May 2008 Newsletter - by Jack Spears

THINKING ABOUT BUYING A HOTEL?

Husband and wife teams work better than single persons, especially if they are able to work together in harmony. Each needs to do their share, i.e. front desk, paperwork, housekeeping supervision and maintenance / upkeep. One or the other really needs to be the boss / leader. Too many chiefs in any business isn't going to work as well. Whether you are managing several hotels that you own, supervising a larger 60+ room hotel, or owner-operating a 20 to 50 room property, your personal involvement, time input and team work will be the key ingredients to success.

OK, let's say your first hotel is 40 rooms, grossing $480,000 (Western Montana lodging properties average $10,000 to $14,000 per room per year). It includes a two bedroom living quarters, which means almost all of your living expenses are included in the hotel operating expenses.

Your net operating income, before debt service and capital improvements, will typically be about 45% of your gross - in this example $215,000. You purchased for $1,600,000 (3 to 3.5 X gross is the current value range in Western Montana), with $400,000 cash down, as lenders typically require 25 to 30%. Your debt service on $1,200,000 at say 7.5% over 25 years is about $9,000 per month, totaling $108,000 per year. You do $20,000 the first year in upgrades and replacements. Your net profit for the year would then be $215,000 / less $108,000 / less $20,000 = $87,000. This represents the return on your $400,000 cash down payment and compensation for your time input. Remember, most of your living costs have been paid through hotel operating expenses, and you have reduced your debt.

Or, let's say you have purchased a 70 room property grossing $900,000. The price was $3,000,000 with your cash down payment of $750,000. Operating expenses will be higher because you have a larger staff, more maintenance and upkeep, etc. Of the $900,000, about 40% will end up as net operating profit. Your debt service on the $2,250,000 will be about $15,000 per month = $180,000, and your annual capital improvements will be at least $30,000. This leaves you with approximately $900,000 less $540,000 operating expenses, $180,000 debt service and $30,000 in first year capital improvements = $150,000 net profit. From the net profit on your annual tax return, you and you're accountant will deduct depreciation, annual hotel/franchise conventions, education, travel, automobile/truck, clothing/uniforms, etc.

What I have not included here is that major things can go wrong. You may decide that the hotel needs all new beds, TVs, carpet, air/heat systems, pool improvements, exterior renovation, landscaping, roof, parking lot re-surfacing, etc. In other words, you can decide to spend more than you may need to, hoping to make your property the best it can be. If you base every expense decision on whether or not it is justified as something that will proportionately improve occupancy, rates, income and bottom line, then you won't stray too far into overspending territory. Also, how much time and personal involvement you have with your property and business will directly impact your year end "profit in your pocket."

Another thing to keep in mind here is that for every $1,000 you increase the annual income, the property value goes up by $3,000 to $3,500. Remember, values are calculated at 3 to 3.5 X gross income in western Montana. You are your own boss and have the ability to control your own destiny. Hotel ownership is not for everyone. Only you can know if hotel ownership and operation is for you.