Half the income statement in this hotel fund deck is new to me

A friend forwarded me a private placement deck for a hotel fund. Value-add, three assets, all limited service in secondary markets, one of them a repositioning where they're rebranding and redoing the rooms. Minimum is bigger than anything I've looked at, so I'm not writing a check, but I want to actually understand it.

What's tripping me up is the operating side. The deck shows RevPAR going from about $78 to $104 over four years, occupancy from 63% to 71%, and something called GOP margin going from 33% to 39%. Then there's a management fee line, a franchise fee line, an FF&E reserve at 4% of revenue, and a separate asset management fee to the sponsor. That's a lot of fee lines between gross revenue and what an investor sees.

The part I can't square: they say hotels reprice every night, which they present as the upside. But if rates can go up every night they can go down every night too, and the deck's downside case only takes occupancy to 60%. In 2020 that number would have been much worse.

What I actually want to know is which line in that stack I should be most suspicious of, and whether "limited service, secondary market" is a real thesis or just where the cheap assets are.

3 replies

3hannah_west29 Get yours

Take the fee stack in order, because the order matters and the deck is probably showing it correctly even if it's showing it fast.

Room revenue comes in. Franchise fees come off near the top, usually a royalty on room revenue plus marketing and reservation fees, and combined that's commonly a high single digit percentage of rooms revenue. Departmental costs and undistributed costs come off next, and what's left is gross operating profit. That's your 33% to 39%. Then the base management fee to the operator, typically a small percentage of total revenue, plus an incentive fee tied to profit above a threshold. Then property taxes and insurance, then the FF&E reserve. What survives all of that is net operating income, and only then does the sponsor's asset management fee and any promote come off the investor's side.

So the line I'd push hardest on is the 4% FF&E reserve. Hotels consume their own capital. Soft goods on a roughly seven year cycle, case goods longer, and a brand can require a property improvement plan at reflagging or license renewal on top of the reserve. 4% is a common underwriting figure. Real spend over a full hold is often higher, and reserve underfunding is how a hotel pro forma looks fine and the exit does not.

On limited service secondary market: it's a real thesis when it's tied to a specific demand generator you can name, a hospital system, a university, a logistics corridor, an airport. If the market has no anchor you can point at, cheap is the whole thesis and cheap is not a thesis.

Which assumption the answer hangs on is exit cap rate. Ask what cap they used and what they'd exit at if RevPAR only reaches $92.

2Rena Expert

Two structural points behind what @ledger laid out.

Hotels have no lease. Every other major property type gives you a contract that says someone owes you rent for a stated term. A hotel's income resets nightly, which means demand shocks pass straight through to revenue with no contractual delay. That's why the sector is the most economically sensitive major property type and why it moves with discretionary spending more than office, industrial, or apartments do. It also means operating skill shows up directly in results. A capable operator can drive rate and occupancy in the same building where a weak one erodes both.

That's the reason institutional capital in this sector almost always pairs with an experienced hotel management company rather than self-managing. When you read a hotel deck, the operator's track record on comparable segment and market is as much of the underwriting as the building.

On the downside case: a sponsor's stated downside is an assumption, not a floor. The useful question is what happens to debt service coverage at occupancy levels the market actually hit in its worst two years, and what the loan documents require at those levels. Cash traps and reserve requirements vary by lender and by loan, so ask for the actual terms in writing.

Segment matters more than most beginners expect. Luxury, business transient, extended stay, and leisure destination behaved very differently through the last cycle, and they will again. Extended stay held up differently from full service with large meeting space. Any hotel thesis should say which segment's demand it is buying and why that demand persists through a slowdown. Broad hotel exposure without that answer is a bet on the economy.

Half the income statement in this hotel fund deck is new to me

3 replies