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What Is An
Inn Worth? How Lenders Look at
Value
Article by
Doug Carleton
How much an
inn is worth is always a popular
topic . To an innkeeper who has
invested capital, a number (maybe
a lot) of years and, most of all,
a tremendous amount of emotional
and physical energy, the inn has
one value. To a buyer an inn will
probably have a different value,
and it is not going to be the
same for every buyer. A buyer
looking for a business who does
not need to count on the income
from the inn to support them may
be willing to pay one price. A
buyer looking at an inn purely as
a business venture (albeit a very
attractive business with
interesting clientele) that has
to be the sole source of income
may have another
value.
And there may
be a third party interested in a
value. If the buyer needs to get
a mortgage, a lender is going to
establish a value for the inn,
and it may be different from
either the buyer's or the
seller's. How a lender arrives at
a value for loan purposes is
something that can be helpful for
both sellers and buyers to
understand.
In our
industry, there is a segment of
inns that contain between one and
four rooms. They operate like
other inns, but because of their
size generally are not considered
commercial properties. This has a
bearing on how lenders will value
them and determine how much they
are willing to loan. Properties
of up to four rooms will usually
be viewed by lenders as
residential properties, which
simplifies the valuation and loan
process considerably. In
residential lending, the normal
process for a lender to establish
a value is to have an appraisal
done, against which the lender
will usually lend a certain
percentage, say 75% or 80% of the
appraised value. The buyer of
such an inn qualifies for the
loan based on their personal
income available to pay the loan,
just like a house purchase. In
this situation, the lender
generally doesn't care how much
income the inn earns because it
will not usually be enough to
support a mortgage. The lender
looks purely to the borrower and
their income.
Once an inn
gets to five rooms and above, it
is probably going to become a
commercial property for mortgage
purposes, and the process of
determining how much loan to make
becomes much more complex. Now
the income from the inn available
to service the mortgage becomes
the critical factor, both in
terms of valuing the inn and in
terms of how much a buyer can
borrow.
Let's look
first at a commercial mortgage.
One of the most important
determinants of how much someone
can borrow on a mortgage is
governed largely by what the
debt-coverage ratio will be. The
debt-coverage ratio is the ratio
between the amount of cash
available from the inn to make
mortgage payments and the
payments themselves. The way to
determine the debt-coverage ratio
is, first, to determine the net
operating income (NOI) of the
inn. This is simply the gross
income minus operating expenses.
The operating expenses are all
the expenses, both fixed and
variable, that are required to
run the inn on a day-to-day
basis. The NOI is what is left to
pay the debt service, with
whatever is left over going to
the innkeeper.
To use a
simple example, if the NOI is
$1,000, and the amount of annual
debt service is $700, the
debt-coverage ratio is 1.43
($1,000 divided by $700). If a
lender has a requirement that
their debt service needs to be
covered at least 1.25 times,
divide the $1,000 by 1.25, and it
gives you $800 available to make
mortgage payments. Then, by
applying an interest rate and a
term, you can determine how much
loan a property will support. In
the above example, if the loan
terms were 71Ú2% for 25 years,
the $800 would support a loan of
$9,021.
The most
important thing to a lender is to
feel assured that their loan is
going to be paid back. And it is
the NOI that is going to be used
to make the loan payments. A
lender is not going to care how
much someone says a property is
worth if it does not generate
enough cash to pay the
mortgage.
Now let's go
back to the NOI and its
relationship to value. If an inn
is considered a commercial
property, a commercial appraisal
will be required as part of the
loan approval process. In
commercial appraising, value is
established using a combination
of three approaches &endash; the
income capitalization approach,
the cost approach and the sales
comparison approach. In the
income capitalization approach,
the net operating income (NOI) is
converted into a value by means
of the capitalization process. To
illustrate the capitalization
process in the simplest possible
way, suppose you are going to buy
an investment and you have a rule
that you want to earn at least
10% on your invested capital.
That 10% is your capitalization
rate, which you will use as a
means of determining value. If
you are offered an investment
that has a cash flow (NOI) of
$1,000, you would be willing to
pay $10,000 for that investment
because it would give you a 10%
return, or $1,000 a year.
Therefore, to you, the value of
that investment is $10,000. If an
inn has an NOI of $70,000 and the
appraiser is using a 10%
capitalization rate, the
indicated value under the income
capitalization approach is
$700,000.
In the bed
& breakfast industry, the
cost approach is the least
accurate except in cases of a new
construction project, in which
case the value established by the
cost approach will be the actual
cost to build it. For existing
inns, the cost approach becomes
less reliable or useless. For
example, to apply the cost
approach in an appraisal of a
1790 brick Federal-style inn
would be a waste of time because
it would cost a fortune to
reproduce faithfully, and would
be highly unlikely to be sold as
a business at that
price.
The sales
comparison approach can be more
useful, but it has its own
built-in set of limitations. The
farther apart geographically the
sales comparables that an
appraiser can find, the less
relevant they become. It's one
thing to compare a 56-room Sleep
Inn in one state with a 56-room
Sleep Inn in an adjacent state
because the physical facilities
are identical and the room rates
are similar because it is a
franchise. But to compare a
seven-room inn in the mountains
of one state with a seven-room
inn near the seacoast in an
adjacent state, or even the same
state, becomes more difficult.
Also, the buildings themselves
may be dramatically
different.
There are two
other frequently used valuation
techniques in the bed &
breakfast industry that are
variations of the sales
comparison approach. One is the
sale price per guestroom. This is
simply the sale price divided by
the number of rooms. This is a
commonly used method in the
hotel/motel industry where there
are a relatively large number of
sales of properties that are
essentially the same. Because of
this, it is much easier to draw a
value conclusion for a hotel or
motel property because an
appraiser may find ten sales of a
comparable market segment
property (such as a particular
flag motel). But in the bed &
breakfast industry, because
properties are almost universally
so dissimilar, this method leads
to a very imprecise measure of
value.
The other
method used in the industry is
the Gross Revenue Multiplier
(GRM). This method simply takes
the sale price of a property and
divides it by the gross revenue
of the inn. So, for example, an
inn that had gross revenues of
$100,000 and sold for $500,000
would have a GRM of 5. The GRM is
closely akin to the sale price
per room, and suffers from the
same limitations.
Establishing a
fair and accurate value for an
inn is important for anyone
either already owning an inn or
contemplating a purchase,
especially if a mortgage is going
to be required by a buyer once an
inn is sold. Fortunately, for
smaller inns, those of less than
five rooms, the process can be
relatively simple because the
value is usually going to be
based on the inn's value as a
single-family residence, and
residential appraisals are very
straightforward and simple
compared to a commercial
appraisal. For larger inns that
must be valued as commercial
properties, there are several
different ways to come up with
values. But as a starting point,
establishing a value as though
you were a commercial lender is
the most realistic place to
start. Apply a capitalization
rate of between 9 and 11% to the
NOI of the inn, and you will have
a very good starting point. Many
other factors may ultimately come
into play in determining the
final value, but a value based on
cash available to make loan
payments is usually the most
accurate and widely used method
in the hospitality
industry.
Buying
Assets or Shares - What's the
Difference?
Terry
Elder
Tax
accountants acting on behalf of
either sellers or purchasers of
businesses are often asked if it
is better to sell/buy the assets
or the shares of a
company.
Although there
are many factors which enter into
answering such a question, the
simple answer is that, in most
cases, if you are a vendor, you
should sell shares and, if you
are a buyer, it is better for you
to purchase assets. However, as
you would expect, there are many
caveats and mitigating factors
which will determine your best
course of action, whether you are
buying or selling.
Tax Pros
and Cons
As an
individual seller of shares, you
have a definite tax advantage
because much of any gain will
either be sheltered by the
capital gains exemption or taxed
at a maximum rate of
25%.
If a holding
company sells the shares it holds
or its net assets, it is the
company that has the capital gain
and, since a company has no
capital gains exemption, it would
have to pay taxes within the
company on the gain.
From a buyers'
point of view, the purchase of
shares provides no immediate tax
breaks. The cost of the shares
cannot be deducted against the
earnings of the business
acquired, although, with the
proper structuring, the interest
costs on money borrowed to
finance the share acquisition can
be deducted. The cost of buying
the shares can be deducted only
against the proceeds of a future
sale of the shares and this could
be many years away.
If the buyer
were to buy the net assets from a
company, then the assets could
normally be written off against
future earnings of the
business.
Buying
History
Since the
shares of a company represent a
separate legal entity, when a
buyer purchases the shares, he or
she is buying the history of that
business, including the name and
any contracts and leases entered
into by the company.
If there are
taxes owing from prior years and
which are not recorded on the
financial statements, the company
continues to be responsible, as
do the new directors. If a legal
claim or other unrecorded
liability arises as result of
products sold in prior years, the
company would continue to be
liable for damages.
Normally, on
the purchase of shares of a
business, the buyer would ask
that the seller provide a
warranty for such contingencies.
Should a claim arise during the
warranty period, then the amount
would be deducted from the
remaining amount owing to the
vendor. If the full sale amount
had already been paid to the
seller when a claim arose, then
it would up to the new owner to
try to claim back the contingency
cost from the seller (good
luck!).
On an asset
purchase, the buyer would not
necessarily have these concerns.
The assets are sold out of the
company and any claim or lawsuit
would be against the limited
company, not against the new
owner of the assets.
Employees
A more
important issue for the buyer of
shares is that the company
normally continues to employ its
workers. Should the new owner
wish to terminate any employee
for whatever reason, the company
could be faced with significant
termination benefits.
Unless these
are factored into the purchase
cost of the shares, the new owner
could be faced with a serious
situation if the employees'
skills and requirements for the
business had not been properly
evaluated before the
purchase.
For someone
buying assets, the purchaser
could decide which employees to
hire for the ongoing business and
leave the worries - and costs -
of terminating the rest of the
employees with the previous
company and its owner.
Tax Loss
Carry Forwards
So far, the
scale is tipped heavily in favour
of a buyer purchasing assets.
However, one good reason a buyer
might wish to acquire shares
would be if the target company
had significant tax losses
available for application against
future taxable income. Providing
the acquiror continues in the
same or similar business as that
which produced the tax losses, a
purchaser could significantly
reduce the company's future tax
bills. In certain circumstances,
this benefit could far outweigh
the disadvantages of buying
shares.
The purchase
and sale of a business can be
extremely complex. Knowing the
pitfalls and advantages of a
share or asset sale/purchase will
be an important first step in
commencing the
negotiations.
Terry
W. Elder, FCA, and Elder
Financial Services Inc. provide
financial consulting services to
private businesses and their
owners and managers.
To
find out more about Terry's
practice,
please
click
here
What
Is Your Inn Worth?
David
Caples
It has been
five years since you opened your
bed-and-breakfast, and your
seven-room inn is finally
starting to produce the way you
had anticipated. In fact, you
have even mused about "moving on
up." There's a 12-room inn
further south that needs your
care and you need its
climate.
Hmmm...the
mental questions
start:
* I wonder
what this inn is
worth?
* Have we
built up enough equity to make a
new deal work?
* Will buyers
be interested?
* Will they
think it's worth our asking
price?
You asked the
same questions when you bought
the inn originally:
Is it worth
this price?
Potential
buyers are going to ask the same
question, but today they are
better prepared. They come fresh
from aspiring innkeeper courses
and valuation seminars at
national meetings. They have
lodging industry and B&B
studies and often a consultant or
buyer advocate to help them
review the numbers.
In today's
world, the transfer of an inn
property is best accomplished if
both the seller and the buyer are
well prepared. For both parties,
this will take some pre-planning
and investment of time and money
to be sure it's accomplished
correctly.
Advantages
to the seller:
* You will get
the full value of the "sweat" and
investment you have put into
shaping the inn into a
business.
* The inn will
sell within the time frame that
is important to your future
plan.
* It is not
uncommon that you will have to
participate in financing some of
the acquisition, and the more
equitable the deal is, the less
likely you will have to take it
back.
Advantages
to the buyer:
*
Well-organized operating data
will be available from the seller
to provide a profile of the
investment.
* The
financing process will be
accelerated and is often more
successful when a strong business
plan is presented with documented
historical data and
well-thought-out
pro-formas.
Sellers
Checklist
Back to our
seven-room inn. What do you need
to get your inn ready for sale?
Let's look at the
checklist:
Document
your operating
statistics.
In our
opinion, you have to be ready to
sell your inn the day after you
buy it. Whether the inn was a
lifestyle, economic or combined
decision, it's still an
investment when it's time to
sell. And you can't always
predict when you will have to
sell, such as if you were to
become ill or
disabled.
Just like your
personal money-market-account
balance, daily stock prices and
monthly rental income statement
from that apartment investment,
your daily, weekly and monthly
inn statistics should always be
at your fingertips. Those numbers
should be treated with as much or
more care as any other
investment.
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Action:
Maintain
a Daily
Report.
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Clean up
your operating
statement.
The real value
of an inn-setting aside the
(non-economic) lifestyle
component-is its ability to
generate cash flow. Our sample
inn should produce about $59,926
in net income before debt (38
percent of gross). But the
innkeepers have operated the inn
in a manner that fits their
personal objectives and family
needs. Additional staff and other
expenses have accrued. The actual
net is $47,310.
This reduced
net income could have the effect
of undervaluing the inn by
$115,000 (see Income
Capitalization). As you can see,
it's important to clean up the
operating statement before having
the inn valued or listed for
sale. It can take two to three
years to create clean statements
reflecting a historical trend
that a prospective buyer can rely
on. So some pre-planning is
essential.
Estimate
the value of the inn
yourself.
Utilize the
three methods described below.
Use them in concert with one
another to give you perspective.
Never use one by itself. As an
example, the term "Price Per
Room" can be misleading if used
by itself. This number most often
represents an average price of
inn rooms in a geographical area
or of a particular size. It
really doesn't consider the
situational nature of an
individual inn, its operating
season, revenue steam or real
firepower&emdash;the ability to
put income to the bottom line. If
you are serious about the sale of
your inn, value the inn from the
perspective of a buyer and ask
yourself: If they pay my price,
will the inn be able to pay for
itself?
Have the
inn valued by a
professional.
We look at
more than 100 inns a year, and
our observation is that the
majority suffer from overstated
and/or unsubstantiated asking
prices. Equally distressing are
situations in which the innkeeper
has underestimated the value of
the inn. This is money left on
the table from which the seller
should have benefited.
In either
case, an appraisal and/or a
valuation by an outside,
independent professional would
probably have established a
realistic asking price, supported
and documented the data and
accelerated the transfer
process.
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Sample
Profile:
Let's say you and your
spouse want to sell your
historical inn, which
was built in the late
1800's and has been
meticulously restored
and embellished since
you took it over. Your
65 percent occupancy is
above the national
average (53 percent,
according to PAII's
Industry Study of Bed
and Breakfasts/Country
Inns, 1996 Study). The
average daily rate (ADR)
is at $95, a little
below the PAII-reported
$107 national average.
This produces a gross
revenue of $157,700, but
a slightly below average
net-before-debt of
$47,310 (30
percent).
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Appraisal
Look for a
certified appraiser that has
demonstrated experience with
appraising inns. There aren't
many, but those who have the
experience usually list this as a
specialty. Initiate a
"competitive" search and request
a bid. Quoted prices can vary
substantially. A reasonable range
might be between $1,500 and
$3,000. Make sure the appraiser
understands that the objective is
to determine a fair market price
for an anticipated
transfer.
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Action:
Ask your banker for
recommendations on
appraisers.
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Valuation
There are
approximately a dozen consultants
nationally that have significant
experience valuing small inns.
Three or four criteria are used
to determine market value of the
inn. The consultant should be
able to look beyond the valuation
at hand and assist you with a
strategic plan to effect a
transfer. This could include a
review of the inn product, its
operating performance data and
recommendations regarding
improving the bottom
line.
Prepare
a profile
package.
Subsequent to
determining your asking price and
concurrent with making a
commitment to sell the inn, you
should be prepared to "open up
your chest" to all queries. This
is no time to be shy or have
"proprietary
withdrawal."
Qualification
is a two-way process. The seller
wants to be sure the prospective
purchaser is capable of affecting
a transfer. The buyer doesn't
want to waste time with an inn
that doesn't meet his objectives.
But more importantly, the buyer
can't make a reasonable offer
without seeing the operating
performance data. Anyone who has
bought or sold a business knows
this is the case.
At the get-go,
you or your representative should
prepare a short profile package
that will fulfill most of the
initial tire-kicking criteria,
including:
1. A
description of the inn and a
historical background
2. Location
and land description
3. Zoning and
licensing status
4. A brief
building and furniture/ fixtures
description
5. An
explanation of the main sources
of revenue
6. Up to a
five-year history of occupancy,
gross revenue, room nights sold
and ADR.
Work to
the end.
Smart
innkeeper sellers never break
stride. From the operating
statement/clean-up period through
the sales/marketing process, the
seller should be diligent in the
endeavor to improve the net
income-generating ability of the
inn. This can include additional
marketing tactics, continued
product improvement, room
expansion and/or creation of new
sources of revenue. Each
additional $1,000 brought to the
bottom line (net before debt)
could add up to $10,000 to the
final sales price.
Valuation
Techniques for Buyers and
Sellers
There are
three calculations for valuing
inns. When used in aggregate,
they will be reliable in
assisting you in determining a
fair market value for the inn in
question.
1. Price
per guest room.
This is the
most often quoted statistic on
inn sales, and the most
unreliable when used by itself.
This number is most often an
average of final inn transaction
prices over a period of time, by
geographical area or by the size
of the inns surveyed.
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Calculation:
Sales price ÷
number of guest
rooms
Example:
$630,000 (sale price)
÷ 7 (rooms) =
$90,000
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If a seller
were to use this number by itself
in determining a potential asking
price, the outcome could easily
be understated or overstated. One
example might go like this: "The
Franklins' got $105,000 per room
for their inn. Wow! Ours has to
be worth $115,000." The fallacy
in this approach is that the cost
per room does not reveal some of
the background issues that may
have affected the price. Was the
sale arm's length? Were there
special terms that encouraged the
buyer? Does the inn have
expansion potential? Is there a
separate owner's cottage? Is the
inn profitable?
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Action:
The best way to use this
number is as a
benchmark. Several
consultants and brokers
conduct studies on
geographical areas and
report this statistic.
Lodging Resources
Workshops compiled a
report for the Southeast
that reflects an average
$90,000 per room for
inns sold in the last 24
months.
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2. Gross
Revenue Multiplier
(GRM).
This is a more
reliable calculation that looks
at the inn's ability to create a
revenue stream as a factor of its
value.
In setting the
price of an inn, a "multiplier"
value must be applied. After
researching sales nationally and
subsequently completing "proof
calculations," we have found that
(4) is most often a multiplier
that creates a fair price for
both seller and buyer.
We find the
window for most transactions is
the three-to-five range. There
certainly may be factors that
would encourage a seller or buyer
to exceed this range, including
recent past performance of the
inn, historical significance of
the property, additional vacant
land or buildings for expansion
and/or an unusual furniture
inventory. For the informed
buyer, exceeding the
three-to-five multiplier will
often raise a flag of caution and
will require further explanation
from the seller.
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Calculation:
Gross annual revenue x
GRM
Example:
Using our same
seven-room inn profiled
above.
Gross
revenue =
$157,700
$157,700
x 3.5 =
$551,950
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3. Income
Capitalization.
Definition:
Income capitalization is based on
the principle that the present
worth of a future income stream
is the real value of a going
concern. The calculation of value
focuses on the Net Before Debt
(NBD). This is the amount left
after deducting all expenses from
revenue, excluding depreciation,
debt service and owner draws. The
NBD is then divided by a cap
rate. The cap rate is a
reasonable rate of interest one
would expect to earn on an
investment at a certain level of
risk.
Nothing beats
this index as the acid test of
inn valuation. Income
capitalization focuses on the
fire-power of an inn&emdash;its
ability to put income to the
bottom line to service debt and
generate profit. In essence, will
the inn pay for itself and
generate the desired profit for
the owners?
Our
observation of consultant
valuations and formal appraisals
puts the cap rate for inns
between 9% and 12%. Lodging
Resources Workshops finds most of
its valuations calculated with a
cap of 10-11% PKF's 1997
Hospitality Investment Survey
reflects the cap rate for lodging
"to hover around the 11% mark"
since 1986.
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Calculation:
Net before Debt ÷
Cap rate
7-Room
Example:
Gross
revenue =
$157,700
Net
Before Debt =
$59,926*
Cap
rate = .11
$59,926
÷ .11 =
$544,781
*38
percent after clean-up
of the operating
statement
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The innkeeper
of our seven-room inn now has a
reasonable valuation window. The
potential seller can determine if
the time is right to sell,
relative to the values developed
by the three approaches. Asking
price strategy and negotiation
limits can now be
established.
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Valuation
Summary
Price
Per Guest Room =
$630,000
Gross
Revenue Multiplier =
$551,950
Income
Capitalization =
$544,781
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The decision
to put your inn up for sale, in
the best of worlds, should be a
long-term, choreographed "dance"
in which the outcome is
predictable. It is the
near-perfect timing of matching
your personal and financial
objectives. It is the product of
continuous shaping and attention
to detail. The result is a
transfer price that is fair to
the buyer as well as the seller,
but meets the seller's investment
objectives.
What Will a
Lender Want to Know When You
Sell?
How You Can Help Your
Buyer's Lender Say Yes
Let your mind
roam ahead in time for a moment.
You have put your property on the
market and you now have an offer.
The buyer is going to apply for a
mortgage. What you are doing
today, or not doing, can affect
your borrower's loan application
and possibly your sale. When the
time comes to sell, you can have
a package of information that is
not only a good sales package,
but also beneficial to the lender
as well as the appraiser when
analyzing your property for a
loan.
Residential
Loans vs. Commercial
Loans
When you sell,
if you have three or four rooms,
there is a possibility that your
buyer might be able to get a
residential mortgage because of
the ease of turning the house
back into a residence
(alternative use, in lenders'
terms). A residential mortgage is
usually based largely on the
value of the real estate and the
borrower's ability to pay the
mortgage from his/her personal
income. This would dramatically
simplify your sale because the
primary information the lender
needs for a residential loan is
the value of the property and the
borrower's income. The income
from the B&B is not
considered.
If you have
been running your B&B as a
profit-making venture and have
five rooms or more, then your
buyer is probably going to be
required to get a commercial
loan. A commercial loan is more
complex than a simple residential
loan. For a commercial loan, a
lender needs a great deal more
information because the business
and its ability to generate
enough cash flow to support a
loan are what will be
analyzed.
BUILDING A
GOOD Sales Package
Building a
good sales package can help
facilitate the commercial loan
process and possibly speed up
your sale. Put together a
sales/lender package now while
you have plenty of time to
collect, correct and enhance
information about your
B&B.
Start by
asking yourself some questions:
Has your property changed any
since you bought it (renovations,
more rooms, etc.)?; Was it a
"lifestyle" purchase that turned
into a business?; Have you added
any lines of business, such as
weddings or business meetings?;
Do you cater to a different kind
of traveler now?; Have
demand-generators in your market
area changed?; Has your
competition changed? With these
questions in mind, here is a
suggested outline of a sales
package that would be very useful
to a lender.
Identification
Of The Property
Give a
detailed description of the
property. You should include the
size of the inn, size of the
property, number of rooms, legal
description (deed book and page
number). Don't forget to include
a plat. Photographs can be of
great value to the lender. When a
buyer applies for a loan to
purchase your property, usually
the lender will know nothing
about the property other than
what is in the loan application,
and may even be halfway across
the country. The lender may go to
your web site where you probably
have some pictures, but this is
not very effective. By having a
portfolio of pictures of your
property you can highlight
features that are not on your web
site. You may have some
spectacular views, or you may
have a magnificent property that
is on the National Register of
Historic Places. You are selling
your buyer, but you are also
selling the lender.
Market Area
Analysis
Highlight any
important facets of the area
economy that influence real
estate values. For example, is
the area growing, stable or
declining? Why? This can affect
the general value of your
property apart from its value as
a business. If the area is
stable, or even declining in some
way, it's better to deal with it
up front and show why it has not
had a negative effect on your
business. Local economic
development offices are
frequently a good source of this
type of information.
Neighborhood
Description
The
"neighborhood description" can
cover a fairly broad area with a
B&B, depending on the
location. What is nearby that
attracts people to your area, and
therefore, your B&B? In many
cases, it is something very
specific, like water, or
mountains, or birds, or a nearby
college. Eco-tourism, for
example, is becoming big
business. This information is
extremely important to your
package because it is probably
what will continue to draw
travelers to the inn for your
buyer. Lenders and the SBA know
that many times when a business
changes hands, a business that
was successful under one owner is
not automatically as successful
under a new owner. What draws
people to your area is not likely
to change. For that reason, the
lender can feel a higher degree
of confidence that a change of
ownership will have a minimum
effect on why people come to the
area and to your
B&B.
Lodging
Trends And Market
Analysis
You should
include an analysis of local
hotel/motel supply and demand if
at all possible. This is not
necessarily easy to do, but
between chamber of commerce and
tourism bureaus (both local and
state) and the Internet, you
should be able to piece together
a picture of how well the lodging
market is doing in your area.
Even though it may not have any
impact on your specific property,
it does give a lender an idea of
the desirability of the lodging
market in general. If the hotel
market is strong, that could make
a lender feel more favorably
disposed toward your inn. The
converse is also true.
Discuss your
competition. What other lodging
choices, both B&B and hotel,
do visitors have in your area?
Competition within the B&B
industry could be an issue that
is going to become more of a
factor in the future in buying
and lending decisions. In some
states there are already a large
number of B&Bs and country
inns, offering more choices than
ever for prospective travelers.
For example, if a lender
discovers that there could be
forty-plus B&Bs and inns in
Charleston, S.C., or close to
five hundred inns in Maine, or
well over four hundred in Texas,
he might become a little more
interested in how you deal with
the competition in your area.
This is before even taking into
account the additional
competition from hotels and
motels.
The B&B
industry is maturing and becoming
more mainstream as a choice for
travelers, particularly business
travelers and especially women
business travelers. As a result,
to a lender looking to finance
the sale of your property at some
point in the future, you may find
yourself being looked at as part
of the total lodging industry
rather than as a unique subset.
So it is more important than ever
for you to build a strong case
now for the continued success of
your B&B.
Another thing
to consider is whether there is
seasonality to your market. Is it
a year-round area or highly
seasonal? This can have a strong
impact on a lender's feelings
about a business, and being able
to show how you deal with that
will be to your benefit. The
buyer's lender wants the mortgage
paid twelve months a year. If you
shut down your business for
three, you'd better be able to
convince the lender (through your
buyer) that there will be enough
cash flow in the high season to
cover the low season.
Financial
Information
There are
certain financial documents that
the buyer's lender will require
from your business.
The last three
years' business tax returns and
financial statements (profit and
loss and balance sheet) are the
primary documents. Your operating
statements should also be in
lodging industry format rather
than just some general format. An
interim profit and loss statement
and balance sheet current to
within 60 days will also need to
be included. Almost as important
are three years and current
interim of occupancy percentages
and ADR's, with the last twelve
months broken down
month-by-month. Remember, aside
from the beautiful sunsets,
mountain views, water views,
people, breakfasts etc., you are
still in the lodging business.
You sell room nights, just like
an airline sells seats. If you
don't sell enough room nights to
generate sufficient cash flow to
support the payments on a buyer's
loan, financing for the buyer may
be hard to come by and you may
wind up holding a portion of it
yourself. The quality and detail
of your operating statements
could have a direct effect on the
price you ultimately get for your
property.
Another
important point to consider is
your salary. Are you taking a
salary as owner, and, if so, is
it showing as one of the expenses
on your profit and loss statement
and tax return? If you are not,
perhaps because you have outside
income, a lender is probably
going to impute a salary for the
new owner unless the buyer can
prove outside income. If that
happens, it will come straight
off your profit number and have a
serious negative effect on your
sales price.
For example,
suppose you were not showing a
salary and the lender decided to
impute a $25,000 salary for a new
owner, which would lower your
reported profit by $25,000. One
reason a lender will do this, and
it is legitimate, is as a
contingency against having to put
someone in to run the business if
things don't work out with the
new owner. If the cash flow from
the business covers this number
as well, then the lender is much
more comfortable. If an appraiser
is using a 10% capitalization
rate as part of the appraisal,
lowering your profit by $25,000
will lower the value of the inn
by $250,000!
The more
details a lender has, and the
more information about why the
business is successful, apart
from the numbers they look at,
the better the chances for a
successful conclusion to your
sale - especially if the lender
is not from your area.
Selling might
be the farthest thing from your
mind right now (except on certain
days), but it is going to happen
eventually. A minimum amount of
work now could go a long way
toward maximizing the value of
your current
investment.
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