Hospitality Design - May 2013 - 95

perspectives

business sense

hotel investment 101
By A.J. Singh (Ph.D., ISHC) Michigan State University

GETTING DOWN
TO BUSINESS
overview of the hotel development process
Hotel investment is a complex process with several players involved at
various stages in the lifecycle of a hotel, which includes conceptualization
of the project; assessment of its feasibility; assembling a development team;
financial commitment of debt and equity; design, layout, and construction;
management; and final disposition or sale of the hotel investment. This
article is the first in a series in collaboration with the International Society
of Hospitality Consultants (ISHC) that will demystify the hotel investment
process and players.

conceptualization
and planning

project feasibility

Who’s Who

According to the American Hotel & Lodging Association (AH&LA), the
hotel industry consists of approximately 50,000 hotels and five million
hotel rooms. Who owns and operates these hotels? While consumers
are familiar with household names such as Marriott, Hilton, Hyatt, and
Holiday Inn, these companies don’t necessarily own the land, or the
physical structure on which it is developed (jointly known as real estate).
The typical arrangement calls for an owner/investor or developer to
conceive a project in a particular market and contract with a franchise
company to “fly” its flag, and perhaps in some cases, contract with a
management company to manage the business. As a simple illustration,
let’s say the authors of this article hit the lottery and decide to develop a
boutique hotel. Since they may know nothing about operating a hotel they
could approach a company such as InterContinental Hotels Group (IHG)
and sign a franchise agreement for its boutique brand Hotel Indigo and
also sign a management contract with IHG to operate the hotel. While the
authors own the physical structure and the underlying land, they pay a fee
to the management company to operate their hotel and also franchise fees
to use the brand name (Hotel Indigo in this case) and become part of the
central reservation system to market the hotel.
While individual entrepreneurs and private hotel companies still
constitute a large percentage of owners and developers of hotels in the
U.S., the landscape of hotel ownership has changed in the past 20 years to
include institutional ownership. Since the mid-1990s, publically traded real
estate companies known as REITs (Real Estate Investment Trusts) have
made major investments in the ownership of hotel real estate. Currently,
in the U.S. there are 17 REITs with investments in the hotel industry and
include companies such as Host Hotels, Hospitality Properties Trust,
Pebblebrook Hotel Trust, Hersha Hospitality, and LaSalle Hotel Properties.
Other hotel owners include private institutional sources of ownership
such as private equity funds (Blackstone and Colony Capital), pension
funds, high net-worth individuals, and sovereign wealth funds (overseas
government funds making international hotel investments). A relatively
new source of hotel ownership is through the EB-5 program, which allows
hotel investors with a minimum investment of $500,000 to $1 million to

project commitment

design, layout, and
construction

management and
operation

receive a visa for a two-year residency, which can be converted into a green
card if the investment generates at least 10 jobs.

Show Me the Money

An understanding of hotel development costs is important, as hotels are a
high-risk investment. Based on a recent survey, Hotel Development Cost
Survey 2012/2013 from HVS, the average cost in the U.S. to develop an
economy hotel was $71,700 per room, midscale was $102,000 per room,
and a full service hotel cost $260,000 per room to develop. In general,
about 11-15 percent of these expenditures constitute land, 60-65 percent
are allocated to the building, about 10-11 percent are part of (FF&E) and
soft costs (including consulting and professional fees), and pre-opening
expenses range between 13 and 18 percent. hd
The next article will look at the various sources of debt and equity capital to
develop and acquire hotels, and will clarify lending and investment terms
associated with these sources of capital.

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