All hotel properties require periodic refreshes and property improvement plans (PIPs) that can demand significant capital investment.
From a practical standpoint, these property improvements will address physical aspects like mechanical systems, plumbing, and electrical; corridors, guest rooms, and spaces such as meeting rooms or fitness centers; communication and security systems; landscaping, lighting, and parking. More extensive programs might include lobby space, modifying the arrival experience, and adding or reconfiguring restaurants, all of which can be costly.
From a strategic standpoint, property improvements are meant to improve guest satisfaction and enhance competitiveness. These improvements are intended to increase market share and drive both occupancy and rates, while reducing fixed expenses. The ultimate goals are to enhance operating profit and asset value.
PIPs as a transaction way of life
Most every hotel transaction, especially for branded properties, will trigger a mandated, formal property improvement plan, making it an important initial step in valuing the asset.
The PIP provides a renovation scope and timeframe that a hotel buyer must implement following a change of ownership. In recent years, PIP expenditures have increased greatly, rendering an outsized impact on sale proceeds.
Complicating the matter, with the hospitality industry enjoying steady RevPAR growth for nearly a decade, most brands have become more aggressive in their PIP requirements, asking for more capital to be spent as the industry enjoys this profitable period.
The ongoing proliferation of brand options and competition within key markets has also contributed to rising PIP costs, as parent brands seek to differentiate consumer experiences at each of their sub-brands within a given property type, whether select service, full service or extended stay.
Brands may also use PIPs to persuade owners to another sub-brand. This can happen in markets where a brand may want to pave the way for the development of a new property under an existing flag, or downgrade or upgrade an existing hotel to a different chain scale within their brand umbrella. By tweaking the requirements and corresponding costs of PIPs with multiple sub-brand options, brands can largely dictate the direction a new owner takes.
Strategies that sellers and buyers can pursue to obtain the best value from PIP scopes
Which brand maximizes the value of my hotel? Sellers and buyers alike should always evaluate brand options during a change of ownership, especially if a franchise agreement is nearing expiration. Might another brand capture additional market share or improve ADR? Or, if the property is “locked” into the current brand, would the parent brand be willing to re-flag to a different brand within its system? Such a switch can potentially lead to new revenue opportunities or operating efficiencies.
Timing is everything. Usually, three to six weeks are required to prepare a PIP document, which generally remains valid for six to 12 months. We encourage sellers to order PIPs as early in the sale process as possible, preferably before an asset even hits the market. Having the PIP document in hand prior to going to market helps sellers understand the capital expenditures that investors will be underwriting—critical information for estimating eventual sale proceeds. This head start also allows for the opportunity to negotiate scope and timing as noted below. Once a hotel is listed for sale, sharing the PIP as early as possible allows a seller to convey cohesive and transparent information to the market, bolstering the effectiveness of the disposition process.
It’s a negotiation. The scope and completion timeframe of a PIP are often negotiable. In particular, brands are typically receptive to sellers and buyers who have existing relationships with the brand and own or manage other franchised properties. Is it possible to push back the guest bath renovation an additional 12 months? Would the brand consider omitting certain elements of a PIP, taking into consideration all the other capital being spent at the property and other franchised hotels? Is there another property with the same flag that recently transacted, but was not subject to such a comprehensive PIP? We recommend that sellers negotiate as much as they can upfront before sharing the PIP with potential investors, and also encourage buyers to take another bite at the apple with the brand once they have been awarded the purchase of a property.
Be wary of any projected return on investment. In most cases, new guest room and public area furnishings allow a hotel to be more competitive. Investors will often underwrite both ADR and occupancy increases following a renovation, with the expectation that the property will increase market penetration relative to its competitive set. However, sellers and buyers alike need to honestly assess whether property efficiency and revenue potential is already maxed. In these situations, there may be little financial justification for pouring additional capital into a property, and investors may opt to deduct estimated PIP costs from their purchase price on a dollar-for-dollar basis without allocating any ROI to their expenditure.
What else is needed beyond the PIP? Change-of-ownership PIPs typically revolve around guest-facing furniture and finishes in guest rooms, corridors, lobbies, meeting rooms and other public areas. However, as suggested earlier, the PIP may only paint a partial picture of the capital needs at a property. Items outside the scope of a PIP, such as elevator modernizations, roof replacements, kitchen equipment upgrades and or mechanical systems, can often cost investors (and by derivative, sellers) more than the PIP amount.
Capital expenditures, the $64,000+++ question. Capital expenditures tend to be one of the largest variables in a transaction. Buyers must understand sellers’ estimates of capital needs and how they factor into pricing guidance. By the same token, we encourage sellers to request estimates of PIP and other capital expenditures from prospective buyers when submitting their letters of intent. This measure allows sellers to compare “all-in” valuations between investors on an “apples-to-apples” basis, minimizing the potential for unexpected surprises or purchase price reductions during the purchaser’s due diligence period.
As indicated, PIPs continue to take center stage in many hotel dispositions. Planning for, scrutinizing and negotiating PIPs early on can directly increase proceeds to sellers and lower the costs for buyers in most hotel transactions.
Nicholas Plasencia serves as managing director of The Plasencia Group, a national hospitality sales, investment consulting and advisory group. He specializes in investment sales efforts in full-service, boutique and resort properties. Guy Lindsey is senior managing director, development management consulting, with the firm. He has 32 years of experience in the hospitality industry.