Hotel Financial Strategies Demystifies Investor Motivation

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. October 14, 2008

NOVEMBER 17, 2006. While no such thing as the "ideal" investment exists, its pursuit may not be so academic as it may sound. This first concept speaks of questions such as "What motivates different kinds of investors in the marketplace? What are particular investor's prime objectives and where can these goals be dovetailed into an available investment opportunity? What secondary objectives is an investor willing to give up to meet the primary objective?

OPPORTUNITY COSTS

Investments made one way require giving up other ways of using the same funds. No matter how small or unsophisticated any investor is, this thought is always present even though it may not be identified with the key words "opportunity costs."

TIME VALUE OF MONEY

The term "time value of money" is an intriguing expression which seems to have many different meanings. It is not easy to define it "head on," so perhaps all one can do is to talk around it.

Time is money. Anyone borrowing someone else's capital can expect to pay rent (interest) for its use. Equity investors foregoing other alternatives also hope and anticipate that targeted yields will in fact come on line as predicted over projected time dimension or horizon associated with it; that is, the value of any input of capital today is measured by the contribution it can make to something over time.

PRESENT VALUE ESTIMATES

To any investor buying the equity in a real estate position or anything else, present value estimates indicate how many dollars (both equity and debt) will be or should be paid out to acquire the investment. Based on investment objectives, present values can also point to a position available in the marketplace at a price the investor is willing to pay. Investors of all sorts buy the future - based on history. To repeat, the value of every kind of real estate or personal property held for investment purposes is the present worth of all future net benefits.

RETURN ON INVESTMENT (ROI)

Return on investment might be defined as the rate of interest (yield) at which the present worth of all the future net benefits equals the original amount of investment - or that rate of interest which equates the present worth of the outflows with the present worth of the inflows.

RISK TAKER BY DESIGN

It is logical to hope that the goal of an intelligent, rational investor is not to be a risk taker by nature, but a risk taker by design. The risk taker should ask:

1. What are my specific investment objectives?

2. How much can I afford to lose?

3. How well can I recognize, analyze, manage and measure risk?

4. Are all the remaining risks I cannot manage worth the return associated with the investment opportunity?

GENERAL CATEGORIES OF INVESTMENT RISK

Risk analysis is the orderly process of identifying all the uncertainties of any investment opportunity to get a total picture of the downside risks involved - particularly those of a major sort. There are said to be three general categories of risk attached to any kind-of investment:

1. Market Risk: The risk of loss caused by changes unrelated to the intrinsic characteristics of the investment. Real estate does not exist isolated within its own economic, political, and social vacuum. Some examples are:

---|a. National economic trends, such as unemployment and recessions of longer-term inflation;

---|b. A deteriorating regional economic base;

---|c. Economic obsolescence, perhaps due to a changing neighborhood environment; and

---|d. Flood, fire, and other natural or manmade disasters.

1. Business Risk: The risk of loss caused by the intrinsic characteristics of the investment. Some examples are:

---|e. A second mortgage or subordinated land fee;

---|f. Higher risk properties, such as a seasonal second-rate motel or special purpose golf course occupied by an average-credit tenant;

---|g. Functional in utility, lack of quality construction, or simply age in a general-purpose property; and

---|h. Those kinds of properties having high operating expense ratios and requiring very specialized kinds of management (that is, nursing homes, hotels).

1. Money or Capital Risk: The risk of losing net income cash flow, principal, or purchasing power. Some examples are:

---|i. Simply paying too much;

---|j. The availability, terms, and effective cost of financing of all sorts and its effect on present and future value. Many learned painfully that leverage is always important but not always favorable;

---|k. Recapture or return of capital invested if often referred to as payback expectations. In any uncertain real estate investment climate, how soon does the investor get a return - in terms of real dollars, that is? Do others have a prior claim on income or assets? If so, is the investor personally or corporately liable to any one of them?

---|l. The reinvestment risk. Investment portfolio total return is made up of three elements, not just current yield and investment appreciation. In order to achieve an effective actual total return on any portfolio over a specified holding period equal to the estimated yield to maturity at the time of investment, current income must be reinvested at that yield to maturity. Clearly, future levels and continuity of interest rates and investments yields over the entire investment period are major determinants of portfolio total return.

RISK TAKER BY DESIGN

Modern risk management techniques are not related to being either a generalist or a detail man, an optimist or a pessimist, a determinist or a fatalist. Nor do they have anything to do with 100 percent hindsight vision, wearing rose-colored glasses, or making "windshield" appraisals.

Again, the rational investor/risk taker:

1. Specifically delineates the investment objectives as to return and other goals.

2. Identifies all the possible risks, particularly the major ones.

3. Eliminates certain risks, transfers others, and puts "fences" around some remaining ones by a variety of means.

4. Decides whether or not the estimated returns and rewards are worth the risks still remaining.

5. Make a "go/no go" decision.

MEASURING RISK-STATE OF THE ART

Dr. Stephen Pyhrr of the University of Texas has done as much market-related research in the area of real estate investment risk measurement as anyone. Years ago, Dr. Pyhrr said real estate decision-makers claim they take "calculated risks," but few of them make very clear just how they calculate these risks. Traditionally, because of the difficulties, the dislike, or lack of knowledge of how to deal explicitly with risk in decisions, most people concentrated on a few key assumptions about the future, examined a few rules of thumb, mulled over the situation, and then decided. Although some of the risk considerations were explicit, most of the mathematics of risk was left to the four horsemen of the implicit decision making apparatus: judgment, hunch, instinct, and intuition.

Special Resort Financing Program:

Mezzanine for the development of condos, condo-hotels, vacation clubs, timeshare, fractional shares

$5 - $30 million

85% Loan-to-Cost

3 - 5 Years

Pay and accrual

Non-Recourse