Buying smart in a tough economy

Even in today’s challenging economic climate, there are market segments that are still active for hospitality real estate transactions, and certain properties are continuing to be sold as they would in any market, good or bad.However, understanding and accurately assessing hotel market values in the current hospitality real estate market is a difficult task, even for the most experienced professionals. Many appraisers, lenders, owners and buyers are calling upon experienced brokers in this regard. By following the right steps, buyers can make educated decisions that result in profitable transactions, even in the toughest economic climate.Step 1: Be aware of the current market and act accordingly. Based on recent transactions and market trends, more buyers are showing concern for clearly stated exit strategies and looking for markets with high barriers to entry. Educated buyers are also factoring new development and ongoing capital improvement programs into the proposed value of a property.Step 2: Identify areas of opportunity and capitalize on them. A very important factor in the current New England market is the aging of area hotels.When purchasing an older property that may be nearing the end of its economic life, it is important to consider potential redevelopment opportunities as an exit strategy.Many older properties occupy locations where the value of the site is greater than the value of the hotel based on the revenue the hotel generates. Redeveloping the property may be a terrific exit strategy. Where an old, functionally obsolete hotel resides, new retail shops, restaurant pad sites or large box stores could create much higher value.Step 3: Know the key factors that affect sale price and transaction structure. When considering the purchase of a hospitality real estate property in any market, knowledgeable buyers must consider the cost of the product improvement plan (PIP) for the property and how that plan affects the hotel value. Educated buyers should not assume that just because they plan a property refresh that revenues will increase — in fact, it is more likely that the refresh will be necessary just to maintain the same revenues.Allocation of sales price is often a very important part of structuring a transaction. Proper price allocation can create favorable tax treatment for both sides of the transaction.Also, do not be fooled by quoted sale prices that are based on state tax stamps, as state tax stamps are paid only on the allocation of land and building when the deed is recorded. Many appraisers, buyers and lenders are often misled when the value of a property is assumed to be equal to the state tax stamps paid on that property, when in fact the actual sale price may be much higher due to the allocations of personal property and goodwill.Step 4: Make smart choices for the future based on knowledge of the past. Hospitality real estate industry consolidation since the early ’90s has allowed for fewer foreclosures in this downturn, since more owners have concentrated on maintaining capital reserves, better management and expense control. Today, hotel owners should focus on keeping operating costs as low as possible while still exceeding customer expectations.Finding bottomMany participants in the hospitality real estate market believe that the market hit bottom between May and July of this year, based on revenue and a slowing in the decline of values. In the Northeast, this time may have been affected as much by rainy weather as it was by the recession. Regardless of the cause, hotel revenues have been down, along with cash flow and net operating income. So the big question for hotel owners, buyers and sellers is: “Will prices continue to drop?”It is reasonable to predict that revenues in 2010 will be, at the very least, the same as 2009, and that the worst of the revenue decline is over. Therefore, it is safe to assume that cap rates will be geared toward the cost of funds and the required yield on equity.A buyer who expects a 20 percent return on equity — a return that has historically been more in line with hotel operators based on risk — and who will be looking at a 6 percent interest rate, will require a cap rate of 11.4 percent, which is much higher than cap rates of the past few years.Earle Wason, CCIM, is president and owner of Wason Associates Hospitality Real Estate Brokerage Group, Portsmouth, and author of “Buying Smart in a Tough Economy.” He can be reached at 603-539-5545 or earle@earlewason.com.