One of the most popular real estate investing strategies is value-add investing. With value-add investing, owners make strategic property improvements that help to force appreciation. This strategy is frequently used by hotel owners and operators. In today’s article, we examine some of the best ways to add value to hotel properties.
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What are the different ways of adding value to a hotel?
While there are endless ways to add value to hotel properties, the most impactful strategies will typically fall into one of five categories: (1) Rebranding or “up-flagging” the hotel; (2) deploying a Property Improvement Plan; (3) increasing the key count, (4) adding or improving amenities, and (5) operational improvements.
1. Rebranding or “Up-Flagging”
The biggest value-add for a hotel is generally a rebranding of the hotel flag. This can be either adding a flag (e.g., an independent hotel becoming a franchise) or upgrading the flag from one brand to a higher brand.
For example, we recently looked at a Best Western hotel around Atlanta. It was about 15 years old. We know that Best Western is a good brand, but we also know that this specific market could support a higher brand, like a Fairfield Inn and Suites.
Rebranding doesn’t happen overnight. We cannot just renegotiate the franchise agreement. Instead, we had to look at Marriott’s Property Improvement Plan (PIP) to see what their brand standards are for a Fairfield hotel. In this case, we had to expand and upgrade the fitness area, combine a few rooms to make larger suites, and upgrade some of the room amenities (for instance, replacing 48” TVs with 55” TVs and upgrading the Wifi to Category 5 or 6).
On a 100-key hotel, these improvements could cost upwards of $2 million. That requires a significant up-front capital investment. However, we looked at market studies to see how other Marriott properties were doing in that market. We felt like we could almost double revenue (going from approx. $1.5 million to $2.5+ million). With numbers like these, the hotel can recover the costs in just three or four years and then would be significantly more profitable thereafter.
Rebranding or up-flagging is especially common among select-service hotel operators. Trying to rebrand a luxury property is more challenging. Many luxury properties are unique and were built to certain specifications; upgrading these properties even further may not be financially feasible. For example, you will rarely see someone upgrade a J.W. Marriott to a Ritz-Carlton Marriott. Trying to upgrade luxury properties often requires a total rebuild, which is rarely financially feasible.
2. Key Money
One thing that can make up-branding even more attractive is when the parent company offers the operator what is called “key money”. Key money is where the hotel, usually at closing, provides a lump sum of money to the franchisee for opening under its brand.
We often see independent hotels secure key money when shopping around among different franchisors. For instance, an owner might approach both Marriott and Hilton, neither of which currently have a hotel in that marketplace. These brands might not be inclined to develop a new hotel but would be willing to enter the market by flagging an existing independently operated hotel.
Let us say the owner approaches Marriott first. Marriott may offer a 20-year franchise agreement in which they collect 8% in franchise fees on a hotel expected to do $5 million in annual revenue. In this scenario, Marriott stands to make $400,000 a year for the next 20 years. To entice the owner to flag as a Marriott brand, Marriott may offer $500,000 in “key money” to sweeten the deal. From Marriott’s perspective, this is a modest investment that will quickly be repaid per the terms of the franchise agreement.
Now, that same owner might then approach Hilton. The owner could explain that they have a key money offer to open as a Courtyard Marriott and ask whether Hilton would be interested in them opening as a Hilton Garden Inn instead. Hilton may offer a lower franchise fee and $750,000 in key money to ensure they get the flag over Marriott.
3. Property Improvement Plan
Hotel brands have what are known as “Property Improvement Plans,” or PIPs, that their franchisees must adhere to. Most PIPs require upgrades and renovations to occur every 7 or 14 years. As noted above, PIPs can be utilized when trying to up-brand. But they are also a great way to add value even for hotels that are not looking to reclassify.
A PIP will usually outline exactly what improvements are needed and on what timeframe. This is to account for the regular wear and tear that occurs in rooms. For example, over time, beds will become sunken, carpets will become stained, and there will be patch jobs on the walls. A PIP requires the franchise operator to make specified improvements.
Essentially, a PIP is like a renovation plan for the hotel that keeps it feeling fresh and up to guest standards.
One benefit of implementing a PIP is that the hotel can then advertise as being “newly renovated”. This will often increase hotel revenue by 15-20% on average.
4. Increasing the Key Count
Another value-add strategy is to add keys to a hotel. This is often referred to as “development” and can be quite costly. Let’s say an owner has an 80-key hotel that is sitting on a three acre property. They have the space to add another wing or standalone building that would increase the key count by 20 or 25 rooms. That can increase the value of the property significantly.
Of course, before adding rooms, an owner will want to carefully analyze the local market data to ensure sufficient market absorption.
5. Adding Amenities
In the select service market, hotel amenities tend to be rather sparse. However, one way to add value is to strategically invest in specific hotel amenities.
For example, we purchased a unique property in eastern Texas. It is located close to a federal courthouse and in turn, draws lawyers from all over the country. When we purchased the property, it only had a small 400 square foot board room.
Traveling lawyers, who were often preparing for big trials, would ask us about additional meeting space. A nearby hotel had more meeting space and as a result, we were losing guests to that hotel. Recognizing this, we made the decision to convert two of our hotel rooms into a larger meeting space room. This proved to be a great value-add investment.
Hotel operators can consider repurposing underutilized space with other amenities, too. We have seen people carve out space near their breakfast area where guests can host small parties or baby showers. This makes the hotel more attractive, but it also offers another revenue generating opportunity as people rent the spaces.
6. Operational Improvements
Many of the value-add strategies listed above are applicable to all real estate types. However, one strategy that stands out among hotel properties is the ability to make low-cost operational improvements.
Here are a few examples of some of the operational improvements we have made.
We purchased a hotel in South Dallas that was about three years old. It had been built by a developer who then owner-operated the hotel, despite his lack of hospitality experience. The owner had about three or four properties in his hotel portfolio, all of which he was looking to sell. The hotel in South Dallas was profitable, earning about $2.3 million in revenue per year. During our due diligence on the property, we realized that the hotel was being run at 90-100% occupancy despite being the only Marriott hotel in that market.
We noticed that the hotel was charging about the same rate as the Best Western and La Quinta in the area. Our thesis was that if we purchased the hotel, we could work with our revenue manager to increase the average daily rate (ADR) from $100 to closer to $180 or $200 per night and still maintain occupancy.
Our thesis proved to be correct. Upon purchasing the property, we increased rates by 50% and held occupancy steady around 87%.
Increasing the rate, even with the marginal impact to occupancy, also proved to be more operationally efficient.
When we purchased the 78-key hotel, it was operating with 25 full-time employees – or roughly one full time employee for every three rooms, a very high ratio by industry standards. Many of these people were employed by a third-party company.
Upon taking over ownership, we right-sized the staff and brought the staff in-house. We no longer had to pay fees to the third-party operator and were able to put that money back in the pockets of our housekeeping staff. This required us to do some hiring and training, but the cost savings were significant.
Finally, hotel brands can achieve operational savings by scaling their regional portfolios.
For example, we purchased an independent hotel that was paying its sales director about $60,000 per year. Our acquisition made it a part of a regional portfolio of about 1,200+ keys. We utilized our existing Sales Director, who we paid $10,000 more for his added work. This was a net cost savings of $50,000. Our Sales Director, who is more experienced than the person he replaced, helped increase annual revenue by $400,000 alone. That’s a 40-to-1 return on our investment – something virtually unheard of with other asset classes.
There are countless other cost-savings associated with scale, such as purchasing hotel linens and bathroom products in bulk to renegotiating contracts with third-party vendors where you ultimately pay less on a per-key basis than you would if you only owned and operated a single hotel.
Operational improvements like these can boost revenue by upwards of 50% and require very little up-front investment, especially when the changes are made using in-place software and staff.
Can “Downgrading” a Flag Add Value to a Hotel?
As noted above, one of the best ways to add value to a hotel is by adding or upgrading its flag. However, there are some situations where downgrading a flag can also prove to be profitable.
The most common reason to downgrade a flag is when the franchisor is planning to pull the flag from the hotel. Pulling a flag is typically a result of the hotel’s performance, but it can also occur when new competition comes online in that market. Hilton, for example, might pull the flag from a Hampton Inn if a new hotel is being built down the street that would be better suited for its brand. Instead of losing the flag, the operator of the Hampton Inn might agree to downgrade its flag to remain within the brand portfolio.
One benefit to downgrading a flag is that it generally results in lower franchise fees. The hotel operator might also be able to negotiate key money in exchange for taking on a slightly lower brand. The combination of these two things can be a significant value-add if the hotel operator is otherwise able to keep revenue the same.
What are the Strategies for Increasing Revenue in a Hotel?
In our experience, one of the most effective ways to increase hotel revenue is through effective revenue management.
Many hotel operators are overly focused on increasing occupancy for the sake of increasing occupancy. They have a mindset that the hotel should run at 90-95% occupancy, which means that they have to lower the average daily rate (ADR) to do so. Experienced hotel operators know that you must strike a balance between occupancy and ADR. In fact, running at a higher occupancy with a lower ADR can lead to operational inefficiencies that result in lower net income. The optimal occupancy may actually be closer to 70-75% at a slightly higher ADR.
Most hotels will have a dedicated revenue manager who explores these nuances. The revenue manager also monitors local competition and adjusts room rates on a daily basis, sometimes even hourly.
In our experience, a premium brand should always be charging slightly more than the local competition. Rev-PAR should be the top of the market. The key is finding where that “top” should be.
Often, longtime owners become fixated on a certain “top” number that they do not feel they can exceed. It might be, for instance, that they do not want to charge more than $199 per night. This is true even if the revenue feels the market could support room rates of $249-299 per night. An effective revenue manager will test out higher rates to determine what impact, if any, the higher rates have on occupancy. They can then work to find the optimal balance between room rates and occupancy. This helps demonstrate the inelasticity of your hotel product.
We also find that when we raise our rates, the entire market follows. The other hotels raise their rates to just below ours (assuming we have the market’s premium brand). This rising tide lifts all boats; the inverse—where everyone lowers their rates—creates a race to the bottom, which is not good for anyone in the industry.
Sales Strategies that Increase Hotel Revenue
Having an effective sales strategy is critically important when trying to drive hotel revenue.
Key to this is understanding where your sales are coming from, such as corporate vs. leisure travel. Corporate travel can be a fantastic source of revenue, particularly if you have strong corporate accounts with returning guests. However, leisure travel tends to be the most profitable type of travel. People are willing to pay higher rates for leisure than they are for corporate. Knowing your market will help drive your sales strategy.
For example, one of the hotels we purchased had so many corporate accounts that they could not accommodate the higher-paying leisure or walk-in guests – despite their prime location next to a water park in a tourist-heavy market. They had been filling the hotel with corporate guests paying $89 to $99 per night when they could be leaving room for leisure travelers who would pay upwards of $149 per night. Upon assuming ownership of this hotel, we cut back on corporate travel to accommodate more leisure which immediately increased our revenue.
Moreover, hotel operators should always be using a Customer Relationship Management (CRM) system to measure the effectiveness of their sales strategy. A CRM system helps track all outreach and communications, a lot of which can be automated over time. We also use a CRM system to monitor direct sales efforts, such as reaching out to contractors who do a lot of business in our specific markets.
Hotel operators should always be thinking creatively about their sales strategies. For instance, one of our hotels is in an area that has several large athletic tournaments. Athletes and their parents travel from far and wide for these tournaments. We will reach out to the organizers of these events to promote our business by offering a favorable rate to any of the teams stay with us. Direct outreach efforts like these are low cost but can really drive hotel revenue.
How Can Hotels Increase Revenue in the Low Season?
Seasonality is something that can really impact hotel revenue, particularly in destination markets. Some hotels will simply scale back their staff during the low period. Others will shut down entirely for a few months. These cost-saving measures can maintain a hotel’s profitability. An alternative strategy is to find ways to increase revenue during the low season.
Let us use the case of one of our luxury hotels located in a warm-weather climate. This hotel does incredibly well from September through April, their “high” season for leisure travel. However, the summer months were dismal at best.
Luxury brands can really struggle during their low seasons. Unlike extended stay properties, luxury hotels cannot rely on the same corporate or business travel to keep them afloat, even at discounted rates.
Instead, we had to think of what would draw people in the summer—things that would keep people cool. We expanded the facility by adding a lazy river, a water park, and a splash pad for kids. By amping up the excitement and fun, the hotel started drawing people year-round. To be sure, this was a significant investment of around $17 million. However, the increase in low-season revenue quickly offset these costs and made it a worthwhile investment. Now, the hotel no longer loses money during the low season like it did before.
Another strategy we have used to increase revenue during the low-season is to offer “memberships” that allow local residents to use our hotel’s amenities.
Let us use the same example of a luxury property, in a warm weather climate, that caters to leisure travelers in the winter months. In the summer months, we offer exclusive memberships for residents who want to use the property’s pool, fitness center, and workspaces. “Members” also get discounts at the hotel’s restaurants and on spa services.
These memberships have proven to be so successful that we now have waiting lists for people wanting to use these exclusive amenities. They pay thousands of dollars in an initiation fee plus substantial monthly dues, both of which we use to offset revenue losses during the low season. Better yet, selling these memberships costs us virtually nothing—there is no major capital investment required to provide access to our existing facilities. This revenue is almost entirely profit.
What Are the Best Ways to Add Value for Guests?
Guest satisfaction should be at the core of every hotel’s operational model. After all, this is the hospitality industry.
We rely heavily on guest satisfaction surveys to determine how our teams are performing. We use them to learn more about our guests’ experience, including what improvements or amenities we could invest in to make their stay more pleasurable.
The top priority for guests is always cleanliness. This is the bare minimum that guests expect. Another top priority is providing a fresh, hot, and varied breakfast, especially at extended-stay properties.
Beyond that, we look at the “human” element which can be a big differentiator for hotels. People like to feel as though they are being catered to, so we strive to provide luxury service at limited-service prices. We train people using a “five and ten” rule: when you are ten feet away, look up and make eye contact with a guest. When you are five feet away, acknowledge the guest by saying good morning, good afternoon, etc. We are always mindful of guests’ requests, too. If they have asked for a crib in advance, we will set that crib up in their room ahead of time. Small gestures like these can really improve the guest experience.
We also try to “delight and surprise” our guests in ways that they are not expecting. We try to find out why our guests are traveling and then make small efforts to acknowledge them accordingly. For instance, we might give someone a larger room if we know they are traveling with kids. We might also leave a few games or activities for the children in the room to keep them occupied. This delivers above and beyond what the guests are expecting, which translates into a more positive guest experience.
There are other low-cost, easy ways to cater to guests. For example, at our hotel that is located near a water park, we offer sunscreen, goggles, pool toys and more. At our property that is located near a federal courthouse, where we tend to have lawyers staying with us, we have additional charging cables, extension cords, and other business-related items that prove to be handy in a pinch.
Being able to anticipate the value or the needs of the guests, and then meeting those preemptively, is single-handedly the best thing a hotel operator can do to add value for their guests.
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Conclusion
Hotels are different than other real estate asset classes in that you are running a business in addition to managing the physical real estate. Using strategies like these to increase the value of the hotel business will, in turn, improve the profitability of the overarching hotel investment.
As an experienced hotel operator, we at Wolfgramm Capital carefully assess the potential costs and revenue impacts of various value-add strategies based on the hotel type, market, and business model. This detailed analysis ensures that we are making the most strategic investments that result in the greatest profitability.
