In the Checking Into Your Hotel post, I discussed the importance of the condition of the hotel in the annual review process. A hotel with deferred maintenance items or improvements the franchise is forcing to complete may cause a problem in cash flow, both in the expenses for the improvements and a possible drop in top line revenues.
This post will look into the finances and look at several questions the astute commercial officer should ask. So is there anything else that must be done once you have reviewed the financials and tested the debt service coverage? Once that is complete and the ratio passes the minimum threshold are you finished with your analysis?
Not yet. A good analysis of a history of income and expenses from year to year is helpful. This may show any large, one-time expenses in a year or also any deteriorating or improving trends. A discussion with the owner will reveal if these trends are likely to occur in the future or if they will not. This analysis may be an early indication of a problem loan in the future, even if all seems to be fine today.
Questions on the composition of the gross revenues should be asked. Are there any large contracts for rooms? Here we are not talking about a group that takes a block of rooms for a weekend. We are talking about a large number of rooms being taken for an extended period of time. If so are these likely to continue and how are they priced compared to other room rates. A few years ago, the Southeast Missouri State found it ran out of dorm rooms for students with the increased enrollment. They elected to have new apartments built by a third party and then enter into a master lease with the developer for the buildings, which they in turn, rented to students.
The apartment towers were several years away from completion and they needed spaces for students now. The school officials contracted with several hotels to rent entire floors of hotels for student housing. These contracts proved to be a blessing and a curse to the hotel owners. It was a blessing with a large slice of revenues becoming more certain. The school rents ran through the slower period of the winter months and still left the hotel open to travelers in the high occupancy summer months.
But it also was a curse. The block rents were below what the hotel could rent rooms for on a nightly basis. The younger student room renters tended to be harder on the property than the average traveler. This drove up repair expenses. A challenge to the loan officer is to help understand when the large block revenue will end and what will happen to the hotel’s income statement. In this case, the owner expected to have a drop in revenue by 10% without the university’s contract income. They expected their room rates would increase overall. Management also expected to see a substantial drop in repair expenses.
Some hotels are completely dominated by contracts from one source. I once looked at a hotel in Kansas that had a contract to rent 80% of its rooms to the railroad. The hotel was the only one in that small town, so it enjoyed this constant stream of revenue for years. The only risk would be if the railroad decided they did not need the rooms or if more competing hotels were built in the area.
I always ask for the year ending Smith’s Travel Research (STR) Report. This is offered free to the hotel owner in exchange of them submitting numbers for occupancy, rooms available to rent, and average room rates. STR allows the hotel owner to select other hotels they view as competition in their market area and provides information of the performance of their hotel compared to the peer group.
The STR is helpful in tracking trends in occupancy, average daily hotel room rates and also daily revenue per available room (RevPAR). Caution should be used when looking at the peer comparisons. Since the hotel owner can select his own peer group, that selection may or may not accurately represent the competition.
Questioning the components of the income statement further and an analysis of the STR report can be valuable tools for your annual check into your hotel loan. These strategies may help you understand problems that will occur years before they begin.—Phil Love