateofannualnetoperatingincome.Mostconsultantsusea fiveto10yearprojectionperiod,sothisprocessneedstoberepeatedforeachyear. ThelaststepistoconverttheprojectedNOIintoanestimateofvalueusingaweightedcostofcapital discountedcashflowprocedure.Theendresultisanestimateofeconomicvaluethatcanbecomparedtothe totalprojectcost. Someconsultantswillsubstituteanetpresentvaluecalculationordeterminetheinternalrateofreturn(IRR) forthelaststep.However,Ipreferusingtheeconomicvalueapproachbecauseyouendupcomparing appleswithapplesi.e.costwithvalue. Asyoucansee,thisprocessofdeterminingeconomicvaluerequireslocalmarketknowledge,hotelfinancial expertiseandexperiencewithvaluationmethodology.Luckilyforarchitectsandhoteldevelopers,therearetwo simplerulesofthumbsthatwillprovidearoughapproximationastowhetheraprojectiseconomically feasible. Thefirstthumbruleteststhecostofthelandtodeterminewhetheritexceedsasupportableeconomicland value.Thefollowingformulacalculateseconomiclandvalue: OccupancyxADRxRoomsx365x.04/.08=EconomicLandValue. Asexample,aproposedhotelisbeingconsideredonaparceloflandthatcanbeacquiredfor$3,800,000. Zoningpermitsthedevelopmentof200rooms.Basedonlocalmarketconditions,theproposedhotelshould achieveastabilizedoccupancyof70%andanaverageroomrateof$150.UsingtheseinputstheEconomic LandValuewouldbecalculatedasfollows: .70Occupancyx$150ADRx200Roomsx365x.04/.08=$3,832,500. ThecalculationshowstheEconomicLandValueisabovethecostofthelandsothedeveloperisnot overpayingfortheland.Ifthelandcostwas$4,000,000orabove,thedeveloperneedstoreevaluatethe projectbecauseitsnotsupportedbythehotelsunderlyingeconomics.Perhapsadditionalroomscouldbe added,whichwouldincreasetheroomcountorahigherqualityofhoteldevelopedwouldincreasethe
HVS,whichStevefoundedin1980,hasprovided consultingservicesforthousandsofclientsinall 50statesandmorethan60foreigncountries.Its professionalstaffofmorethan400industry specialistsoffersawiderangeofservices, includingmarketfeasibilitystudies,valuations, strategicanalyses,developmentplanning,and litigationsupport.Throughitsdivisions,HVS suppliesuniquehotelconsultingexpertiseinthe areasofexecutivesearch,foodandbeverage operations,gaming,technology,hoteloperations, assetmanagement,marketing,interiordesign, parking,golf,andinvestmentcounseling.HVSis theindustry'sprimarysourceofhotelsales information.Itsdatabasescontaininformationon morethan13,000hoteltransactionsand thousandsoffinancialstatements.HVSisalsothe mostcomprehensivesourceofhotel compensationdata. Asaleadingauthorityandprolificauthoronthe topicofhotelfeasibilitystudiesandappraisals, SteveRushmorehaswrittenallfivetextbooksand twoseminarsfortheAppraisalInstitutecovering thissubject.Hehasalsoauthoredthreereference booksonhotelinvestingandhaspublishedmore than300articles.HewritesacolumnforLodging Hospitalitymagazineandiswidelyquotedby majorbusinessandprofessionalpublications. Stevelecturesextensivelyonhoteltrendsand hastaughthundredsofclassesandseminarsto morethan20,000industryprofessionals.Heis alsoafrequentlectureratmajorhotelschools aroundtheworld,includingLausanne,Cornell, Houston,andIMHI.

AboutSteveRushmore
SteveRushmoreisthepresidentandfounderof HVS,aglobalhospitalityconsultingorganization with30officesaroundtheglobe.Hedirectsthe worldwideoperationofthisfirmandis responsibleforfutureofficeexpansionandnew productdevelopment.Stevehasprovided consultationservicesformorethan15,000hotels throughouttheworldduringhis40yearcareer andspecializesincomplexissuesinvolvinghotel feasibility,valuations,andfinancing.Hewasone ofthecreatorsoftheMicrotelconceptandwas instrumentalinitsIPO.SteveisapartnerinHEI Hospitality,LLC,ahotelinvestmentfund,which makeshimoneofthefewhospitalityconsultants thatactuallyinvestinandownhotels.

averageroomrate.ThisEconomicLandValueformulaworkswellinmostmarkets.Forprimecentercity locationsthe.04factorcanbemovedupto.08. ThesecondruleofthumbistheAverageRateMultiplierformula.Thisisaverysimplewaytoapproximatea hotelstotaleconomicvalue.Theformulaisasfollows: ADRxRoomsx1,000=EconomicValue UsingthenumbersfromtheexampleaboveproducesthefollowingEconomicValue: $150x200x1,000=$30,000,000 Ifthehotelstotaldevelopmentcostisover$30,000,000,therecouldbeafeasibilityproblem.Inmostcases wherethedevelopmentcostissignificantlyhigherthantheeconomicvalueitisbecausethelocalmarkets averageroomrateistoolowtosupportthecontemplatedimprovements.Inthesesituationstheproposed plansandspecificationsneedtobescaledbackinordertoproducealowertotalprojectcost,whichmight thencreateafeasibleproject. Oneadditionalpointofreferencelooksatthepercentagerelationshipbetweenthehotelslandcostandthe economicvalue.Inthisexample,thevalueofthelandisapproximately13%oftheoveralleconomicvalue ($3,832,500/30,000,000=13%).Thisrelationshipshouldbenomorethan15%to20%.Inotherpartsofthe worldwherelaborcostislow,thispercentagerelationshipcanbehigher. Usingthesehotelfeasibilityrulesofthumbcombinedwithaprofessionallypreparedstudywillinsurethe architectanddeveloperarenotcreatingaprojectthathasnoeconomicviability.Aswithanyruleofthumb, therearenumerousexceptionsthatneedtobefactoredintotheevaluation.Beforeabandoningaproject becausetherulesdontproducethedesiredresults,itisagoodtimetocallinaprofessionalconsultantto prepareamoreindepthanalysistoeitherverifyordisputetheconclusionsproducedbytherulesofthumb. StephenRushmoreispresidentandfounderofHVS,aglobalhospitalityconsultingorganizationwithoffices aroundtheworld.Stevehasprovidedconsultationservicesformorethan12,000hotelsthroughouttheworld duringhis35yearcareerandspecializesincomplexissuesinvolvinghotelfeasibility,valuationsand financing.Hecanbereachedatsrushmore@hvs.comor5162488828ext.204. FiledUnderCategoryHotelFranchises

StevehasaBSdegreefromtheCornellHotel SchoolandanMBAfromtheUniversityofBuffalo. HeholdsMAIandFRICSappraisaldesignations andisaCHA(certifiedhoteladministrator).Heisa memberofnumeroushotelindustrycommittees, includingIREFACandtheNYUHotelInvestment Conference.In1999,Stevewasrecognizedby theNewYorkchapteroftheCornellHotelSociety as"HotelieoftheYear.Inhisfreetime,heenjoys skiing,diving,andsailing.Heholdsacommercial pilot'slicensewithmultiengineinstrumentrating, collectshotelkeytags,andisoneoftheforemost authoritiesonregionaldining (www.roadfood.com).

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