First hotel LP position: which line do you stress before anything else?

Question

Someone asked me last week which number to check first on a hospitality deck when you've never done one, and I gave an answer I'm no longer sure about. I want to see if the room splits.

The candidates, on a typical select service or upper-midscale deal:

RevPAR growth. It drives everything above the line, it's the assumption that varies most with the economy, and sponsors put a growth curve in there that's usually smoother than any real market has ever been.

Expense inflation, mostly labor. Hotels are staffed operations and payroll doesn't fall as fast as revenue does. A model with 3% revenue growth and 3% expense growth is telling you margin never moves, which is a strong claim.

The fee stack. Management fee off revenue, incentive fee off profit, franchise and marketing fees, asset management fee to the sponsor, plus the promote. Every one of those sits between the property's performance and your distribution, and none of them appear on the summary page.

Capex and the FF&E reserve. Rooms wear out on a schedule and brands enforce it, and an under-funded reserve turns into a call for money at the worst point of the cycle.

I think a case can be made that any of these is the first stop, and the case depends on whether you believe you can judge a market better than you can judge a document. Where would you start?

joe_delgado5 · Answer

Fee stack, and it's not close for me. I can't tell you what RevPAR does in 2028 and neither can the sponsor. I can add up what comes off the top before I see a dollar, and on the two hospitality decks I've looked at that number was bigger than I expected once the marketing fee and the reserve were in there.

Thin margins are my whole world on the active side. When your spread is small the fixed drag decides whether the deal works, and fees are the one part of this you can actually read today.

aaron_fitz10 · Answer

@flint, doesn't that logic have a limit though? Fees are knowable and they're also mostly market standard. If every sponsor is roughly in the same range, checking them tells you the deal is normal, which isn't the same as telling you the deal is good.

stephen_ok9 · Answer

@kestrel that's the right pushback and I'd still start with expenses rather than either of them. A model where revenue and costs grow at the same rate has assumed away the entire thing that makes hotels risky. Margin is where the cycle actually shows up. If the sponsor grows revenue 4% and expenses 3% for five straight years, they've built compounding margin expansion into the exit value and probably didn't say so anywhere.

RevPAR I check second, because the growth curve is at least visible and people argue about it. The margin assumption tends to go unexamined.

nicole_adeyemi · Answer

Capex and the reserve, every time. The other three affect how much you make. That one affects whether you get asked for more money, and getting asked for more money at the bottom of a travel cycle is how people lose their position in a deal rather than just lose return.

marcus_hale41 · Answer

@parcel and @meridian are picking the two I'd actually rank above the fee stack, and I want to name why the fee answer keeps winning polls anyway. It's the only one you can verify without an opinion. RevPAR curves and margin paths require you to have a view on a market you've probably never worked in, and most first-time LPs don't, so people gravitate to the checkable thing.

The order I've landed on is reserve first, then margin, then RevPAR, then fees, on the theory that fees only matter if there's profit to take them from. But @flint's point stands for a specific case. If the fee load is heavy enough, even the good scenario doesn't pay you much, and you can find that out in twenty minutes.

First hotel LP position: which line do you stress before anything else?

5 replies