Charting a new path to profitability
 
Charting a new path to profitability
13 DECEMBER 2018 8:37 AM

As an owner, you should always be looking at ways for your business to be most profitable—which means talking with your asset manager to keep what’s needed and cut costs where applicable.

Beginning in budget year 2017, we began to see hotel operating costs rise faster than revenue; that is, revenue, that was driven by revenue-per-available-room “guidance.” As expected, in real dollars, gross operating profits began to erode slightly at first, but owners were told there was nothing to worry about.

The 2018 budgets reflected a similar trend, and the year looks like we will perform to expectations, again; revenues up to “guidance” but expenses are rising faster than revenue with GOP and flow through down again in real dollars. When adjusted for inflation, we lost ground again in 2018. Here, it is important to note that Mark Woodworth at CBRE tells us that “2018 will be the best revenue year in recent history, but only 50% of hotels in the U.S. will bring any of the incremental revenue gains down to the profit line.”

We are now in the midst of the 2019 budget season and behold, forecasts and “guidance” are for modest growth in revenue (2% to 3%). Costs will again increase greater than revenue with flat to declining GOPs budgeted for 2019. The industrywide inability to increase revenues to minimally offset increases in costs has become endemic and appears to be the “new normal.” Yet, the relative indifference of operators to this phenomenon is troubling. This, coupled with brand/operator initiatives and perks to retain guests in the arms race for guest loyalty, impacts both revenue and costs.

It doesn’t take a math major to understand the compounding effect this has on profits and returns to investors. The inevitable result, if not addressed, will be that hotels will be dropped out of the investor class real estate category. Unfortunately, for the foreseeable future, lost profit opportunities cannot be reversed because the revenue jump required to get back to it even would be too great to take all at once. For example, just using rooms revenue as a proxy, if we had say, $100 RevPAR in 2016 and we consistently raised it to offset increased costs of 6% for the periods 2017 through 2019, our 2019 RevPAR would have been $119. Now look at the reality of the 3% that generally prevailed during the same period and you arrive at $109 RevPAR. When the high or small increase ripples through the entire revenue stream, it becomes an existential threat to hotel investors. The bottom line: Operators are working with a revenue strategy that is simply unsustainable.

What should owners do?
A long-term solution will require a wholesale change to the operating model and compensation structure, which is not likely going to happen overnight. In the meantime, owners should be working with their asset managers to uncover opportunities to optimize revenue while also taking a critical look at expenses, and especially those that do not directly correlate to profit. Some examples include:

  • First, recognize that this is a revenue crisis and you can’t possibly cut costs enough to make up the deficits created over the past several years.
  • Review the hotel management agreement and hold the operator to the letter and spirit of the agreement.
  • Challenge corporate expense pass-throughs, chargebacks and “mandatory” programs that may or may not add value to your hotel. Question exactly what gives the operator the right to charge for services that were once included in the base fee.
  • Push back on changes to brand “standards” if they don’t make sense or don’t add value for your property and/or will simply erode GOP.
  • Aggressively challenge budget “guidance;” every market, every corner in the market, and every property is unique, and budgets need to reflect your specific hotel.
  • Determine when prices were last adjusted in any revenue area; if costs increase, so must pricing.
  • Make it known that ownership genuinely wants managers to hit bonus targets, but bonuses and incentives should be performance-based and in alignment with hotel goals and not just treated as an operator perk at the owner’s expense.
  • Take out a machete and cut away dead wood! If it’s not making a profit, question why it needs to remain open or serviced, and what the hours of operation are for that amenity. If the operator insists that it’s a “standard,” demand that it needs to be profitable or shut it down.
  • Make sure the operator has looked at every contract and service agreement and tried to negotiate favorable pricing, not just extensions and/or automatic increases but also attempt to renegotiate midterm, such as lowering rates and lowering services in exchange for contract extensions.
  • Carefully analyze the sales department, staffing, process and mix of demand. Encourage the team to take some pricing risks, especially if your hotel is a price leader, across all segments—group, transient and corporate-negotiated. Be mindful of repeat business and make sure each contract is treated and reviewed as “new,” carefully underwriting profit contribution as opposed to being copied and pasted from the group’s prior stay. Determine the total cost of acquisition of a group roomnight after netting out commissions and bonuses paid on every group room consumed.
  • Encourage re-engineering or the value engineering of how the business is operated. Work with the operating teams to question the status quo, asking “Why are we doing it this way, what is it costing us and what is the benefit to performance, guest satisfaction and employee retention?”
  • Look out for amenity and labor creep and challenge both.
  • Challenge the operator to pursue less expensive ways to outsource services and labor, and analyze currently outsourced services and expenses.
  • In the budgeting process, refuse to accept anything but flow-through in rooms (90% of increased rate, 75% of increased occupied rooms) and 50% on all other revenue.
  • Demand that all capital projects generate an appropriate return on investment.
  • Don’t approve the budget until every issue has been addressed to your satisfaction.
  • If your hotel budget has already been approved, don’t feel you can’t pressure the operator to engage more aggressive strategies. The budget is the operator’s “road map.” There are always alternative paths to the final destination and the operator needs to take an owner’s perspective of continually looking for new and better paths that result in “exceeding” expectations.
  • Finally, now is the time to have contingency plans ready. Ask the operator what their contingency plan is for say, a 10% miss on budgeted revenue and demand that those steps be in place and ready to be implemented immediately if and when market conditions erode.

At the end of the day, it’s the owner’s money, it’s time to demand a return on that investment!

Tom Morone (ISHC) is managing director and EVP of CHMWarnick, the preeminent provider of hotel asset management and owner advisory services. The company asset manages more than 70 hotels comprising approximately 29,000 rooms valued at roughly $15 billion, and is advising on development projects valued at over $2 billion. CHMWarnick’s hotel owner advisory services include asset management, hotel planning and development, acquisition due diligence, owner-entity accounting, management/operator selection and negotiation, capital planning and disposition strategy. CHMWarnick has nine offices nationwide, including locations in Boston, Phoenix, Fort Lauderdale, Honolulu, Los Angeles, Minneapolis, New York, San Francisco and Washington, D.C. For more information, contact 978.522.7000 or visit www.CHMWarnick.com. For the latest company news, follow CHMWarnick on Twitter @CHMWarnick and LinkedIn.

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