Your ‘teenage’ hotel – evaluating franchising options
All good things must come to an end.
You’ve made massive (hopefully) amounts of money in your brand-new. Your guests have beaten it to hell, but it still spits out cash like a camel. But you, I and the brand know that the arbitrary ‘we feel that your hotel looks old’ clock is ticking. And, when that point arrives, your franchise sales rep, designer, contractor, general manager, children etc. will be happy to tell you) that everything needs to be replaced. Your guest reviews are slipping. Pressure is building.
The first thought is – let’s do it all. It’s simple – “I can’t afford to lose this brand”.
I understand the ‘protecting the strength of your portfolio’, the ‘I get satisfaction from owning a higher end property’, and the ‘I don’t want to explain to my bank how this brand will make money’, and the ‘this <insert name of other individual that you’re polite to in person but desperately want to beat> will build a <insert upper midscale brand here> next to his and take all my business’ arguments. I get that these hotels to me – Holiday Inn Expresses (especially in the US), Hampton Inns and maybe Courtyards by Marriott (in certain markets) in my mind – are desirable.
I’d also argue that it’s also time to consider selling the property in the 18 months preceding your first major PIP. You know that area and that property – will you truly have a strong return on investment; in many, many cases I simply don’t think it’s there. Get your franchise PIP and comb through it; you know your rate structure (and don’t be afraid to, if you choose to carry out the PIP, try and get a discount). Most importantly understand the revenue contribution that brand brings. Project those revenues and profits out. It doesn’t always make sense.
Ask yourself these 4 guiding questions:
1) How has my customer changed?
A franchise agreement covers extremely long periods of time. Neighborhoods can change quickly. A ring road can change traffic patterns drastically. The local mine or factory can shut down. The Detroit hotel market flourished, wilted, died and has been reborn in the matter of 50 years.
Consequently, your customers will change. Examine your market mix (comparison of number of guests per market, parking lot counts of yours and similar hotels versus number of rooms sold, changes in vehicles per day count on the supply roads around you. Even the types of cars in your lot can indicate the type of guest you have and give you a good sense of changing customer demands.
Be honest with your assessment. If your business-heavy clientele is migrating to vacationers or industrial workers, work to accommodate them and execute on their required experience. The path of highest profitability will be looking forward rather than fighting with newer hotels to recapture what you’ve lost.
2) How has your market changed?
The past few years have seen unprecedented hotel construction throughout the United States and Canada whether it seemed financially viable or not. Every property in North America has been affected by new supply without question – if you feel yours hasn’t, I’ve got some magic beans to sell you. This product tends to be upscale and above, limited service, and small-to-midsize boxes (75-150 rooms).
A business school staple – a SWOT (strength, weaknesses, opportunities, threats) analysis – for hotels in your regional market works a treat here (instructions on how to do this can be found here). Of the hotels that have entered your market, what segments have they filled? Which hotels have left? What segments have opened up?
New hotels and changing markets shift demand upward and downward. Franchise aside, your renovation should match that emerging market accordingly.
3) What’s the damn hotel made of – literally?
It’s extremely easy to move a wall on paper. You erase them, cross them out or draw around them and they no longer exist. Good times.
Stupid as this sounds, those existing walls are actually real.
That said – what may be achievable on paper may be prohibitively expensive in the real world. Contractors, architects and consultants can be creative, but some miracles are more expensive than others. If your franchise is requiring significant exterior work, load bearing interior walls or adding floors. Plan for the big numbers; if it happens to be cheaper, happy days.
Also – and I can’t stress this enough:
Many of you have heard of asbestos. Most of you should be familiar with black mold. If you have a hotel from the 1990s or older you need to understand whether either of these two things will be a problem.
Know what you’re getting into. Remember – liability for contractors, guests and employees that interact with damaging materials is borne by the Owner primarily.
Protect yourself and do what’s right.
4) Honest Quantitative Unemotional Assessment: Does maintaining your franchise still make sense?
The scariest question in a PIP situation.
The pressure from banks, partners and franchises to stay in a system can be insufferable, but what truly drives an investment decision? We’re in business to make money, and the status quo isn’t always the best.
Let’s consider a base case: an older upper midscale hotel (say three design generations old). 100 room, 3-storey interior corridor hotel. Franchise wants a massive overhaul; the total dollar amount is $20,000 per key. If not, you’re out and finding something new. You currently do $1,780,000 in revenue – $75 ADR, 65% occupancy – at a 30% margin, equating to profits of $534,000. A midscale franchise offers to convert your property with minimal changes – carpet, paint, artwork, signage and linens – at $3,000 per key.
What’s the best way to evaluate this?
Option 1: Stay Upper Midscale
At $20K/door your renovation costs $1,700,000. You fund your renovations through an interest only loan at 5%.
You estimate that the renovation might bring back a few old corporate accounts and sneak the occupancy up to 70% and pull up your ADR to $80 even though the brand and target customer are still the same. New revenue of $2,044,000 and $613,200 in profits. That, less the $85,000 in new interest per year, takes us to $528,200.
Option 2: Move to Midscale
Your midscale renovation, at $3K per key, costs $300,000. You borrow these funds at 5%
You estimate your occupancy at 65% but drop your ADR to $70. Revenue goes down to $1,660,000 and $498,000. That, less the $15,000 in new interest per year, takes us to $483,000.
At these numbers we have an overall difference of $1,400,000 ($1,700,000 – $1,400,000) in construction costs yielding an additional $45,000 ($528,200 – $483,000) in income. A quick, back of the envelope return rate of $45,000/$1,400,000 is 3.2%, notwithstanding the additional risk of taking on a larger loan.
I understand the math will be different for each case, but is it truly worth it?
If you choose to stay with your current franchise, talk to your contractors and compile a list of the big-ticket items of their plan. Walk your franchise or PIP representative through your math. Your franchise should want you to make money; if they understand the pain points then they can do something about them. Push for additional time or a lower fee structure to get them done.
You have a decision to make. I don’t envy it. Insofar as possible take the emotion out of it and make the best decision at the point you have it. Projecting the future can be a fool’s game, anyway. If it wasn’t, Greg Oden would be a superstar, Britain would still be in the EU, no one would have purchased Knights’ Inn and I’d be dining out on my Amazon stock from my high school days ($13/share!!!) and not writing this.