January 17, 2023
The hotel industry grew to $341.7 billion from 2018 to 2023, at a CAGR of 7.7% through some of its most troubling years. 2023 alone is expected to see a CAGR of 17.9% and profits of 23.6%. There is significant opportunity for continued growth in the hotel industry, so there may be many good reasons for you to consider buying a hotel.
In this article I wanted to highlight the steps to buy a hotel, key considerations, and provide you with some tools and resources to help you along the way. I plan to cover the following:
- Why a hotel can be a good investment?
- What are the different types of hotels to consider?
- What are the steps to buy a hotel?
- How much does it cost to buy a hotel?
- How much profit can a hotel make?
With that as our guide, let's dive in!
Is a Hotel a Good Investment?
Investing in a hotel can be a lucrative venture for many reasons, provided one does due diligence, understands the market, and manages the investment wisely. Here are some reasons why a hotel can be a good investment:
- Steady Income Stream: Hotels, especially those in prime locations or popular tourist destinations, can generate a consistent income stream. This can come from room bookings, as well as ancillary services such as food & beverage, event spaces, and other amenities.
- Real Estate Appreciation: Apart from the operational income, the underlying real estate of the hotel usually appreciates over time. As cities expand and areas develop, the value of the land and building can increase, providing a long-term capital gain opportunity.
- Diversification: For investors with a diversified portfolio, a hotel can be a good addition to spread risks across different sectors and assets.
- Tax Benefits: Depending on the region, hotel owners can benefit from tax incentives or deductions, which can include depreciation, interest expenses, and other operating expenses.
- Leverage: Like many real estate investments, it's possible to leverage a hotel investment by using debt to finance a significant portion of the purchase price. If managed well, this can amplify returns.
The type of hotel can go a long way toward whether your investment provides a strong return. Let's dive into the different types of hotels now.
Types of Hotels
Some of the most common types of hotels include:
- Hotels – This might seem a bit obvious, but the bare-bones hotel is still the most common type of accommodation in the industry. These are aimed at tourists or travelers and have rooms, typically for short-term stays, as well as sometimes meals and extra services.
- B&Bs – These are typically smaller places, often with a much more personal touch. They can be house conversions and the owner may or may not live in the same building. As with classic hotels, there are both low-cost and luxury versions of this model. Our Airbnb cash flow calculator can help you forecast your potential profits.
- Motels – For long-distance travelers, motels offer generally low-cost accommodation aimed at motorists. Their location is entirely different from the previous two options as is their style; motels will usually have fewer amenities and services and are generally aimed at people looking for a single night.
- Inns – An inn is usually attached to a restaurant or diner, and is typically smaller than a hotel. It appeals to a market somewhere between a hotel and a motel and offers private rooms for short-term stays.
- Resorts – These usually have a hotel attached and offer a much wider range of amenities and services, designed for more high-end customers who want to have a contained holiday or break. The idea of a resort is to provide everything the customer needs within the premises.
- Hostels - For travelers on a budget, hostels offer cheap accommodation with a range of rooms from dorms to single or doubles. The amenities are usually basic, though they may include a pool and a bar. Typically, guests pay for a single bed in a dorm of between 4 and 10 beds, and these are more of a social
As you can probably tell, each of these requires a different approach to running it and will come with a varying degree of revenue. The size, location, and organization will be significantly different depending on the model you’re after.
If you still have no idea which direction to go in, it will save you time to hold back and figure that out first. If you do have a clear plan, it’s time to go over how to buy a hotel business.
How to Buy a Hotel Business
The process of buying a hotel involves a series of thorough research and analysis steps, including substantial due diligence to make sure the business is as it seems and no unpleasant surprises are lurking. At any stage, if the data you’ve gathered doesn’t match your expectations, you should be prepared to pull out and start again.
Buying a hotel is a multi-step process that requires careful planning and due diligence. Here's a summarized list of the steps involved and a brief description of each:
- Determine Investment Goals and Criteria: Understand why you want to buy a hotel and what you hope to achieve. This includes considering the desired size, location, type, brand affiliation, and financial returns you aim to realize.
- Initial Research: Familiarize yourself with the hotel market, identifying potential opportunities, prevailing price ranges, and industry trends.
- Arrange Financing: Determine how you'll finance the purchase, whether through personal funds, bank loans, or investors. Pre-approval for loans can be advantageous when negotiating.
- Assemble a Team: Gather a team of professionals, including a real estate broker specializing in hotels, an attorney, an accountant, and possibly a hotel consultant to guide you through the buying process.
- Property Search: With the assistance of your broker, identify potential hotel properties that match your criteria.
- Property Evaluation: Once you've shortlisted potential properties, conduct a thorough analysis. This involves reviewing the hotel's financial statements, occupancy rates, reputation, and any potential for growth or improvement.
- Due Diligence: Delve deeper into evaluating the chosen property. This includes inspecting the physical property, verifying financial data, assessing any existing contracts (like franchise agreements), and ensuring there are no legal encumbrances.
- Make an Offer: Based on your evaluations, submit a formal offer or Letter of Intent (LOI) detailing the purchase terms. Negotiations may follow.
- Finalize Financing: Once the offer is accepted, finalize your financing arrangements. This might involve providing the lender with detailed information about the property and your financial situation.
- Legal Paperwork and Closing: Your attorney will help draft the Purchase Agreement and coordinate with the seller's attorney to ensure all necessary documents are in order. After all due diligence is completed and financing is secured, you'll proceed to closing, where ownership is transferred.
This is a great 10 step outline of what it will take to buy a hotel, but I wanted to dive a bit deeper into 3 areas:
- Using an SBA Loan to Buy a Hotel
- Due Diligence for Buying a Hotel
- Financial Projections for a Hotel
How to Buy a Hotel with an SBA Loan
The U.S. Small Business Administration (SBA) offers several loan programs that help entrepreneurs acquire or expand small businesses, including hotels. Acquiring a hotel with an SBA loan involves a series of steps and specific requirements. Here's a breakdown:
- Determine Eligibility: Ensure your business qualifies as a small business according to SBA guidelines. This typically means having a tangible net worth of less than $15 million and an average net income of less than $5 million after taxes for the preceding two years. The business should operate for profit, have a place of operation in the U.S., and make a significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor.
- Choose the Right SBA Loan Program: The SBA 7(a) Loan Program is the most common for buying real estate, including hotels. Another option might be the CDC/504 Loan Program, which can be used for real estate and equipment purchases.
- Prepare a Hotel Business Plan: Lenders will want to see a comprehensive hotel business plan. It should outline your business's mission, structure, market analysis, marketing and sales strategies, and financial projections. For a hotel, include details about location, target market, competitive analysis, and operational strategy.
- Find an SBA-approved Lender: While the SBA provides guidelines and guarantees, it doesn’t issue loans directly. You'll need to find a bank or lender that participates in SBA lending programs.
- Gather Required Documentation: You'll need personal and business financial statements, tax returns, resumes for all principal owners, a history of the business, records of any past loan applications, and details about the hotel you wish to purchase.
- Down Payment: SBA loans typically require a down payment. For real estate, this can range from 10% to 25% of the purchase price. The exact amount can depend on the loan terms, your creditworthiness, and the lender's requirements.
- Complete the Application: Fill out the SBA loan application provided by your lender. They will guide you on any additional documents or forms required.
- Property Appraisal: Lenders will often require an appraisal of the hotel property to ensure its value matches or exceeds the loan amount.
- Underwriting: The lender will review your application and evaluate the risk associated with the loan. This process might involve assessing your creditworthiness, business acumen, and the feasibility of your business plan.
- Loan Approval and Closing: If your application is approved, the lender and the SBA will provide a letter of commitment. Once you accept, you'll move to the closing process where all documents are signed, and the loan amount is disbursed.
While you are working toward finalizing financing with an SBA lender or other financing partner, you should also be completing due diligence. Let's look at that next.
How to do Due Diligence for Buying a Hotel
Conducting due diligence is crucial when buying a hotel to ensure that you're making a sound investment and are aware of all potential challenges and liabilities. Here's a detailed checklist for hotel due diligence:
1. Financial Due Diligence:
- Profit and Loss Statements: Review the last 3-5 years to understand revenue and expenditure trends.
- Balance Sheets: Assess assets, liabilities, and equity.
- Tax Returns: Check for any outstanding liabilities.
- Occupancy Rates: Analyze trends and compare them with industry benchmarks.
- ADR (Average Daily Rate) and RevPAR (Revenue Per Available Room): These metrics give insights into the hotel's pricing strategy and revenue efficiency.
- Debt Load: Understand existing mortgages, liens, or debts.
- Accounts Receivable: Check the age and collectability.
- Capital Expenditure History: Understand past major expenditures and future requirements.
2. Operational Due Diligence:
- Management and Employee Contracts: Review terms, durations, and any potential liabilities.
- Supplier and Vendor Contracts: Assess terms, costs, and obligations.
- Inventory: List of furniture, fixtures, and equipment (FF&E) and their conditions.
- Operational Manuals and Systems: Understand the tools used for reservations, guest management, etc.
- Booking Data: Review advance bookings, reservations, and any associated liabilities.
3. Legal and Regulatory Due Diligence:
- Property Title: Ensure it's free from disputes and encumbrances.
- Licenses and Permits: Verify that all necessary licenses (alcohol, food, entertainment, etc.) are in place and valid.
- Zoning and Land Use: Ensure the property complies with local zoning regulations.
- Litigations: Check for pending or potential lawsuits or disputes.
- Franchise Agreements: If the hotel is part of a franchise, review the agreement's terms, fees, and obligations.
- Employee-related Compliance: Ensure compliance with labor laws, health and safety regulations, etc.
4. Physical Due Diligence:
- Property Inspection: Assess the condition of the building, rooms, common areas, and any other facilities.
- Environmental Assessments: Check for any environmental hazards or issues that could lead to liabilities.
- Renovation and Maintenance Records: Understand past work done and future requirements.
- Utility Bills: Review past bills for electricity, water, etc., to gauge operational costs.
5. Market and Competitive Analysis:
- Local Market Trends: Understand local tourism trends, seasonality, and economic factors.
- Competitor Analysis: Assess the performance, pricing, and offerings of nearby competitors.
- SWOT Analysis: Identify the hotel's strengths, weaknesses, opportunities, and threats in the context of the market.
6. Reputation and Brand Due Diligence:
- Online Reviews: Analyze reviews on platforms like TripAdvisor, Yelp, and Booking.com for guest feedback and reputation.
- Brand Guidelines: If affiliated with a brand, understand their guidelines, support, and any associated fees.
7. Technology and Intellectual Property:
- Software Licenses: Ensure all software (PMS, POS systems) are licensed correctly.
- Website and Domain: Ensure transferability and assess the website's functionality, SEO, and user experience.
- Intellectual Property: Identify trademarks, logos, or any other IP associated with the hotel.
8. Exit Strategy and Future Development:
- Expansion or Renovation Possibilities: Identify opportunities to enhance property value or revenue.
- Exit Terms: If you're considering selling in the future, understand the market conditions and terms that might apply.
Remember, the specifics of due diligence can vary based on the hotel's size, location, and other unique factors. It's advisable to engage professionals, including accountants, lawyers, and hotel consultants, to assist with the due diligence process.
How to Write Complete Financial Projections for a Hotel
During the acquisition process you will likely need to create a set of financial projections. We have a helpful hotel financial projection template built specifically to help you through this process.
How Much Does it Cost to Buy a Hotel?
There are a few different approaches to value a hotel that can help you determine how much it might cost to buy a particular hotel. These approaches include:
- Discounted Cash Flow (DCF): This method forecasts the hotel's future income streams and then discounts them back to present value using a selected discount rate. This method is particularly useful for hotels with fluctuating incomes or those expected to see significant growth in the future.
- Direct Capitalization: Here, the hotel's Net Operating Income (NOI) is divided by a capitalization rate. The NOI is the revenue from the hotel minus the operating expenses (not including debt service). The capitalization rate is determined based on the risk profile of the investment and comparable sales.
- Sales Comparison Approach: This method involves comparing the hotel being valued to other similar hotels that have recently been sold. Adjustments are made for differences in size, location, condition, and other variables. This method is most effective when there's a good number of recent, comparable sales in the area.
- Cost Approach: While less commonly used for hotels, this method involves estimating the land's value and then adding the cost to construct a new building (or reproduce the existing one), minus depreciation. This method can be helpful for newer properties or in areas where land value dominates the total value.
- Gross Income Multiplier (GIM): This is a simplified method where the sale price of a property is divided by its gross income to get a multiplier. This multiplier can then be applied to the gross income of the hotel in question to estimate its value. It's more straightforward than the DCF or Direct Capitalization but may not account for all nuances.
- Franchise Affiliation: If the hotel operates under a franchise, the value of this affiliation is considered. A hotel with a strong brand affiliation can often command higher room rates and occupancies, resulting in higher revenue.
- Real Estate: The underlying value of the land and building can be significant, especially in prime locations.
To provide a rough estimate or average is challenging due to the wide variance based on these factors. But to give you a rough idea, in the United States:
- Budget or economy hotels could range from $1 million to $10 million.
- Mid-scale without food and beverage services could be between $3 million to $15 million.
- Full-service hotels in urban locations could start at $10 million and go up into the hundreds of millions, with luxury landmark properties even reaching over a billion dollars.
How Much Profit Can a Hotel Make?
Although we found that the average hotel profit margin was actually -2%, once you add back in depreciation and interest expense, the average hotel had an EBITDA of roughly 17%.
Buying a hotel can be a particularly lengthy and complex process due to the nature of the business. Hotels are complicated and diverse businesses to run, and this makes it a lot more important to bring in the right kind of help and ensure your research and documentation are accurate.
Before you start, be sure you know what you want. Then, narrow down the options, perform the relevant research well, and lean hard on the due diligence before signing over the funds. If you do all that well, you’ll end up with the hotel business you were looking for.