Maintaining asset value as we continue navigating the new normal of the COVID-19 era has proven challenging. For the past decade owners have been able to rely on trailing 12-month performance as described in a previous post. The challenge is that as we are a few months into the dramatic drop off in operations, trailing 12-month performance is not a reliable indicator of typical operations. If we try to use future 12-month performance, there is a lack of credibility to this data as we do not know how long this downturn will continue. Some analysts are using trailing 12-month performance through December 2019 and applying current cap rates and others are using replacement costs. Until we return to more of a normal operating environment, determining asset value will continue to be a challenge. But determining how to calculate asset value is only part of the challenge, what about maintaining or dare we think about increasing asset value? Efficient operations are the key to asset value, and it may be time to revisit how that can be accomplished.
One of the classic examples is the owner-operator model whereby the hotel owner also operates the property. Be it a franchised or an independent hotel, owners maintain direct control of operations. Some owners are savvy and sophisticated whereas some are not as effective as they strive to be. This is where the third-party operator model comes into play. Owners turn over operations to a skilled and knowledgeable management company that has the wherewithal and greater resources to provide for more effective operations. While the owner no longer has day-to-day control, the owner continues to be involved for major decisions and benefits from the cash flow generated after all expenses, including the management fee, are paid.
The challenge in the current environment is that owner-operators are struggling to navigate the litany of rules, regulations, and guidelines coming from all levels of government. And for branded properties, this is on top of stringent new cleanliness and ancillary standards. And this is on top of meeting all obligations including property taxes and debt service. For third-party operated hotels, although the management companies tend to have better resources to navigate these changes, their fees are tied to the performance of the hotels and as this drastically reduced in the past few months, so has their source of income. As a result, some operators have made significant cuts – some temporary, others not – to their operations because the fees cannot support the entire management operation. The challenge of course is that this can result in diminished performance and thereby, diminished asset value.
Another option to consider is leasing your hotel. This model is popular in Europe while it has typically been on the sidelines of hotel operating models in the US. Leasing your hotel results in the owner turning over complete control of the asset – operations and all – and being paid a percentage fee with no other responsibilities unless they are specifically spelled out in the lease agreement. While owners may be hesitant to turn over control, leasing your hotel may be a way for you to relieve a lot of stress and guarantee some cash flow. The operator is incentivized to maintain the property and increase performance because the operator now benefits from the overall cash flow of the property and not just from the management fee. And as we know, enhanced operational performance results in increased asset value.
These continue to be challenging times as many owners are struggling to maintain hold of their assets. No one wants to turn over their property to the bank. Unless you are considering a sale, revisiting how your hotel is operating can be the difference to retaining your asset and increasing its value over the long run. And considering third-party operations, changing your operator, or leasing your hotel may be the key to coming through this crisis as unscathed as possible.