Simple is usually better.
We have a detailed underwriting model, but any real estate deal can be analyzed on the back of a napkin.
Here is my simple approach to underwriting a hotel investment.
1. Review the T12 Revenue and determine any upsides to that revenue - this could be through better management or a renovation.
2. If there is an upside, adjust revenue accordingly.
Now you have your topline. Lets get the bottom line.
3. Review the in-place T12 NOI %. Make any adjustments, positive or negative, based on your business plan.
A typical hotel's NOI margin will be between 20% and 40%.
Remember, when determining a purchase price, remember not to pay the seller for YOUR value add upside!
4. Multiple the revenue by the inverse projected NOI %.
For example, $100 of Revenue multiplied by 70% gives you $30 of NOI (30%)
If you had a 40-room hotel, this would be .75 cent of Net Operating Income per hotel key.
$30 is your profit before debt service.
Now lets factor in the purchase price and cost of renovations or improvements.
5. The seller wanted to sell this 40-room hotel for $200. There are $10 of closing costs, and $50 of improvements needed. The total acquisition cost is then $260
So you are going to be $260 all in.
Assuming no debt, the hotel is generating $30 of cash flow and will cost $260 to buy.
To calculate the un-levered yield on cost, divide $30 by $260, which equals 12%.
12% Unlevered Yeild for a cash-flowing asset is a solid return.
Let's look at some debt.
Typical Hotel debt is about 60%. In today environment the cost of that debt might be 7%.
Multiply the total cost of the deal ($260) by 60% to get the loan amount.
8. Next let's calculate the levered return. This is the cash flow after debt service.
Assuming I/O, multiply the loan amount by the interest (7%) to determine the annual payment.
In this case, it is $10.9 in debt service per year.
Debt Service : $10.9
Cashflow =~ $19
We have $19 of annual cash flow, and the equity is $104.
This is levered cash on cash return of 18%
But, all the equity will be returned in five and a half years.
This does not include the residual value, which is the price the hotel would be sold for.
10. Now, let's consider selling the hotel after 5 years.
Assuming NOI remains somewhat constant, and grows moderately to $35 in year 5.
Cap Rates will vary but let's assume this hotel would trade at an 8% cap rate at the sale.
$35 divided by 10% = $350 value.
So after 5 years, the hotel has generated $95 in cash flow and is worth $350.
Rember the debt is $156.
Thus the imputed equity value is $194.
The Equity value plus the cash flow equals a total return of $289.
This is a 2.7x return ( $289 / $104 of equity).
You can use this simple analysis to determine quickly if a hotel deal makes sense.
In hospitality, cash flow is an important component of the investment. Layering in a sale price at the end should just be more accretive to the overall deal.
If the deal makes sense at a high level then you need to do more diligence and verify all of the numbers and assumptions.
This framework will allow you to quickly sort through deals and not spend wasted time on a full scale underwriting.
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