At the recent Canadian Hotel Investment Conference held this past May in Toronto, one of the breakout sessions posed the question: CapEx - How Much is Enough? A focus of the discussion was the CapEx 2007 Study produced by the International Society of Hospitality Consultants (ISHC). Brian Stanford, Director of PKF Consulting, (and an ISHC member) provided some interesting discussion on the amount or percentage of reserves that should be set aside for capital expenditure. The panel comprised industry consultants, hotel investors and lenders who were polled to identify consensus on the issue. This article will draw from that session and highlight some of the findings from the CapEx 2007 Study to determine if the historic 3% or the current 4% reserve for replacement guidelines are still adequate.
Commissioned by the ISHC, CapEx 2007 is a study of historical capital expenditure trends in the hotel industry from 2000 to 2005. The data was drawn from a sample of 377 hotels representing more than 30 hotel brands and a number of independent hotels owned and managed by experienced hotel professionals in North America. This study is useful for asset managers and advisors as it is a barometer for industry expenditure. It should be noted that the results represent what was spent over the 2000 to 2005 period and was not necessarily required to be spent.
Figure 1
A natural tendency is to focus on guest product when discussing replacement costs for FF&E rather than the physical plant of the hotel. The CapEx 2007 Study found that the split between expenditures on guest product and the physical plant was significant and varied by hotel type. As Figure 1 shows, Full Service/Luxury hotel expenditure on guest product accounted for $1,589 per room or 55% of total expenditure while the balance, $1,300 per room or 45% went toward building, mechanical and structural related improvements. A 60/40 split toward guest product was found for Extended Stay hotels, however Select Service expenditures on the physical plant were $794 per room or 70% of total expenditures exceeding guest product expenditures by $454 per room.
The CapEx 2007 study confirmed that overall FF&E expenditures increase as hotels age, and by hotel type. As newer hotels have the latest design and physical plant elements, which are at the start of their useful life, capital expenditures are minimized in the early years of operation. However, expenditures will increase dramatically over time as the hotel ages. The study reported the overall total FF&E expenditure for Full Service/Luxury and Select Service hotels averaged 5.1% and almost 5.0% of revenue respectively, while Extended Stay hotels averaged 5.9%. This shows that the traditional 4% reserve was not sufficient and suggests that a reserve closer to a 5.0% may be necessary (Figure 2).
Figure 2
For all hotels, in the first 15 years of operation, a 4% reserve was found to be more than sufficient. For example, Figure 2 shows Select Service and Extended Stay hotels in operation for less than 5 years, expenditures were less than $500 per room or 0.7% of revenue. For Full Service/Luxury hotels 5-15 years in operation, total FF&E expenditure amounted to over $2,000 per room or 3.5% of revenue. The study found that those hotels in operation in excess of 15 years required an increased level of expenditures. Select Service and Extended Stay properties expenditure totalled 8.7% of revenue (or $2,000 per room) and 10.5% revenue (or $3,500 per room) respectively, compared to 5.4% of revenue (or $3,000 per room) for Full Service/Luxury hotels.
Some conclusions that can be drawn are as follows: Owners of Full Service/Luxury hotels are faced with higher expenditure levels, however the average levels of expenditure are more consistent over time. Owners of Select Service and Extended Stay hotels will minimize their capital expenditures in initial years of operation (as seen in Figure 2) but will incur higher expenditures as the assets age.
With respect to FF&E replacement it is recommended that operators prepare a 5-year capital plan and that the total dollars required be accrued instead of placing the focus on the actual FF&E percentage to reserve. The dollar amount set aside for capital expenditure should ultimately be approached on a case-by-case basis, but the data clearly indicates that over the mid to long-term on a percentage basis, even a 4% reserve is probably not adequate.
- The ISHC 2007 CapEx study is available through the American Hotel and Lodging Association.
Christopher J Pinto, Consultant
PKF Consulting, Toronto
