The sponsor's flow-through assumption is doing all the lifting on $26k a key

Sorry, wrong handle order in my head, this is your deal not mine. On the flow-through: 68% is defensible on occupancy-driven revenue and aggressive on rate-driven revenue, and your deal is mostly rate. Incremental occupancy costs you housekeeping, laundry, amenities, maybe some front desk hours. Incremental rate on an already-occupied room costs you almost nothing except commissions and credit card fees. So mechanically rate should flow through better, which cuts against my first sentence.

The reason 68% still bothers me is that the fixed base does not stay fixed for three years. Wages, insurance, property tax after a $17M+ basis reassessment in many states, brand fees on a higher revenue number. Your denominator grows without any help from the pro forma.

Rebuild it as two lines. Incremental revenue at 80% flow-through, then a separate inflation line growing the year-one expense base at 3.5% to 4% a year. You'll land somewhere below $2.36M and you'll be able to say why. Then look at the exit. 8.0 on $2.36M is $29.5M against $17.3M all-in, and that spread is where the whole return is.

The exit cap is the assumption I'd argue with first. They bought at roughly a 9.9% in-place yield and they're selling at an 8.0. That's 190 basis points of cap compression on top of a 67% NOI increase. Either the conversion genuinely moves this asset into a different buyer pool, or someone picked a friendly number.

Run it at the going-in yield. 9.9% on $2.36M is $23.8M. Still a gain, much smaller one, and it tells you how much of the deal is operations versus the capital markets being kind on the way out.

Displacement. On a 118-key with a conversion you're likely doing floors in phases, 25 to 30 rooms out at a time, six to ten weeks a phase. Call it 20% of inventory unavailable for two thirds of a year, plus rate softness because you're selling a hotel with hallways under plastic.

I'd model a full year of revenue at 12 to 15% below trailing and see if the debt still covers. That's the year that kills these, not year three.

@quarry that's the number I'd want too. @thicket, is there an interest reserve in the loan sized for the renovation period, or is debt service coming out of operations while a fifth of the rooms are dark?

Also the nine day window. I've talked myself out of two deals by overanalyzing and I'm trying to stop doing that, so I'll say the other side: nine days is enough to rebuild the flow-through and check the loan, and it isn't enough to get comfortable with an operator you've never worked with. Those are different problems and only one of them is solvable in nine days.

Can someone explain the owner's priority at 9% in plain terms? I read it as the operator gets 3% of revenue no matter what, and then extra money only after you've made 9% on what you put in. If that's right, why would the operator take that deal instead of a straight percentage?

@wren that's basically it. Operators take it because the base fee off gross revenue is the real money and it's paid whether the hotel makes a profit or not. The incentive is upside they'll take if it shows up. Which is why @thicket's instinct that the threshold aligns interests only goes so far, the operator's core economics are tied to revenue, not profit.

That's the thing I'd push on. An operator paid on gross revenue will happily spend $1.20 to get $1.00 of rate.

Different angle. Is the land owned in fee or is any part of it ground leased, and are the parking and the sign easement inside the same parcel? Hospital-adjacent interstate sites get subdivided oddly and I've seen a hotel where the second entrance ran across a neighboring pad site by handshake.

Also check the zoning on the conversion. Brand standards sometimes want a bigger porte cochere or a relocated pool, and setbacks do not care what the brand wants. Requirements vary by jurisdiction, so pull the actual ordinance rather than asking the seller.

Someone define flow-through for me properly. I read it as "of each new dollar of revenue, this much becomes profit," and if that's right then 68% seems low, not high? Feels like the extra dollar of room rate costs you almost nothing.

@ember your instinct on rate is right in the sense @sextant described, the extra dollar of rate is nearly free. The reason the whole-hotel number lands lower is that everything else on the expense side is drifting up at the same time, so the net margin improves slower than the incremental math suggests.

On the construction side, @thicket, $26k a key for a conversion with a brand change is thin depending on what the brand wants. If they're requiring bathroom tubs to showers, that's demolition and plumbing in 118 units and I'd not want to be holding a fixed budget on it. Get the PIP document itself, with the inspector's punch items, not the sponsor's summary of it.

Labor. Nobody has said the word yet and it's 40% of your expense line.

A conversion to a higher brand usually brings higher brand standards on service, which means more hours per occupied room, not fewer. Breakfast standards, housekeeping frequency, front desk coverage. If the pro forma has payroll growing slower than revenue across the conversion, ask the operator to show you the staffing model in hours per occupied room at 64% and at 70%. Real operators have that. If they hand you a percentage of revenue instead, they haven't built it.

Also ask what the local labor market looks like. Secondary markets near a hospital can be tight, because the hospital pays better than a hotel does.

The nine days is the part I'd be most honest with yourself about. I've funded two things on a short window because the sponsor was someone I'd done a deal with, and one of those relationships was worth exactly one deal's worth of trust, not two.

One industrial deal together does not tell you whether they can supervise a 118-key renovation. Ask what hotel conversions this specific team has closed and finished, and ask to speak to the LPs from the last one. If the answer is that hospitality is new for them and the operator brings the experience, you're underwriting the operator and the sponsor is a middleman on your fee stack.

Small point from running a team through jobs like this: the operator's regional support matters more than the brand. Ask how many properties the regional director carries and how far away they are. An operator with one asset in your state is going to be managing your hotel by phone.

You're buying a cyclically sensitive operating business at a 67% NOI increase on a three year clock, with the exit priced tighter than the entry. That can work. It works best when you can wait, and the structure you described does not sound like it lets you wait.

So I'd ask what the loan maturity is and whether there are extension options with conditions you can actually meet. If the loan comes due in year four and the exit cap has gone the other way, the pro forma stops mattering.

Naive question since I'm mostly here for income: is anything distributed during the renovation, or is it two years of nothing? If it's nothing, the yield people quote on these deals is really a yield on the back half of the hold, and I'd want to see it stated that way.

@marlow that's the right question and it applies to the whole structure. @thicket, the 9% owner's priority, is it cumulative and compounding, or does it reset annually? If it accrues during a year with no distributions, your position is different from a deal where the operator's clock restarts each January.

And on the four questions that have piled up here, the ones I'd rank as fund-or-pass are the displacement year that @quarry described, the PIP scope that @solder wants, and whether this sponsor has finished a hotel conversion before. Nine days is enough for those three. Everything else you can keep arguing with after you've either sent the money or not.