Over our years of experience in advising hotel licensees, we know you know that keeping your hotel looking up-to-date is an important part of hotel ownership. Furniture, equipment, carpet, audio visual gear and lighting all have a finite life and need to be replaced over time. This can be done periodically, but most owners will usually approach it as a project and undertake a number of upgrades at the same time. The dilemma faced is often assessing how much the capital investment will return and how it should be funded. Working out the cost with a builder and getting quotes from suppliers is the easy part of the equation.
One of the first things to do is determine the replacement items within the project. For example, if you are replacing old and troublesome air-conditioners or refrigerators, then these are likely to have already been fully depreciated over time. From a financial viewpoint you are replacing an old asset with a new asset with little or no future revenue benefits (other than a refreshed depreciation claim).
Where you are changing the look and feel of the hotel (or an area of the hotel), it’s important to forecast the revenue impact of the renovation project In our experience, this can be quite an art and the harder part of the renovation equation.
So where do we start and what things should we be looking at to understand the feasibility of the renovation project?
- Understand your target market. It is really important to be crystal clear about the market you are trying to attract and to understand their tastes and preferences. If you are proposing to expand the appeal of the venue to a wider market to attract a different demographic then be very careful not to alienate your existing customer base in the process. For example, say a relatively well performing “tradie style” gaming room is renovated to look like the Monte Carlo casino inspired by a recent trip to Las Vegas. The result? A gaming revenue decline due to the tradies feeling intimidated and uncomfortable around the leather bound gaming stools and chandeliers after a hard day at work.
- Be realistic about your revenue projections. This is probably the hardest part of any feasibility assessment and also requires the most amount of research and collaboration. Start with a detailed assessment of the area and it’s optimal potential. For example, a 100 seat restaurant may only be able to do 1.5 sittings (table turns) on a busy night. Therefore the optimal potential will be 150 covers for that night assuming every table is full and the seats are effectively turned. You can then apply an average meal check value to the expected covers and work out your likely sales revenue. Do this for each day of the week and also seasonally adjust for busy and quiet months of the year. Remember that most new renovations also go through an initial “honeymoon” period of trade where trade will be buoyed by the initial excitement with a lot of new customers coming just to have a look because it is “new”. This can last up to 6 months.
- Benchmark your project against other similarly styled and located venues. Doing your research and checking out how your competitors with similar concepts are going will help you verify the logic in your sales assumptions. Look at the style of customers, peak trading hours and how they run the venue. If you know them, they may share some information that can help your assessment on your own project.
- Develop the budget and feasibility. Once you are satisfied with your sales projections, start to apply the likely costs against them such as cost of goods sold, labour and direct overheads including increased power and cleaning costs. Also look at your indirect costs as some of these may increase as well and need to be factored into the budget, such as insurance and office labour. Finally, remember to factor in the lost income that you may sustain whilst the project works are being undertaken (rarely does a build run on time).
To give you an understanding of the risk profile of the project, perhaps also look at some scenarios. Consider your worst case budget (capital budget and operating budget) as well as your best case budget.
A specialist hospitality accountant can advise you on the tax ramifications of the project and in particular the depreciation allowances for the various components. Tax savings are cashflow savings and maximising your tax claims lowers the after tax cost of capital employed. Once this is determined, you can then match the funding to the style and life of the renovation elements.
With those steps complete you will be in a good position to derive a sensible bottom line profit for the project and compare that against the project cost to understand the likely return on investment. The return will need to be sufficient to reward you for the riskiness of the project and the likely “life” of the project before further work needs to be done.
- Calculate your return over the project life. As a “rule of thumb” we generally look at most renovation projects over a 5 year feasibility period. Some areas such as nightclubs will usually have a shorter life before a refurbishment is required, but other areas such as the bottleshop may have a longer useful life. The important thing to remember is that you will need to not only get your initial spend back, but also make a return in excess of your cost of capital.
Hanrick Curran has extensive experience in the hotel industry and helping clients with major renovation projects. If you need assistance in this area, please contact one of our Hospitality specialists Peter Maletz, Kim Hanrick, or Ian Van Der Woude on 07 3218 3900 or in Cairns on 07 4052 7524.
Please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice.