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Reducing Risk to Improve the Value of Your Hotel

The Hanrick Curran Hospitality Services Team has recently been running a Risk Assessment Workshop at some QHA regional forums to assist hotel operators better understand and manage risks within their business. This is the first article in a 2-part series summarising the workshop points and articulating actions that you can take to manage risk and improve the value of your business.

The relationship between Risk and Asset Value

It is a well-known principle in finance that the value of an asset is a function of both earnings and risk. The higher the risk (and sometimes this can be just perceived) the higher the return sought by the investor. For example, government bonds are purchased at low yields because they are seen as a very low risk investment. Conversely, investments in high risk assets such as in new technology companies will be offered at a high yield to attract investors who would otherwise be wary.

This investment principle is embodied in the Capital Asset Pricing Model and also underlies the view valuers (and also purchasers) take when viewing a hotel asset that has been offered for sale. Hotel operators that have been around a while recognise that well located suburban assets with steady earnings and a diversified income base around gaming, bars, food, retail and accommodation will always transact at a better price (and implicitly a better capitalisation rate or yield) than a one-dimensional regional hotel. For example, we have seen quality inner suburban hotels typically attract a capitalisation rate in the 10-14% range from the valuers, whereas a regional hotel in a mining or agricultural centre will typically transact at up to 25%.

Managing Risk in Your Hotel Business

Whilst the location of your hotel is something you cannot change, there are still a number of other risks in a hotel business that can be managed to improve the value of your asset.

  1. Profit Risk – The classical “headline” measure of risk is volatility in earnings. If your hotel has a history of large fluctuations in earnings then a strategy that aims at smoothing out the earnings stream (over months and years) should be considered. If the underlying issue is volatile sales then perhaps consider marketing initiatives that can boost sales in quiet times and also look at the timing of major discretionary expenses such as back of house R&M : plan to coincide these with the months with greater earnings to level the peaks and troughs.
  2. Compliance Risk – The history and frequency of compliance incidents at your venue will have an impact on your risk profile. In particular, if you have had a number of OLGR, Food Safety, WH&S or public liability incidents, then these could come back to haunt you during a due-diligence investigation by a prospective purchaser. Consider putting in place programmes that regularly monitor and audit your compliance to ensure incidents are minimised.
  3. Finance Risk – The way you structure your finance facilities can also have an impact on the risk profile of your hotel business. If you are close to your loan covenant limits such as your loan-to-valuation ratio or interest cover ratio then this should be investigated and a plan put in place to give you some room to move should a revaluation of the property be required by your financier, or you need to refinance, or you experience a downturn in trade.
  4. Staffing Risk – One of the major contributors to the success or failure of a hotel is the way your workforce is structured and managed. If you have experienced a high level of staff turnover and have a history of staff related incidents such as theft, discrimination or harassment, then this should be sounding alarm bells: this is a risk that can be managed with the right leadership and organisational procedures. The QHA offers assistance with industrial relations matters and award interpretation.
  5. Control Risk – Hotels typically handle large amounts of cash and also deal with stock that has a high theft value. Red flags from a control risk point of view include regular high till variances and high stock variances. In an era of sophisticated retail Point of Sale systems and video monitoring systems, this is a risk that can be quickly reduced and managed.
  6. Operation Risk – A large part of managing a hotel is monitoring and setting the operational parameters for the business such as trading hours, pricing, discounts and promotions. How these are executed and monitored will have a bearing on the risk profile of your venue: a well run venue will have tight procedures around each major spend category and a process in place to monitor the performance of each department including reporting and accountability for gross profit, wages, direct expenses and stock. Importantly, variances to budget are investigated and management are held responsible for their results.

In our next edition we will cover some of the other risk areas of a hotel business including Budget and Planning risk, competitors, accounting risk, marketing risk and succession risk.  To assess the risk rating of your venue, please contact our hospitality team on 07 3218 3900 to arrange a complimentary assessment followed by a discussion about a few strategies you could implement to reduce the risk and increase the value of your venue. Contact Peter Maletz, Kim Hanrick or Tony Hunt.

Please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice.