Ms. Watson

Development & Construction

Is it Better to Renovate/Convert an Existing Asset or Build a New One?

By Julia Watson, Project Director / Sr. VP of Business Development, FARROW Commercial, Inc.

One could almost say that age discrimination exists when it comes to evaluating whether or not to acquire existing hotels for the purpose of repositioning the product or operate them as they are. It seems like there is a bias in the industry to "build new," but seemingly everyone has the same "no construction financing" problem.

The partiality to new construction seems strange in a climate where there is a surplus of supply and it makes little sense to build more. However, with the downturn of the economy and construction financing becoming almost entirely obsolete, we realized an unprecedented cease of new development all together. Supply may keep up with demand for now, but soon enough won't be sufficient to compensate for the complete desolation of ground-up construction over the past several years.

Separately, when market share potential is limited due to decreased demand, it is often better to have the newest and best product available among competitors. For these reasons it does make a great deal of sense to pursue ground-up deals.

Yet, for those who are able to piece together the obvious necessary components of a real estate/construction deal, in this climate it's still difficult to tell what type of transaction to pursue. The payoff when a development deal goes well can be huge, but so is the risk. It's no secret that billions were lost when the economy crashed, and it's not at all curious why most proceed now with extreme caution before ponying up their dollars for new-builds.

Also, with the current surplus of distressed assets, isn't it better to take advantage of the low real estate costs and operate a refreshed product? I have heard it said more than once in jest, "the second person to own a hotel wins."

Clearly a case can be built in favor of and more easily, against both acquisitions and new development. So how do you know when it's a good time to build and when it's better to acquire an existing facility and renovate? All other conditions permitting (i.e. construction financing is secured, property is available, etc.) there are many variables that should factor into making a major real estate decision such as this, but understanding what those elements are can be cumbersome.

Fear not; there is help for those who persevere. Following a series of straightforward steps will serve you well to make an educated decision.

When considering construction of any sort, organizations commonly begin the flow-chart process by conducting a feasibility study. Dependent upon the proposed product type, these studies can cost several thousands of dollars to reveal whether the product is viable. Proceed to the feasibility study stage only after first conducting comprehensive internal due diligence.

Collect information from the various entities involved in the transaction. If there are multiple stake holders, gather input from them inclusive of their assumptions individually as well as the expectations of the collective. This will aid in clearly defining the objectives of the team, each party's role, and will allow you to be creative in problem-solving as you make the decision to renovate or build.

Equipped with a fundamental foundation of where the interests of all parties involved lay, the next step is to define goals. Objectives should include all ideas that pertain to the long term as well as the short term and should be quantified.

For example:

  • Are you looking to own and operate the product after completion of construction? If so, what type of ADR are you hoping to achieve?

  • Are you going to try and sell shortly after construction is completed?

  • What type of margin are you looking to achieve?

  • What are your attainable goals for assembling the capital stack?

  • Which, if any brands are you going to pursue?

Setting goals will serve as a road map for navigating the process from beginning to end and will help to create bench marks for progress toward making a decision. This information can also be used for process of elimination and define what projects are not real candidates.

For instance, if you are seeking a select service product, you probably wouldn't be looking at areas for development that could only service an economy level clientele. Conversely, if you want a full-service hotel, you likely wouldn't search for conversion opportunities of select service assets, as they typically don't meet the architectural criteria. Eliminating projects that don't fit within the parameters of the product will reduce confusion and help to streamline the decision process.

Next, assemble a team of experts. All parties involved (real estate, banks, legal, brand development, design, architecture/engineering, and construction) should have extensive background in their respective field as it pertains to hotels. Each entity brings another layer of expertise that can aid in directing your decision to build or renovate, as these are the players who have their fingers on the pulse of the industry. You can leverage these resources to provide insight as to whether a project is viable before wasting precious time and money on something with no real potential.

As an example, a hospitality-specific architect, designer, or general contractor can quickly look at an existing structure to advise how the product can be repositioned, guide you on the structural integrity of the building, and provide budget figures for making upgrades. Alternatively, for a new-build opportunity, that same team may have experience in the entitlements process within certain cities and can advise on what may be involved, how much time and money may be required, and any challenges they anticipate.

Franchise development officers can also be a great resource as they have extensive data on what markets perform best, the current and former health of properties in the area, what other projects are planned which could affect market share, etc.. You will also be able to gauge their level of interest in a project; to some extent demonstrating its true intrinsic value. The more information that can be obtained in the process the more easily an informed decision can be reached.

Once a project has to some extent been qualified, it's time to initiate the feasibility study. A feasibility study is critical to making an objective decision about whether to proceed. Do not cut corners with this process. It's essential to explore on a deeper level the nuances of a proposed project. If conducted on an existing structure, any red flags that pertain to the integrity should be noted. If executed for a new-build site, this process may reveal costly environmental or other issues that the project may ensue.

Finally, what it all comes down to is time and money. A renovation project doesn't make sense (unless in an area where no land is available) if it will cost more than building new. Additionally, due to current code standards and ADA (Americans with Disabilities Act) compliance requirements, a renovation project may demand as much planning and approval time as a new-build. Alternatively, a ground-up project doesn't make sense if a hotel can be repurposed and render the same income potential in a shorter amount of time.

Whether developing a new or renovating an existing hotel, the process is arduous and is not for the faint of heart. Though it's highly demanding, risk can be reduced significantly by clearly defining goals for growth and gathering critical pieces of information prior to making a decision. By getting equipped with knowledge and utilizing the expertise of a carefully selected team, the ease with which making a successful decision will be optimized.

As Project Director and Senior VP of Business Development, Julia Watson combines her knowledge of construction and her experience in business and relationship development, project management and coordination, estimating, and company-wide systems implementation to hospitality experts, FARROW Commercial, Inc. FARROW is a nationwide commercial construction company specializing in quality based, price sensitive, and production driven services to satisfy the demands of discerning core clients ranging from Resorts/Timeshares/Hotels/Motels to major and/or minor Commercial Tenant Improvements. Ms. Watson can be contacted at 916-474-5375 or julia@farrowcommercial.com Extended Bio...

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