Tipping Your Cap (Rate)

Why hotel owners need to pay attention to RevPAR - By Jean Francois Mourier

We’re going to change things up a bit today and write directly to all the hotel owners out there. So all you GM and revenue managers- or all of you that don’t want to own the place someday- go ahead and put this down, or minimize this window.

Oh, everyone’s still here? OK, let’s get to it then.

We want to talk about RevPAR (no surprise there), but specifically how it pertains to the capitalization rate of the property. Everyone knows how important RevPAR is to cash flow, and to the net income of the operation, but too often RevPAR’s inextricable link to cap rate is overlooked. The relationship is simple and straightforward. And this is unfortunate, because in hotels, even moderate increases in RevPAR can translate into spectacular increases in cap rate; if we take for example a 10% increase in RevPAR at a $50 million in revenue hotel can yield a 50% gain in cap rate or more.

An asset- like the real estate and the physical plant of a hotel- is valued based on not only its natural appreciation, but also on the revenue it produces on an annual basis. The basic measure of this revenue production to the original price the asset was purchased at its cap rate. Capitalization rate, in specific terms, is defined as is the ratio between the net operating income produced or EBTA typically by an asset and its capital cost (the original price paid to buy the asset). The current market value of the asset can also be used as an alternate computation of cap rate. Because of the net operating income aspect of the metric, cap rate often doesn’t figure into the valuation of less dynamic assets, but for hotels it figures quite prominently.

And increasing RevPAR is the most direct way to increase cap rate.

On the surface, this is common sense. After all, hotels are developed on a given piece of real estate in order to establish a reliable revenue stream- more reliable than that generated by residential or retail units (something we all learned playing Monopoly). The link between the revenue generated by the property itself and RevPAR is easily understood as well. But the connection between RevPAR and cap rate does not seem to receive as much emphasis as other financial measures. The fact is, an increase in RevPAR directly correlates to an increase in equity and the value of the property.

This correlation is based in the outsized influence RevPAR has on a hotel’s net operating income; because of the negligible cost of goods sold associated with room sales, and because room sales can represent as much as 90% of total revenues for a hotel, revenue generated per available room is the single most important contributing factor to a hotel property’s net operating income or profit unlike F&B.

To put that into real dollar figures, consider a 100-room hotel with $10 million in annual revenue and $1 million in annual profits. This property, originally valued at $10 million, has a cap rate of 10% where on average hotels are bought and sold in this economy, and the hotel has a RevPAR of $273. The next year, this hotel institutes a program that increases RevPAR by 5% (an increase that is legitimately attainable through the use of a sophisticated revenue management program), which in turn increases annual revenues to $10.5 million. Assuming this hotel runs with typical variable average room costs, this increase will correspond to a bump in annual profits of around $300,000 or a 60% conversion into profit from the increase. The cap rate for the property this year goes up to 13%- a 30% increase over last year! So if a 5% increase in RevPAR translates to a 30% year-over-year gain in property value, that’s a huge difference. And every 1% increase in RevPAR translates into a 6% gain in the value of the hotel and its profit.



To achieve high cap rates, then, it stands to reason that maximization of RevPAR should be priority number one for owners and their agents in hotel operations (GMs). With all of the demands placed on owners of hotel properties, it may be easy to lose sight of this particular aim, but if the overarching goal is to increase the value of your property, then the savvy owner will hone in on RevPAR with intensity.

But if RevPAR is the key to high and positive cap rates, then how should owners and their agents go about maximizing it?

Entire textbooks have been written about ways to increase RevPAR- that subject is also often the focus of our articles- and as every hotel property is different, different RevPAR optimization solutions can and should be utilized. We believe that because RevPAR is closely related to both occupancy percentage and average daily rate, then the optimization of room rates (through real time, demand-based rate modification) coupled with vigilant inventory and sales channel management is the best way to increase RevPAR. Furthermore, we believe that this rate optimization/revenue management process becomes more cost-effective (and more effective, period) through automation, and with the help of a comprehensive system that can perform all of these functions accurately. To be clear, the functions that most influence RevPAR are yield management, channel management, competitive pricing, inventory control, rate optimization, GDS distribution, booking pace, and page positioning on third-party websites (like OTAs).

With the proper system in place, a hotel has a better chance of increasing RevPAR over both the short and long term. With higher RevPAR, a property’s cap rate will increase, driving the overall value of a property much higher as well.

And that’s something that ought to make all the owners out there very happy indeed.

About REVPAR GURU
REVPAR GURU provides hotels around the world with an alternative revenue management software solution, to manage RevPAR intelligently and effectively, and deliver maximum profits. REVPAR GURU’s custom-designed Yield Dynamic Price Engine meets the rapidly changing needs of hotels in a demanding business environment - dynamic rate optimization, real-time pricing, integrated internet and extranet yield channel management, and GDS sales distribution, to increase a hotel’s RevPAR while maintaining rate integrity and automated rate parity. It is the only revenue management solution that automatically optimizes and updates hotel rates across all major consumer travel websites, based on all market variables and in real time, and provides a strategic room inventory control. Once deployed, hotels can boost their occupancy rates and cut their distribution costs dramatically. Headquartered in Miami, Florida, additional information can be found at www.RevPARguru.com or by calling +1.786.478.3500.






Source: RevPar Guru / Nevistas


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