Over the last few years, hospitality real estate has been through extremes in terms of performance cycles. From external threats relating to the Covid-19 pandemic and oil-price shocks to more intrinsic industry-specific issues such as a supply/demand imbalance, inflationary expenses, and pricing power.
These issues have motivated both owners and asset managers to more closely evaluate their hospitality portfolio and identify robust mitigating strategies. Apart from benefitting individual assets on an operational level, it also protects the overall health and value of their entire hospitality portfolio.
As such, investment plans will vary depending on the priority within the overall business portfolio, positioning within the asset lifecycle, owners’ motivation, and general market sentiment. Based on the above, here are some fundamental strategies that can help owners and asset managers safeguard their hospitality assets for the long term:
Asset diversification
As a hospitality portfolio grows, it is imperative that emphasis is given to a full range of products ranging from luxury to extended-stay and budget assets. While owners are right to be ‘focused’ in their ownership vision, macroeconomic shocks such as a pandemic can place an undue burden on one specific asset class over another.
In the case of the Covid-19 pandemic, the impact was acutely felt on upper-upscale business/conference hotels, while extended-stay and leisure hotels fared significantly better. In 2021, STR noted that Middle East and US hotel demand had essentially reverted to pre-pandemic levels while business and group demand was still lagging behind at 60-80 percent of pre-pandemic levels.
Venturing further afield to more mixed-use developments, which include residential or a co-working component, can provide further risk mitigation. Allowing the portfolio to be focused while also building flexibility with assets that can diversify risk will provide the much-needed protection against seismic impacts within the industry and the greater economic climate.
Liquidity management
Nothing quite matches the importance of having sufficient cash reserves – a position that is often easier said than achieved. There are numerous ‘benchmarks’ in the industry that recommend a three to six month working capital, but it is imperative that owners and asset managers look beyond this basic metric. While the individual hotel asset can manage with such benchmarks, an overall asset portfolio’s cash requirements can be far greater depending on the age and positioning within its lifecycle.
Ranging from a strategic change in payroll expenses or an upcoming 10-year Capital Expense (CAPEX) investment plan, to planned disposal of certain assets, each can have a varying impact on the liquidity levels of a business. Constantly keeping all these requirements top of mind will ensure that both working capital requirements and long-term cash are protected.
This available cash can be placed in Certificates of Deposit, which allow for regular interest payouts or in Fixed Deposits that can give a business the necessary comfort to weather almost all negative industry impacts. For example, today’s deposits can yield over 5 percent in interest. This equals or exceeds the current furniture, fixtures, and equipment (FF&E) reserve percentages, thereby enabling owner funds to generate free cash flow, which can compound if prudently placed in deposits.
Lastly, it is critical to have a robust relationship with lenders and suppliers. Even when times are good, it is prudent to always assess current lender terms or key payable and receivable terms with suppliers. These regular checks ensure a positive cash flow cycle and give owners necessary buffers, if and when financial conditions worsen.
Best in class and Unique Selling Proposition (USP) investments
As the hospitality industry is constantly evolving, impacted by external changes in technology and labour, ensuring assets and the overall portfolio are always ‘best in class’ is crucial to mitigate negative shocks to the business. For example, developing and upgrading hospitality assets that do not have best-in-class technology, accessibility, design or sustainable practices will eventually lead the asset to fall behind its competitive set of hotels and drive down financial performance.
Another aspect of this strategy is, when building a greenfield asset, to always build for quality and ensure each asset is built to ‘stand the test of time.’ This will help the asset to hold value for as long as possible, and long-term valuations will hold higher even during challenging times.
Ensuring maximum revenue within the asset
Oftentimes hospitality real estate thinking is only focused on typical key performance indicators such as occupancy, Average Daily Rate (ADR), Food & Beverage (F&B) covers, average food and beverage check and only looks at the uses within departments of rooms, F&B and banqueting. Asset managers and owners must focus on total revenue and profitability per square foot.
An owner’s total capital outlay is on the entire BUA and not just the rooms and restaurants. Every useable space within the asset should generate revenue and profitability is critical to ensure the asset fully realises its financial potential, to sustain itself across seasons.
Think about leasing unused spaces within the lobby for a giftshop, corridors for an ATM, or elevators for digital signage, which can capture unrealised revenue and further support profitability.
For example, Stirling Hospitality Advisors’ proprietary data shows that driving revenues in non-core components of a hotel can generate up to 1-2.5 percent of top-line revenue based on strong flow through profitability and can contribute almost 2-4 percent of Adjusted Net Operating Profit.
By keeping these strategies in mind, asset managers and owners can better safeguard their hospitality investments.