Build or Buy? It All Depends...

There are advantages to building a hotel. There are advantages to buying one. How do you decide?

There is no single clear choice. Which route you take depends on the market, your access to financing, and the ROI your investors require. Also key: your personality and the culture of your company.

No matter which route you take, you have to evaluate the overall market, inventory and analyze the hotels and segments that exist in the community you want to enter. You also need to look at the cost of building versus the cost of buying to determine which is your most strategic investment.  That’s primarily the territory of a new-build.

If you want to acquire an existing hotel, figure you’re going to pay more of a premium for a strong-performing property because it’s already stabilized and ramped up and is generating positive revenues and cash flows. 

Another factor to consider is the condition of the existing hotel. If you buy a lodging property whose cash flow improvement requires a substantial PIP, the cost per key could be equal to or greater than the cost to build a new one.

Building new can be risky, too. If you’re leaning toward that, you have to go through the development risk and the time and cost associated with developing. Besides, it’s still difficult to find financing for new construction, and even if you line it up, you have to go through the ramp-up stage – typically 24 to 36 months – to stabilize the hotel’s performance and get the revenue and cash flow up. You also have to figure in the cost of land.

The first step, however, is closer to home: It’s critical to look at yourself, your company’s culture and approach.

Some hoteliers like to build, are comfortable finding a market that has a need for new supply and are very efficient at developing, so their cost per key is lower; they can go in and develop cheaper than a lot of others can. They like to find a market and build the newest and best hotel at a reasonable cost, stabilize it, and get returns quickly. Other hoteliers have a growth strategy in which they may prefer to acquire existing properties. Because they’re not as well-versed in building and developing, they either look to get a bargain property or a hotel that’s underperforming because it’s not being managed effectively. They want to acquire that, improve the operations and grow cash flows. Or they might build their approach around a PIP, putting a nice one into the property, upgrading it and then watching the capital grow. It all depends on the market, what the market needs and the growth strategy of the operator. Finding the right mesh is the goal.

By Greg Morris