Hotel renovations are essential in order for properties to compete effectively in their market. Like all other real estate asset classes, hotels require regular reinvestment through improvements or upgrades. A hotel is both a substantial physical asset and an active operating business. These two factors can have different, and occasionally competing, influences on an owner’s decision about how and where to allocate funds for reinvestment.
In Canada, typical underwriting criteria requires that a reserve for asset replacement of four per cent of gross revenue be included in order to account for reasonable levels of reinvestment to maintain the property in its current condition. If the asset has not been well maintained, then there is likely a burden of deferred maintenance for the asset over and above the reserve.
In a 100-room hotel with $5 million in gross revenues, the annual reserve would be $2,000 per room, or $10,000 per room over a five-year period. This level of reserve may be sufficient to complete some cosmetic upgrades to the guestrooms every five years in a limited or select service hotel that has few amenities and services.
However, it is likely insufficient for full service or luxury hotels, with amenity spaces such as multiple restaurants, meeting facilities, spa facilities and retail facilities that also need to be maintained or upgraded. Undertaking a refresh of the guestrooms and corridors in these buildings could easily cost $20,000 or more.
For owners, the decision of when and in what areas to reinvest is driven by a variety of factors, including the age and condition of the asset, guest expectations, and in some cases brand requirements. Improvements to the property generally fall under one of two broad categories: guest facing or non-guest facing.
These improvements are most often furniture, fixtures and equipment related, and are generally tied to front-of-house areas or guest contact points. When an owner decides to renovate the hotel’s guestrooms, restaurants or meeting spaces, the changes will directly impact the guests’ experience at the hotel. These changes have the potential to generate incremental revenues. However, when an asset has been neglected, these upgrades may only be sufficient to maintain or protect performance levels.
These improvements are most often related to the building’s condition and are generally done in back-of-house areas. Although they are necessary to maintain the asset, upgrades to the hotels elevator mechanisms or the fire suppression system do not directly impact the guest experience. This it is highly unlikely that any incremental revenues would be generated by these improvements.
It may be challenging for owners to decide how to allocate funds, as while guest-facing improvements have the potential to enhance revenues, foregoing non-guest facing improvements can jeopardize the asset and lead to higher costs in the long run.
Many owners utilize a five-year capital plan to provide guidance for the allocation of funds and ensure that the priorities of the business and the asset are balanced. A strong five-year capital plan will include guest experience improvements, including refreshed guestrooms or meeting spaces, and revenue generating projects, such as a new restaurant. It will also include brand-required improvements, including a refreshed lobby space or event management system upgrades, and mechanical or structural upgrades, such as a new roof or HVAC system improvements. Capital plans should be constantly revised to adapt to shifting priorities.
Nicole Nguyen is an associate at PKF Consulting Inc. She works with the firm to provide a wide range of advisory services to the hospitality and tourism industry.