Hotel Feasibility Study Methodology

A hotel feasibility study is generally required by the mortgage lender or investor before a developer or organization is able to move forward with constructing a new hotel. Typically completed by an independent third-party consultant who specializes in analyzing hotel projects, a feasibility study determines whether a proposed hotel development is economically feasible and if the value of the proposed project equals or exceeds the development costs when completed and operational. The hotel feasibility study will analyze revenues, expenses, and net income to determine the value of the proposed project compared to its projected development costs.

This overview highlights the major components of a hotel feasibility study that should be analyzed as part of determining the potential success of a hotel.

Major Components of a Hotel Feasibility Study

The following major components should be included in a market feasibility and financial analysis study for a hotel project:

  1. Area, Demographic, and Neighborhood Analysis
  2. Site Review
  3. Proposed Development Recommendations and Costs
  4. Market Analysis
  5. Proposed Development Occupancy and Average Daily Rate (ADR)
  6. Financial Analysis
  7. Feasibility Analysis
  8. Comparison of Value Created to Projected Costs
  1. AREA, DEMOGRAPHIC, AND NEIGHBORHOOD ANALYSIS

The area, demographic, and neighborhood analysis evaluates the local economy surrounding the proposed hotel. The area analysis focuses on the social, economic, governmental, and environmental forces that influence the performance and valuation of a hotel property. Demographic information, including population, households, income levels, employment levels, etc., should be reviewed in detail to calculate the number of people and potential customers who live within the local and regional areas. The following are some questions the study should answer:

  • Population trends: What is the area population and is the number increasing or decreasing?
  • Household growth:  How large is the typical household?
  • Household economics: What is the unemployment rate?  What is the median income? How much disposable income do area households have?
  • Area economics: Which large corporations are based in the area? Who is growing or shrinking? What is office vacancy rate?
  • Attractions: Are there tourist attractions in the area?  What are the demand generators for leisure and group travelers?
  • Area transportation: How is access to airports, interstate and local highways, and rail stations compared to competition?

A neighborhood analysis of nearby commercial and tourist establishments is important since many successful hotel projects are proposed in areas with complementary real estate uses. Successful hotels are developed in neighborhoods where overnight guests are already traveling and looking for places to stay.

  1. SITE REVIEW

The site review evaluates the subject parcel’s size, access and visibility, topography, availability of utilities, and other site-related attributes necessary for a successful hotel project. The hotel’s proximity to demand generators is an important consideration since hotel guests appreciate convenient access from area highways, employers, and their destinations. The following are some questions the study should answer:

  • Site: Is the site large enough to support the planned hotel?  Is there room for future expansions?
  • Amenities: Are there nearby amenities that would complement the proposed project?
  • Governmental impacts: How do the subject’s ad valorem taxes, zoning, sales history, governmental restrictions, environmental regulations and other factors affect the subject property?
  1. PROPOSED DEVELOPMENT RECOMMENDATIONS AND COSTS

The consultant will review plans for the facility, the scope of the development and projected costs to make recommendations for the proposed hotel. The scope of recommendations includes the number of guestrooms, number of restaurants and lounges, amount of meeting space, recreational and aquatic features, retail shops, spa and other amenities to include.

The consultant may estimate a range of costs for the proposed development based upon recently-constructed projects, or the client may hire an architect and/or engineer for formal cost estimate for the proposed hotel. The following are some questions the study should answer:

  • Physical plant information: Have any architectural plans been developed?
  • Facility size: How many rooms should the hotel offer? How many food and beverage outlets should be developed within the hotel?
  • Branding: Should the hotel have a franchise affiliation or be an independent property?
  1. MARKET ANALYSIS

A thorough market analysis of the local and regional hotel market is essential as the projections of financial performance will depend heavily upon the data gathered. The consultant will analyze occupancy, average daily rate (ADR), and revenue per available room (RevPAR) of a market area. A hotel market report from STR and interviews with management of competitive hotels will help the consultant gain a greater understanding of the state of the hotel market. Additionally, the consultant will identify all new hotels that are proposed, under construction, and in development that could compete with the proposed resort project. The following factors are critical to the market analysis:

  • Hotel competitors:  How many competitors are in the market and to what degree are they competitive in terms of amenity offerings, affordability, etc.?  How have they performed in past years in terms of occupancy, ADR and RevPAR?
  • Employer analysis: Who are the major employers that utilize hotels in the market? What are their training needs? Are there many meetings in the market?
  • Recent hotel openings:  How many hotels have opened in recent years and how have they impacted the market?
  • Potential hotel openings:  How many hotel projects are in the works?  What types of hotels will they be?  How many rooms will they have?  What is their projected impact on the current supply and demand in the market?
  • Market segmentation and market penetration: What is the market segmentation and penetration of each competitor in the market?  The consultant will review all market segments, including corporate, leisure, group, and contract markets. Hotels in the area that garner the largest share of the most relevant market segments will be the subject property’s main competitors.
  • Projections:  Based on the current market situation, how will the subject likely perform in terms of occupancy, ADR, and revenue per available room (RevPAR)?  What are its potential penetration rates and market segmentation?
  1. PROPOSED DEVELOPMENT OCCUPANCY AND ADR

In estimating the performance of a hotel, the study will project the number of occupied rooms, ADR, and revenue per available room for the proposed hotel property. A detailed supply and demand model that calculates the historical performance of the market and makes projections for the subject property should be presented. The following are some questions to consider:

  • Occupancy and ADR: What are the historical and projected performance of  competitive hotels in the market? How will the subject property penetrate the existing demand in the commercial, group, leisure, and contract segments? What is the projected ADR by segment?
  • Demand:  What is the projected performance of the subject property?  How plentiful are demand generators in the area?  Will the projected demand for the hotel be spread among numerous organizations and attractions or will it be concentrated on a few demand generators?

FINANCIAL ANALYSIS

The financial analysis estimates a property’s capacity to generate income and makes financial projections for the property. Estimating annual operating results for the subject property involves an analysis of the subject’s scope and characteristics compared with comparable properties and industry standards. The general steps include the following:

  • Estimate the potential gross revenues for the subject property based upon an examination of the prior operating history of the subject property (if available), operating history of comparable properties in the subject market area and on a national basis, and an analysis of industry trends.
  • Analyze departmental, undistributed, and fixed expenses, and project appropriate amounts in each category.
  • Project the resultant net operating income (cash flow before debt service) over an appropriate holding period.

HOTEL FEASIBILITY ANALYSIS

The economic value of a hotel is calculated through a discounted cash flow analysis or a direct capitalization analysis. The discounted cash flow analysis utilizes the property’s projected net income before debt service for a period of 11 years and applies a discount rate and terminal capitalization rate to determine the valuation. The discount rate is the average annual rate of return necessary to attract capital based upon the overall investment characteristics. The terminal capitalization rate is applied to a future year’s net income to calculate a potential sale price for the property in the future.

COMPARISON OF VALUE CREATED TO PROJECTED COSTS

The key component of a feasibility study is to determine if the projected value created as shown from the discounted cash flow analysis equals or exceeds the development cost for the proposed project. A feasibility study should present the projected value created after a detailed analysis of the factors that determine success of the proposed properties. In some cases, detailed costs will not be available, and this conclusion will be determined after the client has cost estimates performed by building contractors and architects. In other cases, the client has estimates of construction costs, and the feasibility study will present these estimates and compare the value created to the development costs to determine if the project is feasible. The most viable projects, which have the greatest investor appeal, are those in which the value created is greater than the development costs for the proposal. Even if the value created is less than the development costs, the project may still be feasible if the project can attract municipal incentives such as a tax abatement or capital assistance to the developer in terms of infrastructure. This would allow for either improved financial projections or for lower development costs.

Conclusion: The hotel feasibility study requires analysis and expertise beyond other types of commercial real estate. A hotel or resort feasibility study requires a thorough market analysis involving a study of the economic and demographic factors as well as a review of the hotel market. The study also requires a complete financial analysis, which looks at various revenue and expense categories. The purpose of the feasibility study is to provide honest and reliable information to the client to help them decide whether to develop their proposed hotel project.

Author: David J. Sangree, MAI, CPA, ISHC is President and Founder of Hotel & Leisure Advisors, a national hospitality consulting firm. David is a graduate of the Cornell University School of Hotel Administration and an MAI designated appraiser with the Appraisal Institute. In addition, he is a member of the International Society of Hospitality Consultants and is a Certified Public Accountant. As an expert in the hospitality and leisure field, David analyzes hotels, resorts, waterparks, amusement parks, conference centers, ski resorts, casinos, and golf courses. He has prepared more than 2,000 market and financial feasibility studies, appraisals, operational reviews, and site selection studies in over 50 states and provinces in the United States and Canada. He has been an active hospitality consultant since 1987 and has 10 years of work experience in the hotel/restaurant industry, including management positions with four Westin Hotels properties. Since 1987, David has provided consulting services to banks, hotel companies, developers, management companies, and other parties involved in the lodging sector throughout the United States, Canada, and the Caribbean. He would like to thank Heidi Banak for her assistance with this article.

 

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