Hotels operate on short term leases. Guests may stay for just one night in a standard hotel and up to weeks in an extended stay property. However, demand fluctuates throughout the year based on leisure and business conditions and citywide events. This fluctuation is known as seasonality, and it can have a dramatic impact on month-to-month profitability. Neutralize seasonality in your hotel with thoughtful analysis and careful planning.
Compare Monthly Revenue Year Over Year
Seasonality is defined as variations in figures that appear at regular times throughout the year. This may show up in expenses, as in the example of higher utilities costs in winter or summer. However, most seasonality appears on the revenue lines, which reflects demand variation throughout the year.
Regular patterns are at the heart of identifying seasonal differences. At a minimum, you need two years to identify a consistent seasonal pattern, but three years or more would be most beneficial. The longer period allows you to pick out inconsistencies that are caused by special events. In all cases, the data must be monthly to get any clarity.
Smith Travel Research opened the conservative investment world to hotels by launching Smith Travel Accommodation Reports (STAR) in 1988. These reports aggregate occupancy and revenue data from more than 60,000 hotels around the world. STAR Reports are produced monthly and include weighted average data from a management-selected set of competitive hotels.
These reports are ideal sources for spotting revenue patterns in the subject and competitive set hotels. They include month-by-month occupancy, average daily rate, and RevPAR for trailing 18 months. Many STAR subscriptions even include 18 months of month-by-month segmentation data, particularly in full service hotels.
The Competitive Set Report (“Comp” tab) explicitly shows 18 months of data. However, some simple math using percent change figures can extend this monthly data to a full two years. For example, with a December 2017 STAR:
- Go to the “Competitive Set Report” (“Comp” Tab)
- You’ll see month-by-month Occupancy (%), ADR, and RevPAR tables
- July through December 2016 is provided
- To produce January through June:
- Find the % Chg table for each statistic
- [January 2016] = [January 2017] / (1 + [% Chg January 2017])
- Iterate through all months and statistics that are missing
Three years of annual figures are provided on the far-right side of the table. The fourth year can be extrapolated using the same technique above. While these annual figures don’t give you a sense of seasonality, they will point to the need for additional research if there has been a significant year-over-year change.
A single STAR will give you a good idea of where to start looking for seasonality in both the market and the subject property. However, a second STAR will provide a more complete picture over more than two years. At a minimum, request:
- Latest month’s STAR
- Prior year end STAR (e.g. December 2017)
- Three years prior year end STAR (e.g. December 2015)
This will give you four years of monthly occupancy and revenue data to tease out clear patterns in market demand.
Detailed Financial Statements
Hotel financial statements offer a deeper view of seasonality in the subject property. You’ll probably be able to find fine granularity in any institutionally managed property, while less sophisticated operations would be an annual roll-up at best. Many small operators use a non-USALI standard chart of accounts in QuickBooks, which makes sophisticated analysis a bit more complicated.
Standard USALI financial statements provide for a detailed view of occupancy, ADR, and RevPAR by business segment. The high-level categories are Transient, Group, and Contract. These are further broken down as follows:
- Association / Convention
- Tour group / Wholesale
A month-by-month financial statement over two or more years will show how demand in each segment changes throughout the year. Look for occupancy and rate peaks and valleys to show where there are opportunities for compression. This will give your sales team the ability to strategically sell business into peak months to drive up transient rates. It will also provide color for your revenue management and marketing teams to prepare appropriately for a valley.
Detailed financial statements also give you a good picture of expenses throughout the year. Early stage deal evaluation is meant to uncover and produce good questions for the seller. Look for expenses that are unusually high or low compared to previous months or years. They could be one-time anomalies or an indication of a consistent pattern.
Special Events vs. Consistent Seasons
Consistency is critical when looking for seasonality, whether in revenue or expenses.
An examination for seasonality may be as simple as reviewing year-over-year percent change and moving on. However, there are times when the percent change is so great that it requires additional explanation. For example, a revenue increase of 10% or more in any month is something worth looking into. Anything less than 10% can readily be explained away by a great sales effort, but more than that is probably being influenced externally.
Seek to understand special events before you look to neutralize seasonality in your hotel. Otherwise, your efforts could be misdirected.
Start with time of the year by looking for unusual weather in your market or major feeder markets. Consider peculiar timing of national or religious holidays.
External factors that significantly influence occupancy and revenue tend to leave a paper trail. These could be major conventions, sports events, elections, or natural disasters. In many cases, they’ll be easy to find by quickly searching the news from that time.
You may be thinking, “why don’t I just ask the seller?” That’s a good point, and it’s usually appropriate to direct all questions like this to the seller to save you time. However, you should also be looking for an unfair advantage.
A sophisticated analysis includes a good understanding of the seasonality of the market and hotel. Many buyers don’t put in the time, though. Go to the seller as a last resort, as there’s a possibility that the seller or broker would alert other buyers of the anomaly.
Use a Monthly Cash Flow Model
A solid understanding of the hotel financial statements and market seasonality is a critical first step. However, it doesn’t mean a whole lot if you’re still working with a financial model that doesn’t correctly capture seasonality. This leaves you open to a variety of risks during the investment period.
Convert Annual Operating Proforma
Monthly operating budgets take a long time to prepare. The three months from October through December is called “budget season” for a reason. You don’t have time to dedicate that level of attention to each year in your investment projection, nor should you.
Accuracy degrades rapidly as you get past one or two years. Therefore, it’s foolish to spend the energy creating a monthly operating budget for every year in your analysis.
Your investment strategy may depend on a monthly timeline that requires special consideration to neutralize seasonality in your hotel in the early years of your investment. For example, a major renovation could displace thousands of room nights over many months. This would be important to build a bespoke monthly cash flow projection to be sure you have adequate reserves.
The stabilized case doesn’t require such in-depth analysis, though. For this, you can model seasonality of a single year and apply that to every subsequent year. The HIT Model does this by taking the previous year’s monthly share of total year times the current year total for each month. Take the sum of all previous months minus the annual total in December to make the year whole (in case of any funky rounding).
Build Capital Accounts to Hold Reserves
As an asset class, hotels are very capital-intensive. The constant wear and tear along with uncertainty in operations requires enhanced focus on capital planning and cash flow management, respectively. Many financial models ignore these concerns because mixing the balance sheet with the statement of cash flows complicates things.
Working capital and interest reserves are the two balance sheet items on your closing statement that help you neutralize seasonality in your hotel by smoothing cash flows. A working capital reserve primes your operating account with cash to pay salaries and expenses. Whereas, an interest reserve helps you meet debt service when renovation displaces a significant amount of potential business.
A monthly model will drain and replenish these capital accounts based on a simple set of conditional rules that you set up across the investment period. You will find so many uses for this technique once you set up your first capital account, including construction and equity draws.
The basic structure of a capital account has the following lines:
- BoP Balance – beginning of period balance – equals the previous period’s EoP Balance
- Contribution – capital account in-flow – usually from initial capitalization and recapitalization prior to an equity distribution
- Draw – capital account out-flow – usually from operating demands and return to equity upon sale or refinance
- EoP Balance – end of period balance – equals the sum of BoP Balance and in/out-flows
The simplicity and elegance of this solution will astound you. Play around with different scenarios. For example, you can delay equity distributions until you have a certain amount in your operating reserve. There is no “right” way to use a capital reserve. The objective is to model as close to life as possible, so you know better how to set up your capital stack.
Roll-up to Summary Using SUMIF
A monthly cash flow model is not pretty to look at even if it is ideal for appropriately modeling seasonality. The best practice for any programming exercise – in Excel or otherwise – is to show your work. This means use multiple lines of computations to do something on the back end, and then roll up to a single cell on a separate worksheet.
Resist the urge to simplify on the back end.
The model-view-controller (MVC) framework used in the HIT Model and many other popular apps separates the user interface (view) from the brains (model and controller). This protects the back end from erroneous input and enhances the user experience.
An annual summary is the expected user experience for most financial models, so it makes sense to roll up your monthly cash flows to annual figures. Simply, adapt your cash flow model to include a row for years that correspond with the cash flow columns. Thereafter, you can roll-up any row in your model from months to years with the SUMIF function.
Note: This can be extended to quarters in a similar way if you are dumping the data into a waterfall, for example.
Note 2: You can only use SUMIF across one row at a time. Use additional SUMIF functions to sum across multiple rows, even if they are adjacent.
User experience is paramount in any analysis. Your results are only as good as your ability to tell the right story. Let the brains function separately from the user experience to protect both stakeholders.
Capitalize the Deal Appropriately
All this work boils down to two things – preparing your management team to neutralize seasonality in your hotel and capitalizing the deal appropriately. Your business plan will prepare the management team, but your lenders and investors are concerned with when and how they get paid.
Monthly Debt Service
Senior loans are built on predictability and security. A business plan that accounts for seasonality goes a long way to alleviating many of your lender’s concerns. It shows that you’ve spent the time considering anything that would negatively impact cash flow.
Rough financial models account for debt service on an annual basis, which is fine for a back-of-the-envelope analysis. However, the lender expects you to stroke a monthly check, so you’ll want to understand whether you’ll fall short monthly.
Go to your lender with a clear ask about how you want to pay and how much you need to reserve for operational shortfalls. It may make sense to ask for a little larger working capital reserve than you need with the option to pay it down or distribute to equity upon stabilization.
Seasonality should never be an excuse for coming up short on debt service. Most lenders are commercial real estate generalists, and they don’t know all the details of operating a hotel. Your extra effort to account for seasonality will prove your professionalism and reduce risk to the lender.
Remember, lower risk is usually associated to lower cost of capital.
Model True-to-Life Distributions
Investor distributions may be sporadic and of inconsistent amounts depending on the business plan. A deep renovation, for example, could delay equity distributions for three years or more until the property stabilizes. Like anything with your investors, this only becomes a problem if it is unexpected.
Investor relations starts with good communication. A financial model that provides for potential real-life scenarios will help you appropriately craft that message.
Private placements will detail as many risks as possible, including seasonality, in the private placement memorandum. However, many joint ventures marketing processes that do not go through the same documentation of risks rely on the sponsor’s ability to elucidate these clear and present dangers.
Know your target investors and craft your offer accordingly. For example, if you know that they are interested in consistent cash flows, build a reserve and adjust quarterly distributions accordingly. This will impact time-based investment returns, like IRR, so don’t skip this step.
Seasonality is a major reason that investors avoid some markets. It creates uncertainty and risk that few people are willing and capable of managing effectively. Thin markets with the right business plan and capital create exceptional opportunities for outsized returns and reduced risk – high alpha.
Thoughtful underwriting, a comprehensive financial model, and well-informed stakeholders will allow you to penetrate difficult markets and reduce your cost of capital. Seek to neutralize seasonality in your hotel through astute asset and property management. This is mastery comes with experience, and that experience will drive many considerations on your front-end evaluation.