The post Purchased Choice Hotels first appeared on ValueInvestingNow.com.
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This morning 03/05/24, the Value Investment Fund purchased 100 shares of Choice Hotels. The market price is $109.46 per share at opening. The Fund pays a $1 per share transaction fee into an accounting pool account that covers the costs of actual broker fees, website activity, professional fees and maintenance fees for the website. Total investment is $11,046.00.
The predesignated sale price is $141.00 per share to net $140 per share. Act on Knowledge.
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]]>The post Hospitality Industry Characterized by High Fixed Costs first appeared on ValueInvestingNow.com.
]]>There is one unique financial characteristic that is synonymous with the hospitality industry; that is high fixed costs. Or another way of stating the same financial attribute is to simply state that the hospitality industry has low variable costs. There are several different cost drivers that force this industry to incur high fixed costs. These include location, initial cost of construction, costs of capital and an economy of scale. Each of these business attributes contribute to the high fixed costs of operations.
In general the hospitality industry takes care of guests for an extended period of time (at least several hours). Some writers indicate that your fancier sit down restaurants are in this industry and they are not. All restaurants are in the food service industry. Hospitality involves longer periods of contact or utility time with the guest than simply the time it takes to consume a meal.
The hospitality industry is comprised of the following lines of business:
- Hotel/Motel Operations
- Resorts
- Event Planning and Coordination
- Theme Parks
- Golf Courses
- Tourism including Cruise Lines
As the following sections explain the cost drivers for high fixed costs, think of the different lines of business as identified above when evaluating theses costs. The first contributing cost driver that forces a high fixed cost is location.
Hospitality Industry – Location, Location, Location
If you haven’t quite figured it out yet, most of the hospitality based operations have to operate in more expensive geographical zones. Some may not operate at a particular geographical zone but may operate at a competitive site such as an exit off the highway for a motel or hotel. No matter, fair market value drives the cost of purchasing a piece of land.
The cost per acre for land on the ocean or with access to the ocean is much more expensive than a comparable piece of property 20 to 30 miles inland. Often the price per acre is six to ten times more expensive. Think of a theme park or a golf course. These lines of business need many acres and this land needs to be located near a community that attracts outside visitors. In Orlando, FL; how much is one acre of land? Answer: nonresidential land near the heart of activity is selling for nearly $500,000 per acre.
Even a piece of land with access to a main thoroughfare is much more expensive than acreage two to three miles further away from the exit. The location of the property is one of the primary cost drivers for the hospitality industry. Once you own the land, now it has to be developed.
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]]>The post Heads on Beds – Hotel Management first appeared on ValueInvestingNow.com.
]]>The hotel business has one tenet that stands above all other hospitality based business standards. Get heads on beds. Why does this one business standard have so much more value than any other? Well, it is simple, the fixed cost of operations for hotels are over 70% of all costs. Therefore any additional guest sleeping in one of the rooms adds significantly to the potential profit of the hotel. This article is designed to illustrate the math behind this concept of heads on beds.
The first important element of this principle is understanding fixed and variable costs of hotel operations. Then, the business principle of marginal value of one additional guest at the hotel is explained. Finally, a simple aggregated formula is illustrated so any hotel operator can easily understand the value of getting heads on beds.
Fixed and Variable Costs in the Hotel Business
If you imagine the hotel operation you can visualize the respective costs they incur. The most obvious is of course the structure itself. Then there are facilities cost including maintenance, landscaping and inspections (elevator, health and pest). Other costs would include utilities, communications and of course staff to operate the facility. The bulk of the staff will be involved in cleaning and food service along with the front desk operations. Some of these costs are fixed in nature while others are variable and only change as the volume of guests increase or decrease. Let’s break down these costs into the two respective groups.
Fixed Costs
There is one cost each month that drives the cost of operations over any other cost. That’s the mortgage note interest and of course the associated mortgage escrow fees. A typical hotel with 140 rooms will cost around $6 million to construct. Most owners of hotels use 10 year secured market notes and finance around 75% of the total value. A typical mortgage note for a 140 unit hotel has a principle face value of approximately $4,500,000. Average monthly payments run around $26,587 for the principle and interest components. In addition the taxes will approximate $5,800 per month and building insurance will average $4,200 per month. I’m not going to include any form of replacement reserves nor principle escrow and interest rate cap fees. The idea is to keep this simple to illustrate the most important point.
Altogether, the monthly cash payment is $36,587. The interest component in the typical payment is approximately $13,302.
Other fixed costs include taxes and insurance included in our monthly mortgage payment. Continuing with fixed costs we will also find maintenance costs and facility requirements (legal compliance with local codes). From the elevator inspection to maintaining the health license all have to be paid whether we have one guest or we fill the hotel up every night. Believe it or not, the electric bill is mostly fixed in nature. The hotel must be lit up in order to stand ready to receive the first guest. Some of the electric bill will be variable as it will increase as each guest uses a room at night. But in the aggregate, about ½ of the electric and heating bill will exist without any guests.
If you desire to truly understand the concept of fixed costs in business, then please read Fixed Costs. The following is a condensed list of the typical fixed costs in a hotel:
- Mortgage Note Interest and Corresponding Principle
- Taxes
- Insurance (Property, Professional Liability, Errors and Omissions, General Liability)
- Local Revenue/Business License Fee
- Grounds Keeping
- Facilities Maintenance (Pool, Fitness Room, Lounge and Kitchen)
- Principle and Interest on the Furniture/Fixtures/Equipment Note
- Utilities (about ½ is fixed in nature)
- Communications (Internal Phone System, Landlines, Internet Access, Cable and Radios)
- Manager’s Salary/Assistant Management
- Front Desk Clerks
- Back Office Staff
- Professional Fees (Legal & Accounting)
- Subscriptions (Periodicals, Newspaper, Inserts, Flowers)
The key to understanding fixed costs in the hotel industry is the requirement to pay this cost no matter the number of guests. A good example is the annual audit fee paid to the accountants. Most mortgage notes involved in the hospitality industry require an annual audit signed by a Certified Public Accountant. It doesn’t matter whether there is one guest or 140 each night, you still have to pay this fee.
Altogether, these fixed costs will tally around $79,000 per month for a medium size hotel. Or, if we want to look at it on a per room basis, it is $565 per month or about $19 per night. Now that we have a picture of the fixed costs per room per night, let’s look at the variable costs per room per night.
Variable Costs
As stated above, the variable costs average about 30% of all costs. What is included in variable costs? Well the most obvious is cleaning. This includes the staff and supplies to clean those rooms used each night. In addition, the laundry aspect of the cleaning has costs too. Remember, each night the towels, sheets, and covers are washed to maintain a clean and hygienic room for our guests. In addition, there is some consumption of supplies including the standard guest room supplies (soaps and paper products).
Other variable costs include the utilities used that night in the room and the food consumed in the morning at our free breakfast bar.
What about the front desk operations for the guests? It can be argued that the front desk is fixed in nature as they must be there whether there are guests or not. Based on the definition provided for variable costs in business (read Variable Costs for a more thorough understanding of this business concept) the front desk clerks are fixed and not variable.
OK, how much do the variable costs add up for one room for one night? Let’s break it down:
Utilities $2.70
Cleaning/Maintenance Staff 9 .45
Cleaning Supplies .83
Paper Products .73
Food (Breakfast Bar) .94
Food Service .62
Consumables (trash bags etc) .37
Total all Variable Costs $15.64
Total costs for each room each night is about $35. Note, $19 of this is fixed and $16 is variable. Wait a minute! It was stated earlier that variable costs run about 30% of all costs. But based on this information, variable costs are 45% of all costs. Well, that is true. But this assumes that each room is filled each night no matter what. Therefore the fixed costs are spread over all 140 rooms. But the reality is that not all the rooms are filled each and every night. I guarantee you will fill all the rooms on Year Year’s Eve, but not necessarily on New Year’s Day. If your occupancy rate is 50% for the entire year, then what is the ratio? Let’s do the math.
If occupancy is 50% then we really only need to double the fixed costs per room as those rooms being used must absorb the fixed costs for the entire hotel that night. This means fixed costs at 50% occupancy equals $38 per night per occupied room. The variable costs for that room are the same at $16; therefore $16 is 30% of the total costs (16 divided by 54 total costs) for that night.
How can one guest make a difference?
Marginal Value of One Guest (Head on a Bed)
Alright, let’s remember that every guest that comes into our hotel costs $16 to serve that night. If we have a guest that just walks in off the street and says I want to rent a room, how much is he going to cost, $16. As long as we charge at least $16, we will have lost nothing in the exchange. He uses one of the rooms and he neither costs us money nor makes us money. Let’s say we charge him $86 for the one night. His use of the room contributes $70 ($86 – $16) towards payment of the fixed costs. That is, he is generating a marginal $70 of value for the hotel. This is where the saying heads on beds is sourced. He is contributing cash towards paying the fixed costs of the hotel.
Now I know a lot of you are shaking your head because think about it; he is one guest and really is $70 that lucrative? In the overall scheme of things, $70 is not that significant. It will barely dent the $79,000 of fixed costs. But let’s make some reasonable assumptions and do some more math. Let’s say that our occupancy is 30% and we charge $90 per night for the room. Now I know we have different rates for different rooms but let’s just for the sake of analyzing the marginal value of a guest make every room a one bed room and for some strange reason, only individuals rent the rooms. If we have a typical 30 day month then we will rent out 1,260 bed nights (140 rooms X 30 Days X 30% Occupancy), which means we will generate $113,400 of revenue for the hotel.
Now in accordance with our variable costs formula from above, the variable costs will equal $20,160 (1,260 bed nights X $16 in variable costs). Right now the financial report will look like this:
Single Bedroom Stays (1,680 Bed Nights) $113,400
Variable Costs 20,160
Gross Margin $ 93,240
We know fixed costs are $79,000 and therefore we will generate a profit of $14,240. Well, this is great! We made money this month. But if we rented to the one more guest as identified above, our profit will increase $70 to $14,310. Not a big deal is it? Well it is a ½ % increase in profit. Really ½ of 1% increase; you may not think of this as a lot but let’s carry this a bit further and rent one more bed for each night. Now we’ll have a 30 day increase at (let’s stick to the standard rate of $90 per night) which equals $74 per night for 30 nights. That is an increase of $2,220 or a 15.5% increase in profit.
So one more head on a bed each night makes a significant difference in the hotel’s bottom line. This is due to the high fixed costs and low variable costs. If variable costs were $30 each night and the fixed costs remained at $79,000, with a 30% occupancy rate at $90 per night, our gross margin would equal $75,600. This is $3,400 shy of the amount we need to cover fixed costs.
The math simply reinforces the value of a single additional head on a bed when the variable costs are so low in comparison to the rental income earned for that one night.
Aggregated Value of Exercising Heads on Beds
To really drive home the point, an illustration of this concept with three different approaches for the hotel is presented. The first column will represent the hotel using the national registration system exercised by its franchisor and occupancy is 35%. The next column identifies where the hotel uses the local chamber of commerce and a secondary website registration system to increase the occupancy to 37%. The final column represents what happens when one of the clerks negotiates a deal with the local university whereby any guests arriving in town and using this hotel will be charged only $65 per night. The university guarantees 200 guests per year and that is exactly the number that shows up throughout the year.
Again, the conditions are the same as above, the rent is $90 per night, variable costs are $16 per night and our fixed costs remain at $79,000 per month. Let’s see the value of adding 200 more heads on beds at a discounted rate.
35% Occupancy 37% Occupancy 37% w/University Contract
17,885 Bed Days 18,907 Bed Days 19,107 Bed Days
Single BR Stays $1,609,650 $1,701,630 $1,714,630
Variable Costs 286,160 302,512 305,712
Gross Margin $1,323,490 $1,399,118 $1,408,918
Fixed Costs 948,000 948,000 948,000
Profit $375,490 $451,118 $460,918
Wow, look at the difference! The additional 200 bed days at a discounted rate ($65 instead of $90) equates to an additional $9,800 of profit. Look at the difference of 37% occupancy over 35%. This is a marginal 1,022 bed nights over the course of a year and the profit increases a staggering $75,600! This is a mere 3 additional guests per night to achieve a 20% increase in profit.
This truly illustrates the value in the aggregate of getting more heads on beds. Those programs of aligning with certain organizations to house their guests when they come into town or any other program that shows any slight opportunity will make a big difference in the bottom line. This is because in this industry, variable costs are so low, any marginal increase in guests (heads on beds) adds a lot of cash to the coffers. Act on Knowledge.
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]]>The post Value Investing – Absolute Dollars first appeared on ValueInvestingNow.com.
]]>In the hospitality industry, there is one financial tenet that takes precedence over any other business perspective. With this industry, it is about putting the maximum number of dollars (ABSOLUTE DOLLARS) in the register after each day. One of the most misunderstood business dynamics of this industry is the higher than average fixed cost to run the company. Golf courses are a perfect example. Golf courses qualify as one of several different types of hospitality based businesses and they have an extremely high fixed cost for operations.
During a typical day, the grass has to be cut on every green, about 6 holes require mowing and maintenance, all tee boxes and greens need to be watered. And in addition, the pin placements must be changed on all 18 greens every morning. Think about the high labor costs to maintain an entire recreational facility like a golf course. This doesn’t count the cost of labor for the Pro Shop or the concession area. Whether two golfers play or 200 play on any given day, the cost to operate and maintain that golf course is not going to change. This is what is referred to as a high fixed cost based operation (business).
Now there are some marginal costs to operate a golf course. It costs about 40 cents to recharge the batteries in the golf cart each night that is rented by the golfers. Other marginal costs might be the cost of the water used when flushing the toilet or maybe about 50 cents worth of grass seed to repair the divots from the duffers in golf. The point is: there really are no marginal costs in the overall scheme of things for a golfer to play this game. If the course can fill up every slot available every day, they will maximize the annual profit. But they can’t really do that because weather and seasons come into play. Here’s a personal example:
I live in the middle section of the United States; therefore the golf season is generally shorter. This means that from a golf course operational viewpoint, every golfer willing to pay money is valuable to the bottom line. Even if you could only get $10 out of that golfer, that’s $10 more to offset fixed costs. Once the fixed costs are paid, then every marginal dollar is pretty much pure profit! But you must have absolute dollars to pay for the fixed costs first. If not, then you will not make a profit; seriously, those fixed costs have to be paid.
For those of you that don’t understand, fixed costs exist whether you make a sale or not. If you desire a more thorough explanation of this basic business principle it is explained in more detail in this article: Fixed Costs – Explanation and Examples.
On a recent Saturday I took my two sons to a local golf course. They have a great practice facility and both of my boys are on the high school golf team and this place is perfect for practicing. Once we were done practicing on the range, both of them wanted to play nine holes. It was after 5 o’clock, again on a Saturday, and so we knew we could only get in nine holes. When I go out with them, I traditionally will not play because I desire to work with them and teach them about course management (how to reduce your overall score with proper shot placement). I usually get a golf cart for two reasons, first to speed up play and secondly, I need a cart to carry my alcohol which helps me manage my frustration with my sons’ various approaches to the game of golf. I normally walk the course to work off some of the middle aged gut I have but the cart helps my sons focus on their game by eliminating the need to carry their clubs. In effect, it really speeds up play.
Mind you, golf courses make most of their money on Saturdays and Sundays. The demand is high, the availability is low. I never play on Saturday or Sunday until after 2 o’clock because that is the earliest a golf course will offer any kind of discount to their fee structure. I understand this, either pay the rate or another golfer will be there in a few minutes wanting to take your spot on the course. It is simply ‘Supply and Demand’.
OK, so I have set the stage for this interesting interaction between a willing customer and a business operator that has difficulty with simple math. Seriously, 2nd grade math!
I walk into the clubhouse and there behind the counter is one of the assistant managers (of course he is the low man on the totem pole because its Saturday after 5 o’clock). On this particular weekend we have two major sporting events going on in town. First is a NASCAR race which attracts about 90,000 people, I would imagine that about 4 to 10 of them are golfers that would have been possibly here to play if not for the race. The other is a minor league baseball team playoff game. There might be one or two golfers there that would be here if not for the championship game. In addition, let’s not forget, its SATURDAY after 5 o’clock in the early fall and college football is on TV. I’ve already been here for two and half hours working with my sons on the practice range. There were four other folks out there that hit golf balls during that 3 hour time period. We pretty much had the driving range to ourselves. Prior to going into the Pro Shop, I scanned the first tee box and nobody is there, nobody is even on the first hole. Actually, there are about a dozen cars in the parking lot altogether, one of them is mine, and I’m pretty confident another belongs to the guy behind the counter. My point is this: THERE IS HARDLY ANYBODY HERE!
Did I mention, it is SATURDAY, AFTER 5 O’CLOCK. I really doubt there is going to be a sudden influx of golfers at this golf course to justify charging full rates.
Here goes the conversation:
Me: “Hey, how about 9 holes with a cart for two junior golfers. Both are in high school and I’m walking with them. (Because they always ask) One of them is 16 and has a license to operate the cart.”
Assistant: “So you need two carts”. I guess he didn’t quite hear me state that I’m walking; but that is OK, I get that all the time.
Me: “No, I’m walking with them”.
Assistant: “Are you playing?”
Me: “No, I’m working with them in developing their game, and need to walk to work off my gut”. I grab my gut and lift it about two inches indicating the typical middle age male problem from too much beer, sweets and lack of physical exercise.
Assistant: “Let me see here”, runs the register. “That will be eighty dollars ($80)”.
Me: “Excuse me?”
Assistant: “$80”
Me: “No you misunderstood, two juniors, one cart, nine holes”
Assistant: “No, it is right”
Me: “Why so high?”
Assistant: “It’s Saturday”
Me: Pointing outside to the first tee box, “Nobody is here. It’s after 5 o’clock.” Looking at him perplexed, I proceed. “SERIOUSLY?”; now I’m wondering why this guy doesn’t do what every golf course operator does for me when I show up wanting my two kids to play and nobody is on the course. Invariably, I always get the guy behind the register to do a two for one discount or a ‘how about I just charge for an adult and you guys go play?’ This guy, well, I think he must think that this is Augusta, and I need to pay the $80. If it were Augusta, no problem, I would fork over the money in a heartbeat; but this is a simple private golf course open to the public in a county with a population of 90,000 people. There are about 8 golf courses within a 45 minute drive. There is some competition to keep the prices in check.
Assistant: “It’s Saturday”
Me: “After 5 o’clock, there is about 2 and half hours of daylight left?” “Don’t you want some cash in that register tonight”. Now I’m intimating to him about the value of cash in the till box over his insistence that “It’s Saturday”.
Me continuing: “Do you understand the concept of marginal dollars?” “How about you charge me for one junior instead and make some money?”
Assistant: “It’s Saturday”
Me (jaw open): “No thanks, I’m not paying $80 for my two kids to play 9 holes of golf; even if it is Saturday!” “AFTER 5 O’CLOCK” (emphasis added).
I left and we went on down the road towards home and stopped at another course (similar quality of a course, but their practice range isn’t as nice as the one I write about above). The guy behind the counter at the second course gets it: “$12 each” he says. “And I’ll throw in the cart”. We were done by 8 on Saturday.
The difference between these two businesses: The second golf course’s register had $24 more in it than the first course (assuming similar number of players that day). At the end of the year, the bottom line for the latter course is going to be $24 more than if I didn’t show up. The latter guy gets it; it’s about ABSOLUTE DOLLARS to offset fixed costs. Even if it is SATURDAY, AFTER 5 O’CLOCK AND NOBODY IS ON THE GOLF COURSE! Act on Knowledge.
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