March 2010 Issue

Capital Expenditures When Funds are Low – An Asset Manager’s Analysis

Presented by: Tracy Cooper Ramos

Long term capex planning should be guided by a comprehensive 10-year plan, and should be reviewed and updated annually. The 10- year plan should come from a property assessment performed either by onsite management or a professional third party that can identify issues via a Property Condition Assessment (PCA) Report. This PCA Report should have been completed when the property was acquired.

While most owners can rationalize investing capital in revenue producing upgrades such as guestroom FF&E, funding the property’s back of house items (for example new PTAC units, or replacing the property’s main boiler) may ultimately reduce the owner’s expenses in the long term.

Typically FF&E is reserved as a percentage of revenue. However, the significant decline in hotel revenues for the past two years may have resulted in excessively low FF&E reserves. As a result, many owners are feeling the capital crunch and do not have adequate funds set aside for needed capital expenditures. Some owners who intend to sell their hotels in the near term believe that not renovating and/or replacing FF&E is a way to improve their financial returns. But what they might not realize is that when the sale does occur, the property’s sale price may be discounted because of deferred maintenance. Additionally, the hotels that have deferred maintenance may not be benefiting from higher revenue streams that come from stronger market penetration and higher room rates.

The bottom line is that given the decline in hotel revenues, the hotel owner has fewer dollars to spend on FF&E and other capital needs. The asset manager therefore has to recommend the best plan for capital projects and hotel renovations. The following provides some general guidance:

1. Life safety and code compliance issues are always at the top of the list. Your management team should be well versed in what needs to get done from this standpoint. These items should be foreseeable and not a surprise to the asset manager or to the management team.

2. Back of house key component repairs or replacements should be heavily considered. Based on a property equipment assessment, a management team should prepare a schedule for all major equipment and systems in house to include:

• a schedule of estimated useful life remaining
• estimates of dates and cost to repair / replace equipment
• and recommendations regarding urgent repairs/replacement

While back of house improvements may not directly enable a property to capture more demand, not completing these projects may end up being very costly. A carefully considered risk analysis should help determine when and whether these items move to the top of the list.

3. Defensive capital expense items are vital to the success of a property, particularly during a down period. If your property’s guestrooms are in need of renovation relative to your competitors, this can cause a real challenge, particularly in a down market. Finding creative ways to overcome these challenges, perhaps through a minimal investment in soft goods, for example, may allow your hotel to maintain its market share.

4. Finally we consider potential revenue generating items that can yield stronger occupancy or ADR in a struggling market. Focusing on unique, marketable items which give your property’s sales team something to point to. Something that a competitor simply doesn’t, or cannot offer is an ideal capital investment during down periods. These things don’t have to be expensive, and a lot of value can be added in the PR aspects of such items. For example, converting otherwise unused outdoor space into an al fresco dining area. It just might create impact on a guest that turns them into a repeat customer.