How to Know if the Price of an Inn is Right?

This article will appear in the next PAII Newsletter for Aspiring Innkeepers.

Of all the questions that we are asked during our Innkeeping Seminars and in our consulting practice, the most important, and most frequent, one is "How can I know if the price for an inn is the right one?"

First, some general background. Most aspiring innkeepers have previous experience in buying real estate, mostly for their own residence. They understand the concept of comparative market analysis (CMA) in which they, or a real estate professional, compare what they want in a home to many, many houses on the market or recently sold. The problem is that inn businesses are really unique combinations of assets, and there may be very few true comparables from which to get price data with respect to recent sales in a given area. An inn is a very different bundle of assets than a house. It is a combination of real estate (i.e., land, buildings and, most importantly, location), furniture, fixtures and equipment (because most inns are sold on a turnkey basis), and, most of all, the financial capabilities of the inn and its good will. Financial capabilities include both the historic cash flow of the inn after expenses, but more importantly, the projected cash flow from operations in the near term. What you are really buying when you purchase an inn is not what it did in the past, but for better or worse, what will it generate in terms of cash flow in the next few years after the purchase. Good will, on the other hand, is a bit more amorphous, and may include some specific assets like the website, URL, phone numbers, guest list, etc., but also its name and the general reputation of the inn to the public.

Financial Analysis: In determining what to pay for your "ideal" inn, the first and most important analysis that has to be done is to review what the historic cash flow of the inn has been, and to compare that data to other similar inns. If you have expressed serious interest in purchasing an inn on the market, you need to see the financial history of the inn for at least the last three years, including occupancy records, detailed profit and loss statements, and in some cases, tax returns for that period. (You may have to sign a confidentiality agreement to get access to this information.)

Once you have the data, you need to develop a reference point for the expenses of the inn to determine which ones will continue in the future and which ones reflect one time occurrences (like specific renovations or maintenance expenses). Some expenses are attributable to lifestyle or personal choices of the current owners (e.g., if they pay for an expensive car through the inn or have decreased their active participation in day-to-day activities, and more staff is hired to cover for them). PAII’s Industry Study of Operations and Finance is an invaluable source of financial data which can be used to compare the financial income and expenses from a given inn to industry-wide data which is broken down by several different categories (e.g., by region, size, average daily rate, location, etc.) By comparing each individual expense account in an inn's financial data against the appropriate industry averages contained in the PAII study, an aspiring innkeeper can identify those areas of expenses as either personal in nature to the owners of the inn or as unexpected and therefore need further explanation. Once this comparison is done, you can then project what this inn might produce in revenue under your management, and more importantly, what the Net Cash Flow (NCF) would be in future years. For purposes of this article, NCF would be the net income of the inn after all expenses but before interest, taxes, depreciation, amortization, and owner compensation (thus an "EBITDA" calculation).

Rules of Thumb: Most aspiring innkeepers who have been out in the market looking at inns have already heard about the so-called "Rules of Thumb" that industry professionals use to track and compare inn sales. These include, specifically, both Price per Guest Room and Gross Revenue Multiplier (GRM). At each PAII Convention (you should absolutely be going to these if you are really serious about becoming an innkeeper) there is a seminar given by inn brokers, inn consultants, and appraisers from around the country called "Valuations From the Four Corners" which details the inns sold during the last year by region, showing the sales price, price per room, gross annual revenue, GRM, and revenue per room. These seminars will be invaluable to you in determining the correct price to pay for an inn.
Here is a look at some Rules of Thumb: Price per Guest Room simply divides the sale price of an inn by the number of guest rooms. This very simple number tells an aspiring innkeeper very little about the nature of the business of the inn. It is only one of many variables that affect price, and likely the least precise and most unreliable of all of the measures of success. In the 2006 PAII Industry Study, the average national price per room was $125,242. Regional data was also available, and varied widely depending on location. Our own Oates & Bredfeldt data for mostly Northeastern U.S. inn sales showed average Price per Room of $126,498 for bed and breakfast inns.

Another Rule of Thumb is the Gross Revenue Multiplier (GRM) which is a calculation of an inn's ability to produce revenue as a factor of its value. Oates & Bredfeldt data (mostly from the Northeast) for the period 2002-2006 showed a GRM of about 4.47 times. Surprisingly, data presented by Michael Yovino-Young, a very knowledgeable appraiser from California, showed GRM approaching, and in some cases exceeding, six times earnings. The most important thing to ask about all of the data behind a GRM is what does the gross income from any business tell you about its profitability and future earnings? This is an interesting statistic to look at or keep in the back of your mind, but it is no substitute for a detailed review of the financial history of an inn.

Capitalization of Income: This approach to valuation is at the heart of most financial analysis of businesses as going concerns, and is one of the three methods used in every real estate appraisal. It basically takes the historic cash flow from the business and projects what it is likely to do over the near term future. This develops a net cash flow (NCF) for the future as a stream of income. The concept is that the value of a business is the present value of the net income that it will generate over the foreseeable future. The present value is represented by a mathematical computation based on a capitalization rate or "Cap Rate" that is a reflection of the relative risk of investing money in that type of business. Thus, the formula is to divide the NCF by the Cap Rate to find the value. By way of example, if the NCF of a business were $500,000 and the Cap Rate were 10%, under a capitalization of income method, the value of the business would be $5,000,000. The lower the Cap Rate, the higher the value. Historically, Cap Rates for inns have ranged from 9% to 11%, but there have been recent data, particularly from California, that seems to indicate that underlying real estate value can impact the Cap Rate by lowering it, and thus creating higher values. The one thing that this approach does not provide is to determine what is the correct Cap Rate for a given area or particular inn. This is a subjective conclusion that must be made based the relative risk of the investment and the present cost of capital. Thus, you would need to look at not only the consistency of the historic NCF of the inn, but also current interest rates on commercial financing, and comparable investment returns on similar businesses. While the ranges help, determining where you fall within such a range is more difficult, and in some cases may require professional assistance.

Debt Coverage Test: This is another way of looking at price and value. This methodology looks at the historic or projected NCF of a business and determines how much of that NCF is necessary each year to pay the debt service on a normal commercial mortgage on the property and how much above the debt service is available for uncertain future events or owner compensation. Most commercial mortgages are offered at a loan/value ratio of 75% (i.e., the borrower is investing 25% equity) with debt service calculated on a 20 year amortization with usually a fixed rate of interest for the first 5 years of the loan. Using the NCF projected from the inn, an aspiring innkeeper can then determine what the annual debt service on the loan would be and to what extent the NCF exceeds that debt service. The ratio is usually given as a percentage with the formula equal to the NCF/Debt Service. Thus, if the NCF was $130,000 and the annual debt service on the loan was $100,000, the Debt Service Coverage Ratio would be $130,000/$100,000 or 1.3 times. Most financial institutions when underwriting a commercial loan will be looking for at least 1.20 to 1.25 times coverage, meaning that there is a cushion in the NCF equal to at least 20% to 25% of the debt service available for unforeseen events or return to the owners. In looking at the Debt Coverage of an inn, you can therefore determine whether the inn "cash flows" or has sufficient earnings to pay a normal mortgage, and if there is excess cash flow, what kind of return does it provide an owner based on the amount of money invested in the inn business (i.e., the down payment, closing costs, renovations, and working capital invested in the inn). This is a method of making sure that you are investing in a sound business that will succeed over the future.

Conclusion: While all of this seems daunting to many aspiring innkeepers, it is very important to understand that an inn is a business that needs to be carefully analyzed before any price negotiation or offer is made. For those who feel uncomfortable doing this type of financial analysis themselves, there are inn professionals (i.e., consultants, brokers, accountants, and appraisers) who can provide fee-based assistance to aspiring innkeepers in reviewing, analyzing, and comparing this financial data in order to come up with the right price to pay for an inn.

The Art of Obtaining Financial Information

It always amazes me when dealing with people looking to purchase an inn. The other day I received an e-mail inquiring on a property valued at $1.8M. The e-mail was simple. It said “This is the type of inn we are interested in. So, if you can pass on to me 3-5 years of financials, I can look them over”. So here is the dilemma. I don’t know who this person is. We have only communicated for a brief time via e-mails and I don’t even know his last name. In addition, I can’t contact him via telephone because he hasn’t shared it with me. I’m not sure of his family status and if he has children, there isn’t room within the current owner’s quarters. I’m not sure if he wants to be in a city, country, or mountains. Most importantly, I don’t have a clue as to his finances! Yet, he totally expects me to quickly disclose very personal information when I know nothing about him.

So here is the real question…If you owned an inn worth $1.8M would you want me to send your financial overview to everyone that inquires? The answer should be no!! When you are at the point of being a “serious buyer”, you should act accordingly. My motto is simple: “Show me yours, and I’ll show you mine!” A buyer that is serious should be ready to share their financial overview. If a buyer isn’t capable of doing this, they are not serious. So my message to all of the future buyers is to prepare a financial statement and be ready to share it on any inn in which you are seeking their financial data. You will now be treated as a serious buyer!

Even a Bed & Breakfast Needs Food Safety Training

It is taken for granted that restaurants have to worry about food service safety, but it doesn’t stop there! Anyone serving any type or quantity of food to the general public should be concerned as well.

It never occurred to me when I owned a bed and breakfast the harm that could be done by simple procedures, such as breaking eggs into a bowl and leaving them on the counter or defrosting frozen food. However, harmful bacteria doesn’t need much time in a warm environment to grow and therefore potentially making your guest sick. Better yet, the proper sanitation of countertops and hands is equally important. We strongly encourage anyone serving food to enroll in a food service safety class, such as ServSafe. This is a nationally recognized organization which is known by all health inspectors nationally. When the health inspector is at your door and things are not going well, you will gain their respect and a few extra points for taking a food service safety class and becoming better informed. So don’t wait! Be proactive and you’ll be surprised by the information you will learn and better understand the goals of health inspectors.

Call or e-mail us and we will assist you in finding a food safety class near you. Just call 207-563-2772 or mailto:rlevitan@oatesbredfeldt.com

2007 New Year's Resolutions

It is the start of the New Year and this is it! You have decided to finally quit your job in the corporate world and take the plunge into Innkeeping! You are serious, but what to do first? Let’s outline the seven steps to successful Inn ownership in 2007!

1. It is time for a reality check
2. Evaluate your financial situation
3. Define your Inn model and the needs of your family
4. Conduct your search
5. Evaluate the numbers
6. Make an offer
7. Quit the job and close on the Inn!

It is time for a reality check. First, ask yourself if you really want to do it? What impact will it have on the family? Do you really want to work with your significant other 24 hours a day? Can you give up the weekend activities with your friends? Can you adjust to a different lifestyle? Income will be adjusted, can you adapt or will you need a defibrillator? It is okay if you say Innkeeping isn’t for you, but if you are still saying you can deal with these changes, let’s go forward.

Evaluate your financial situation. How much money is in your savings account? What is the capital in your home? How long will it take to liquidate your home? How much money is in your 401K (we don’t really encourage using it, but it is good to have as a back- up plan)? Are there investments that can be liquidated? Will your family be able to assist you in the investment? Finally, look under the mattress and make sure that all monies are accounted for. When this is all tallied, keep in mind that a bank will be asking for about a 25% investment from you when purchasing an Inn. Now you know the price point that you can realistically afford to purchase.

Define your Inn model and the needs of your family. In the Fall, 2005 newsletter (available on our website in newsletter archives), we had an in-depth discussion on building a model. In addition to building a model that works for you, your individual family needs have to be considered as well. Do you have children at home? Are they old enough to be part of the Inn or do you need to have private space away from the Inn? Can you live in a conservative owner’s quarters to begin with and then expand into larger quarters as the time passes? All of these considerations should be incorporated into your model.

Conduct your search. Visit Inns, stay at Inns, speak with Innkeepers, and find an area where you will truly enjoy living. Join Innkeeping associations, network with other people who want to become Innkeepers, and be open to new ideas. This will be a rewarding journey if you approach it with your “eyes wide open”.

Evaluate the numbers! You have found an Inn that meets your needs. The emotions are running high and you need to make an offer before someone else buys it! STOP!! Rein in the emotions and make a logical evaluation of the numbers. Make sure that it all makes sense and hire professionals to assist you. We have been involved with too many Innkeepers who now need assistance because of financial hardships. This could have been avoided if only they had evaluated the Inn prior to purchasing it. SLOW DOWN!

Make an offer. You have poured through the numbers and everything seems to make sense. Make an offer and move forward. This is a stressful time and it is important to have a good working relationship with the Innkeeper who owns the Inn of your dreams. Howard has a saying, “there is a lot between the cup and the lip”, meaning that the offer is only the beginning. There will still be many negotiations as you work through the purchase and sale agreement.

Quit the job and close on The Inn! The offer has been accepted, you have completed the purchase and sale agreement, and the bank has approved your financing. You have waited a long time to do this and have had a good time doing it! Quit the job and don’t look back. It is time for a long overdue lifestyle change. The Inn is in your hands now. Our words of wisdom are to have a good sense of humor, remember that decorating is tax deductible, take at least one full day a week off to enjoy with your partner, and enjoy the new lifestyle. You worked hard to get here and now we want you to enjoy it!

P.S. Burn the suits now because you won't be needing them again! Have Fun!

Yield Management? Not!!

I was looking at the December edition of PAII's Innkeeping this morning, and had a thought that I wanted to pass on. Clearly this falls in the range of “for what it is worth.”

I have heard Bill Carroll talk several times on Yield Management, including at last year’s PAII Conference. He is clearly a bright and thoughtful professor. However, this discussion turns me off every time I hear it. It seems to be all about the money and not about the guest. It seems to be the antithesis of the kind of hospitality that we strive for as Innkeepers. Even mentioning the possibility of overbooking rooms and having different rates for the same type of rooms on the same days, makes me cringe. Working hard to have a strong Inn business is something we have taught for many years, but the means of achieving this goal also matters. I think, bottom line, that Yield Management is perhaps the opposite of what we should be teaching Innkeepers or Aspiring Innkeepers. Our segment of the Hospitality Industry has always, always differentiated ourselves based on the high level of individual hospitality we provide to the guests. This has helped us considerably in the tough times following 9/11 when the larger hotel industry was killing itself with discounting and hotels.com type distribution channels. In my opinion, the future of our way of Innkeeping seems to depend upon increasing the level of hospitality to the guests, not becoming more institutionalized and impersonal. We need to continue to think about what is the next amenity that we can provide to the guests, not how much money we can get.

Now, Bill Carroll is writing about Demand Management. Once I got past the Yield Management stuff in the article, however, I actually thought that some of it made some sense to me. Analyzing marketing expenses, sources of contacts, and tracking web results (i.e. spending time trying to figure out who the guest is, and why and how he finds the Inn) is all something that most good Innkeepers have been doing for years. Asking the question “How did you hear about us?” is such a standard question that every Innkeeper must ask a prospective guest. Treating “loyal guests” (i.e. repeat guests) as special is one of the essentials of good Innkeeping. I recall an article in Innkeeping many years ago by Maureen McGee from Rabbit Hill Inn in Vermont, on how to answer telephone calls for reservations. This was done before anyone ever heard about the Internet. Some of this article is clearly still relevant. Asking about why the guest was coming and how they heard about the Inn were such basics even at that pre-web time. Tracking sources of contacts has been present from the earliest days of bed and breakfast reservation software.

In sum, let’s get back to basics. If we treat all the guests as very special, they may want to come back. If we treat repeat guests even better, they might clearly refer more business to us. No matter how much the Internet and computers become a part of our lives as Innkeepers, the best, least expensive, and most lasting form of marketing, is and always will be treating the guests to superb hospitality. Modern electronic marketing has become very important, and will succeed if we remember that is all about serving the guest and their needs. If Yield Management is the way of the future, then I have sincere doubts about how we can continue to differentiate ourselves from every chain hotel off the highway.

Held Hostage by your Inn Chef?

For those in the full service Country Inn world, one of the greatest fears is to be in the middle of dinner service one evening, only to hear shouting from the kitchen as your chef walks out never to return. As this happens not infrequently with "artistic" staff people, it is very important for all Innkeepers to take control of their destiny by planning for this event before it happens. If you are not "held hostage" to your chef, and he or she knows it, you may never have to deal with this issue.

One of the first elements of the plan is to make sure that in the event of any calamity in the kitchen, be it a walk out or simply a work injury, you are able to complete service through other staff members or by your own familiarity with the menu and cooking techniques. Most Innkeepers have some abilities in the kitchen, and by watching and practicing where appropriate, should be able to at least pinch hit for a night or two. At our Inn in Maine, we took that a step further. We had developed the ability to routinely run the kitchen at least once every few weeks to give the chef a needed day off. The chef still prepared all the food prior to actual service, and we learned how to cook and plate it. The result was that the chef knew that we could survive without him if we had to, and this eliminated a lot of ego issues. During the slower Winter seasons, once of us actually became the sous chef, helping with plating and learning his techniques. In a small dining room operation this turned out to be an excellent plan.

In larger Inn restaurant operations, the plan is different. Here, the goal is to make certain that the chef spends as much time as necessary developing the skills of his sous chef, so that in the event of an emergency or a problem, that individual can step up and replace the chef, at least in the short term. In essence the "plan" is similar to what happens in the corporate world, i.e. the chef is required as a part of his job to train his replacement and to have qualified backup at all times. Thus, the care and feeding of the sous chef becomes a very important part of the plan.

The key to proper management of kitchen staff is to be proactive, to make a concrete plan, and to make certain that "hostage" is never a word to be associated with your operations.

Contract Pricing

When it comes to decorating Innkeepers have a variety of tastes and variations of themes. Whether it is antiques, reproductions or new furniture, it has to be of high quality. There is a way to purchase high quality furniture at lower pricing. It is called "contract pricing". Simply identify a manufacturer of furniture that you like and proceed to their website for information on how to contact them via telephone. When contacting the company, ask to speak with the department that handles contract pricing. When you have arrived at the correct department, advise them that you are an Innkeeper and ask them if they provide contract pricing for Inns. This usually results in purchasing furniture directly from the company at significant savings. This worked for us when we were Innkeepers. The manufacturer we worked with was Hickory Chair. We managed to purchase a $4,800 bedframe at a cost of $1,600. Happy shopping!