Managing capital expenditures is critical to every successful hotel investment. Unfortunately, it’s also one area that most owners don’t give enough attention to.
Professional asset managers are well versed in CapEx planning. In fact, the Hospitality Asset Managers Association recently partnered with the International Society of Hospitality Consultants in a long-term study of historical CapEx spending in the hotel industry. That study highlighted the fact that over time, properties spend well more than the customary 4% of reserved revenues.
Having a comprehensive long-term capital planning model helps owners identify periods when financial contributions beyond the capital reserve funding levels will be required. This, in turn, can influence financing and disposition decisions. In addition, an effective long-term capital planning model can be used to evaluate management’s purchasing, maintenance and preventive maintenance programs.
- Read more: “Brand standards drive record CapEx spending”
This article highlights four key elements of successful capital planning.
1. Thoroughly evaluate the property
There are two critical reports that owners can use in evaluating the property: the property condition report and the property improvement plan.
The PCR will provide an evaluation of the entire building including systems and furniture, fixtures and equipment. The PIP is prepared by the brands and identifies capital items (primarily guest facing and life safety) that will need to be addressed in order to maintain compliance with brand standards.
Together, these two reports provide new owners with a base of information they need for effective long-term capital planning.
In addition to evaluating the property’s condition, consideration also should be given to the hotel’s competitive position and owners’ objectives. Changes in the competitive landscape can affect the timing of cosmetic renovations.
For example, new additions to supply and renovations at a competitor might prompt an owner to move up a planned soft goods renovation for defensive purposes. Owners’ objectives should be considered—specifically, their anticipated hold period and access to capital.
In short, capital planning should not be done in a vacuum, but rather as part of a comprehensive, multi-dimensional analysis.
2. Identify and estimate costs
The PCR and the PIP provide a useful starting point for estimating the useful life of critical systems and some guidance as to replacement costs.
This information, however, must be supplemented with additional research and analysis. For example, firms specializing in procurement can provide guidance on costs to FF&E. Information on major systems replacement costs can be gathered from vendors, contractors and management companies. These same sources can provide information on the useful life of the various components.
3. Develop a long-term model that tracks expenses and reserves
A relatively simple Excel-based model can be developed that outlines anticipated expenses based on the previously conducted research and reserves that are based on extended projections for the property.
A typical time frame for the theses models is 30 years, but some owners go as far as 50 years. This allows for the capture of major systems, such as elevators, HVAC, building skin and windows. Capital reserves can be estimated using long-term, inflation-based growth rates.
By lining up the anticipated capital needs with the projected reserves, the timing of cash shortfalls can be planned for and identified.
4. Monitor and update the plan regularly
Capital planning is an ongoing process. The underlying assumptions to the capital model are continually changing. Therefore, regular inspections should be undertaken to monitor the condition of each item.
Effective preventive maintenance is the most obvious factor affecting useful life, but other factors can play a role. For example, increased efficiencies and higher energy costs might suggest the replacement of critical HVAC systems before the end of their useful life, or a case goods replacement might be moved up to correspond with a delayed soft goods replacement. Just as a comprehensive, multi-dimensional review is critical at the outset, so, too, is it important when updating the plan.
Simply looking at the property condition is not enough. Consideration also should be given to the competitive environment and owners’ goals and objectives. These areas can have a significant impact on the timing and amount of future capital cash flows.
Long-term capital planning is not rocket science, but it does require an upfront investment of time and a concerted ongoing effort. This investment will pay off over the long term by allowing owners to effectively and realistically evaluate their investment and long-term income prospects. Too often, owners fail to adequately reserve enough funds or identify other sources to pay for necessary capital projects. This can lead to diminished competitive positioning, loss of franchise affiliation or even loss of the asset.
Smart owners are always looking at and preparing for the future.
Matthew Arrants, ISHC is the Executive Vice President in charge of Asset Management for Pinnacle Advisory Group. He is the Chairman Emeritus of the International Society of Hospitality Consultants and a member of the Hospitality Asset Managers Association. Prior to joining Pinnacle, Matt worked in operations in various capacities with The Four Seasons Hotel in Boston, and Rock Resorts in Hawaii and Wyoming. He holds a Masters Degree in Hotel Administration from Cornell University and a BA in Political Science from Hartwick College.
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