Risk Analysis of Individual Hotel Assets

Given that most investors seek to minimize risk, asset managers need to understand and neutralize asset risk within hotel investments

That means.and the bottom line is..”working down in the trenches,” that is evaluating, negotiating, and administering various aspects of the property’s performance is the first step.

The ability to understand and to neutralize risk brings value to investors. It is important to remember that hotels are risky investments.

To manage risk, the best asset managers use a set of tactics that can allow the property to “ride the cycles.” This means finding ways to magnify revenue enhancements during the “fat” part of the market cycle and conversely, it means adopting procedures or making changes to minimize costs during the “thin” part of the cycle when demand shrinks.

Managing the business risk of the property is an important means of reaching the asset manager’s goal of increasing the overall value of the property.

Asset managers can also work with owners to manage financial risk. This involves taking advantage of financial leverage in a proactive fashion. The optimal level of debt depends on the point in the cycle. When riding up, increasing the loan-to-value ratio by adding debt can magnify equity returns. When riding down, decreasing the loan-to value ratio by retiring debt enhances the probability that the deal will continue to be worthwhile. Structuring debt to allow a quick, low-cost prepayment is part of proper asset management.

To implement strategic policies that minimize risk, asset managers need a strong understanding of the specific levels of risk a property faces. They need a set of tactics to manage risk. These include the risk-adjusted discount rate, using the weighted cost of capital, or a risk-adjusted cash flows. Here, one estimates cash flows, taking a sort of “bad things might happen” approach.

Also Asset managers consider a number of scenario analysis techniques. Simulation is the best and most widely used. One specifies the probability of distributions for a range of variables or inputs for a model.

A more basic version of simulation is a sensitivity analysis. Here you consider changing one or two inputs at a time, then measure how sensitive an item is to changes in the inputs. For example, what happens if the average rate falls? What happens if occupancy increases dramatically? This method has obvious limits, because situations in which only one or two variables drive changes are rare.

The difficulty is in specifying with any certainty the changes that are likely in a best-case or worst-case scenario.

For advice on how you , as an owner, can use these techniques to minimize your hotel investment risks contact mark@turnerlodgingc.com

 

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