Hotel companies face 2017 with good prospects for the sector in Spain, and in many cases with plans to invest in improving facilities. This highly positive figure –especially considering the difficulties in previous years since 2000- encourages obtaining the greatest potential from the reform in which it is invested, without neglecting the impact it may have on the business as a whole.
When proposing an investment in the reform of rooms, it is necessary to evaluate the optimal range within which a greater return will be obtained, delimiting the floor and ceiling of the investment. In this first article on the subject we will focus on the analysis of the investment floor, and in the next one we will define the ceiling.
Establishment of minimum investment
The minimum investment is set by the needs to maintain an infrastructure in optimal conditions of use and market positioning. The motivation behind this need for intervention can be very varied, such as:
- Updating or repositioning of the product, especially when competitors have emerged around the business with products more adapted to current needs and tastes. When a product becomes obsolete, one of the first symptoms is the drop in room prices.
- Adaptation to a certain regulation (Technical Code), or implementation of a certification that improves the quality of the product (Leed, PassivHaus seals…).
- Incorporation of a technology that has become essential (as Wi-Fi was in its day and today it can be opening rooms with mobile phones, smart TVs, home automation or even digital concierge).
- Functional redistribution of spaces to implement uses in accordance with current users (such as flexible spaces for gastronomy, coworking, leisure and relationship), replacing other obsolete uses (such as the old business centers or beauty salons).
NH Collection Mexico City before and after its room renovation
Segmentation of the refurbishment
In the European environment, these interventions are usually segmented into three bands, depending on the depth of the action and the investment required. Broadly speaking, a first classification of the intervention is based on its scope and the total area of the building:
- Hard renovation. It contemplates important actions in civil works and installations, which can greatly alter the physiognomy and operation of the building. The investment ratio is around €1,250/m2, and may rise if there is a significant structural intervention (demolitions, extensions, volumetric changes…).
- Medium renovation. Without generally affecting distributions except in isolated points, it includes updating finishes, carpentry and toilets. Ratio of €800/m2.
- Soft renotavion. It is normally the segment most used in the renovation of rooms, and includes the replacement of furniture and finishes. Investment ratio of €500/m2.
On the other hand, it is customary to calculate viable global investment ratios per productive unit (understood as each hotel room), in order to arrive at a total figure proportioned for the reform of the business as a whole. In the case of updating equipment, a usual ratio of €10,000 per renovated room is usually calculated.
Next we define how to establish the maximum investment for the renovation of hotel rooms. This limit, together with the minimum (below which the intervention fails to achieve the repositioning objective), define the optimal band within which to place the investment to achieve the highest return.
Maximum investment in a refurbishment
In addition to marking the minimum below which the investment ceases to be productive (because it does not achieve a desired renewal effect or an improvement in functionality), it is necessary to limit the maximum admissible investment. This is related to the market’s ability to produce reasonable returns on the committed investment.
For the definition of this recommended maximum, this simplified rule can be considered: “for each economic unit of increase in our average rate we can invest up to a maximum of one thousand economic units per room”. Translated into a practical example, if you aspire to increase the average price per room by €5, you can admit a maximum investment of €5,000 per room that is renewed. Above this ceiling, the product will surely be attractive, but the market barrier will prevent the return on investment from being commensurate with the investment made. Obviously, this rule must be qualified and adapted to the particularities of each business, but it is a good approximate starting point.
The fact of investing in a reform above a maximum advisable level implies that resources are being limited to allocate to other areas of the business that might need them (such as marketing or digitization); therefore, from a global point of view of the business it would imply an opportunity cost.
NH Latino (Buenos Aires) before and after its room refurbishment
The sweet spot: evaluate and plan before investing
In general, the needs of a business are infinite, while the resources are scarce (and the capacity of the markets to absorb the returns are even scarcer). That is why in the numerous investment plans that we study, investment budgets that are not viable in terms of rates of return on the committed capital are usually presented. And in many cases the problem is detected at a late point, when it is more expensive in financial terms and in terms of time to correct the proposed interventions (because they are already fully or partially carried out, or at least committed to third parties).
To avoid these situations, it is always advisable to: a) define an objective starting point (diagnosis), b) agree on business objectives aligned with the global strategy and the local market, and c) based on them, establish an action and investment plan.
In not a few cases, the conclusion leads to separating the actions based on their term (short, medium or long term), and to distributing the investments in a fully planned manner over successive years. In this way, it is ensured that the highest return on investment is obtained, and an adequate management of amortizations.
