Part 3: Increasing Asset Value Is The Name Of The Game
Now that we have covered Operating Revenue, Departmental Expenses, Undistributed Expenses, and GOP, let’s determine how we use the hotel financial statement to calculate asset value.
Expenses not controlled on property
Following GOP comes a group of expenses that are also associated with the hotel but are not controlled by operations on property. The first of these is the Management Fee, the fee charged by a hotel operator to manage the hotel on behalf of the hotel owner. This fee is negotiated between owner and operator prior to the assumption of management and team members on property have no control over the calculation of this fee. However, this is an important number for the owner to know the monthly cost of
management services and for the operator to know if the efforts of their team members on property are resulting in the hotel providing the anticipated management fee.
The next set of numbers are Non-Operating Income/Expenses. These are additional expenses (and sometimes income) required for hotel operations but are also not controlled by team members on property.
Among these are property taxes, the cost of property insurance, and the cost of a ground lease if that situation exists at your hotel.
Reducing GOP by the Management Fee and Total Non-Operating Income/Expenses results in EBITDA (Earnings Before Interest, Tax,
Depreciation, and Amortization). EBITDA is a crucial metric on the hotel financial statement because it helps to determine asset value. When calculating asset value for a hotel, EBITDA is always reduced by 4% of total revenue because lenders will assume that a traditional hotel capital expenditures (capex) reserve equal to 4% of total revenue is being held by the property. Many lenders require a capex reserve and it protects against future capital outlays for major asset maintenance needs and brand standards compliance such as a brand-mandated lobby renovation. It is important to note that as an asset, the capex reserve sits on the Balance Sheet and does not appear on the hotel P&L. Also, whether or not ownership actually maintains a 4% capex reserve, the assumption will always be made for valuation purposes.
As an example of this calculation, if on an annual basis a hotel has total revenue of $20 million and EBITDA of $5 million, there is an assumption of a capex reserve of $800,000 on
an annual basis (4% of $20 million). If cap rates in the local market for hotels are 6.5, then the hotel’s value would be $64.6 million, calculated as follows:
$5 million – $800,000 = $64.6 million
The items below EBITDA result in Net Income. Net Income approximates the hotel’s overall financial health and profitability in a given period. However, it is important to note that Net Income does not equal the amount of cash available at the end of any given period as cash availability is impacted by non-P&L items. These include any outstanding principal balance on a hotel loan and the amount of money pulled out each month to fund a hotel’s capex reserve.
Thank you for joining us on this brief overview into understanding how to read and utilize hotel financial statements. Sea Glass Hospitality Partners welcomes the opportunity to provide our expertise to analyze your hotel’s financials and determine where operational efficiencies can be realized. Through this process you will maximize asset value and ensure that your hotel reaches its true potential. We look forward to partnering with you!