Mr.

Architecture & Design

Assessing Feasibility: Rules of Thumb and Factors That Influence Them

By , ,

Our passion for hospitality has allowed us to partner with visionary clients throughout the United States and internationally. We are fortunate to have been involved in many successful hotel and resort projects. As a result, we are often asked to provide our opinion regarding the feasibility of hotel projects - whether they are new construction, adaptive reuse, or remodelings. For new construction and adaptive reuse projects, we are asked to provide a “gut check” to see if it is even worth the developer’s effort to engage in a market study. There are a few rules of thumb that we use to quickly evaluate feasibility. While these don’t provide the depth of research that market studies provide regarding historical demand, rate, occupancy, supply, and competitive risks, they have been helpful to our clients in making early decisions that allow them to spend their money and our time more wisely.

There are three primary factors we evaluate initially in the development deal – hotel segmentation, development cost, and average daily rate (ADR).

Hotel segmentation will affect the gross area of a hotel and level of finish for the building. Obviously, an economy hotel will have a different level of finish than an upper-upscale hotel. And a rooms-only select service hotel will have smaller rooms and less public space than a luxury full-service hotel with its restaurants, ballrooms, spa, retail and so on. Therefore, the luxury hotel will have a much higher gross area per key.

Development cost comprises not only construction cost but also includes furniture, fixtures and equipment (FF&E), operating supplies and equipment (OS&E), design and engineering fees, legal expenses, development fees, land acquisition, financing costs and other components that together generally total 35% to 50% of construction cost. The total development cost is driven by the total gross area multiplied by the construction cost with the other soft costs added, less credits, subsidies and other financial assistance.

ADR is the average daily rate after a stabilization period and an assumption of achieving at least fair market occupancy penetration. ADR and occupancy are used to calculate revenue per available room (RevPAR).

There are rules of thumb for each for each of these factors and methods to positively influence each of them. One method of evaluation is the ADR rule of thumb. When applied to new hotels, the rule of thumb says that for every $1 dollar in projected ADR, you can spend $1,000 in development costs. That is a 1:1,000 ratio. Or the other way around - for every $1,000 of development cost, a hotel projects $1 in ADR. We apply the rule exclusive of land cost. So if a 200-key upper-upscale hotel costs $45,000,000, that equates to $225,000 per key. Apply the ADR rule of thumb and the projected stabilized ADR should be around $225. We understand that every market is different and that other factors such as owner’s return requirements, labor costs and hotel segmentation also affect the ratio. However, research over the last ten years has found the rule to be very consistent. We have found that this rule provides a great “gut check” for capital investments.

When applied to remodelings of operating hotels, the ADR rule of thumb ratio changes and generally allows obtaining an incremental increase of $1 in ADR for less than $1,000. This is because many fixed and variable costs such as land acquisition and staff salaries are already in place. We use different ratios depending on many factors, including maintaining existing hotel segmentation within the competitive set or repositioning up to a higher hotel segment. For this example, let’s assume a ratio of 1:750. That is, for every $1 dollar in projected ADR increase, you can invest $750 in development costs. Or vice versa, for every $750 invested, you should expect to increase the ADR by $1. A simple example is the 200-key hotel. A $1,500,000 reinvestment equates to $7,500 per key. That investment should expect to drive a $10 ADR increase.

In most hotels and resorts, not all guestrooms are created equal and that’s okay. Without a doubt, the guest experience must be terrific in any guestroom. We look for ways to create rate segmentation through guestroom differentiation. Examples of differentiation include view, size, height, and amenities. Let’s expand on view as one example. The view premium affects how we lay out new-build properties and how we prioritize remodeling decisions. We’ve been studying the rate premiums associated with views for several years. Our research has included properties representing a cross section of views, seasonality and regions. We also searched existing data and gathered anecdotal evidence, interviewing hotel general managers, sales executives and revenue strategists regarding occupancy as well as rate.

First, our statistical comparative rate data showed premium rates for views across the board, with an average ADR premium of $40 per guestroom through summer 2009, correlating to a 20% rate increase. Premiums ran about 30% for West Coast and Southeast properties, and 20% for East Coast, versus 14% for Midwest properties. Over the last year, premiums have remained intact on a percentage basis but reduced in absolute dollars. Although the view premiums are significant, they don’t always exceed the development cost of building view-only rooms that use single-loaded corridors. These layouts generally require 12% more gross floor area and almost double the exterior area per key than double-loaded corridors. Now combine these factors with a larger foundation and roof, plus less efficient mechanical and data layouts, and the development cost of single loaded guest wings can be 20-30% more than double loaded wings. So if a developer is planning new guestrooms or a hotel wants a single-loaded addition facing a view, then first evaluate the ADR premium to be sure it exceeds the development cost.

Some hoteliers have the challenge of double-loaded corridors where guestrooms on one side face a wonderful view and guestrooms on the back side have no special view at all. They ask us if they should spend more money improving the non-view guestrooms to bring them up to the same ADR as the “view” guestrooms. They suggest better finishes, larger bathrooms, bigger TV’s and so on. Our response has been to invest the capital expenditures where they get the highest return. If those upgrades are expected to lead to a higher ADR then undertake them on the view side that gets the rate premium to begin with.

As an example of ADR in relation to size and amenities, a hotel owner of an existing upscale hotel is fortunate to have guestrooms that are longer than those of the competitive set in its market. The owner has determined that if she can remodel the sleeping chamber, add a partial wall to provide the appearance of a separate living area, and add a fire place, then she can call the guestroom a junior suite and charge a $40 premium. Using a 1:750 ratio she can spend up to $30,000 ($40 x $750 = $30,000) on the guestroom remodeling. When designed and priced, the rooms will cost less than $30,000 per key to renovate and the owner will make the change.

Another example of ADR in relation to size involves a hotel developer who is building a new upper-upscale branded hotel. He has programmed 65% king-bedded rooms and 35% double-double guestrooms. The developer’s third party hotel manager recommends queen sized beds instead of double-sized beds. The brand standards require double-queen sleeping chambers to be two feet deeper than double-double rooms. Multiply those extra two feet by a thirteen-foot, six-inch guestroom width and the developer has to build and furnish an extra 27 square feet of building area per guestroom. If the site constraints allow the increased building depth and we assume an incremental development cost of say $130 per square foot, then the extra development cost is about $3,500 per key. Using a 1:750 ratio, the ADR increase for a double-queen guestroom over a double-double guestroom would be calculated as $3,500 / $750 = $4.67. In this particular example, the developer determines that the market’s rate sensitivity combined with other factors would not support the premium. He makes the decision to keep the double-double configuration. To differentiate the hotel from the competitive set the developer instead focuses on designing a unique arrival experience and market-leading conference facilities.

In summary, there are multiple rules of thumb that can be applied early to hotel development deals that will offer initial evaluations regarding feasibility. For each of the influencing factors there are methods to positively affect the metrics and contribute to a more successful project. Advisors with a unique understanding of the development deal draw from previous experiences to deliver business success for their clients and fabulous experiences for their guests.

I welcome your thoughts and comments.

Mr. can be contacted at Extended Bio...

HotelExecutive.com retains the copyright to the articles published in the Hotel Business Review. Articles cannot be republished without prior written consent by HotelExecutive.com.

Receive our daily newsletter with the latest breaking news and hotel management best practices.
Hotel Business Review on Facebook
RESOURCE CENTER - SEARCH ARCHIVES
General Search:

OCTOBER: New Developments and Best Practices on Maximizing Revenue Management

Angie  Dobney

You’ve heard the expression - "better late than never!"... Well it appears this expression may apply to a majority of the traditional hotel industry when it comes to embracing total revenue optimization. After years of dipping its toes in the water, the hospitality industry appears ready and willing to jump headfirst into a concept that, for more than a decade now, has helped many casino-hotels take their revenues to new heights – anywhere from 5- to 15-percent increases! Below are some of the key practices of casino-hotels that are applicable for traditional hotel to incorporate- READ MORE

Kevin Robinson

Packages are valuable marketing components that increase hotel awareness, create value for the guest, and often times drive room nights over need periods. The effectiveness of the package often is dependent upon the elements associated with the overall experience as well as the price point at which the package is offered. READ MORE

Michael  Brownsdon

Capital allowances are a widely misunderstood routine tax relief that taxpayers regularly fail to maximise. An in-depth analysis of capital expenditure on property assets, including their acquisition, can yield HMRC approved reductions in tax. Poorly defined terms for plant and machinery in legislation gives rise to the undervaluing and misallocation of qualifying assets within tax computations. Reviewing historical and current capital expenditure can result in significant tax savings in current years. READ MORE

Matthew  Goulden

The battle to tilt a traveler's decision in favor of a specific brand - be it for a supplier or an intermediary - continues to get intense. The focus is on identifying a "lead" as soon as it emerges in the digital domain, and that's where travel metasearch engines are showcasing their prowess. A travel supplier such as a hotel chain or airline needs to plan astutely for real-time hotel inventory availability/ pricing, and optimize campaign, budget and bid management. Since suppliers are dealing with an increasing number of traffic generation sites, associated costs have gone up. No category is feeling this more keenly than hotels. And importantly, a large component of this expenditure is going into competing with OTAs, either via brand.com or other channels such as metasearch. This is unproductive since travel suppliers are paying multiple times for the same conversions! How much to embrace the metasearch phenomenon is a topic of debate at hotel distribution conferences such as those held by HEDNA in January and June of this year. READ MORE

Coming Up In The November Online Hotel Business Review


Feature Focus
Hotel Sales & Marketing: The Heart of the Matter
Of all the areas of a hotel’s operation, perhaps none are as crucial, challenging and dynamic as the Sales and Marketing department. In their rapidly evolving world, change is the only constant, driven by technological innovations and the variable demands and expectations of a diverse traveling public. These professionals occupy a vast, multi-channel universe and it is incumbent on them to choose wisely when determining where and how marketing dollars are to be spent to generate revenue from all their multiple constituencies – individuals, corporate guests, groups and wholesalers. Complicated decisions are made and complex plans are devised, based on answers produced from intricate questions – What is the proper balance between Direct vs. Indirect Channel Sales? What kinds of resources are to be devoted to a comprehensive digital marketing program (website, email, social, blog, text and online advertising) on multiple channels (desktop, tablet and smart phone)? What are the elements driving local market conditions and how can local people be attracted and the local competition bested? How does an operation research, analyze and partner with group business generators, meeting planners, wholesalers, incentive travel companies, corporate travel departments, and franchise-sponsored marketing programs? How can effective sales incentive programs be implemented and how can a strategic marketing campaign be deployed? How are new sales leads prospected, qualified, sold and closed? The November Hotel Business Review will examine some of these critical issues and explore what some sales and marketing professionals are doing to address them.