hotel F&B operate vs lease
My fund is looking at acquisition of an existing hotel limited service asset and looking at the F&B margins and valuations from the appraisal, I was curious as to why a limited service hotel (think Cambria) would ever lease out F&B operations given how the cash flows are valued? Wondering what others thought.
Looking at F&B margins operating vs lease, my understanding is as follows:
Operate the F&B: Rev: $100K Op ex: $70K (standard 30% margin) Mgmt/Franch fee: $7K (7%)
F&B NOI: $23K (23% margin)
F&B val (hotel cap of 8%) = $288K
Lease F&B: Tenant Rev: $100K Op ex: $70K (EBITDAR margin 30%) Rent: $10K (market typical is 10% of revenues for NNN leases)
Cash flows to hotel: $10K (10% margin)
If operating yields $23K > $10K, why would you ever lease out operations? Also, doesn't this belie the concept of operate vs lease should come to the same cash flows, since there's no way a tenant would lease the restuarant at $23K as that would imply revenues of $230K (when revenues are $100K). The only way this would make sense is if you cap the $10K lease payments to a much lower cap rate, but that's not realistic since this is likely not an institution grade tenant and instead a mom&pop restaurant owner who's providing this service and renting out the restaurant space from you..
Curious if others have thought through this issue before or if I'm missing something majorly here.
Thanks.
So if I am following this correctly instead of taking the 23K in NOI, a manager is leasing up the F&B operating for 10k.
I am not positive of your situation, but sometimes hotels have crazy management agreements that were put in place in a way that is ripe to change to extract value. Also a limited service hotel that is a chain might require all hotels to lease out the F&B.
Very unusual for a select service hotel to be leasing out their F&B outlet, unless it is an urban asset/non-prototypical with something more than the cookie-cutter F&B outlet intended by the franchisor.
The beauty of select service hotels is that you do not have to worry too much about F&B, which is a loss leader for most hotels and a pain in the neck to operate, as these hotels are focused almost solely on room sales.
Operating and creating value through F&B upside is how the Chatwal guy from Dream Hotel Group made his mark. I guess the way he was looking at it was that he could push room rates anymore so he created more EBITDA/NOI via restaurants since he has a background in that space.
There are many different factors that come to play. In many cases at the higher end, if your hotel is in a good location, you can lease out the space to a notable restaurateur and include a percentage rent provision. Otherwise, restaurants are clearly a different animal in the sense that it is difficult to run a successful operation. It is very time consuming to create a menu/concept and hire a successful management team. Plus you have a greater risk of the operation failing and becoming unprofitable. A successful restaurant can reflect in other parts of the operation such as room revenue.
I think my point was more towards the fact that if the F&B asset is generating $23K in NOI if owned/operated and the leased asset is generating $10K NOI, why would an owner ever lease out F&B asset? Theoeratically, owning/operating an asset and leasing out the same asset should yield similar valuations, given that although and owned/self operated asset yields higher cash flow it is capitalized at a lower rate than a purely leased asset, given the riskiness of the cash flows of the leased asset are lower than if owned/operated. Otherwise, it wouldn't make sense to lease out the asset to a 3rd party. In terms of owning/self operating, even if the owner is not in the business of running that asset, he can hire a mgmt company to do so (ie a 3rd party company), which is exactly what hotel owners are doing.
In my example above, it would only make sense to lease out F&B asset to a tenant if the tenant can achieve revenues of $230K a year (assuming the lease is $23K at 10% margin) and he an operate the restaurant at much higher sales than the hotel owner. But to the hotel owner he is indifferent because at the end of the day he's still getting his $23K NOI or similar valuation of the asset when capitalized.
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