Pinnacle Advisory Group


The Nation's Leading Full Service Hospitality Consulting Firm.

“Upside-Down” Deals – the new Paradigm of Resort Hotel Development Presented by: Gregory T. Bohan, ISHC.

Present by: Gregory T. Bohan, ISHC.

Gregory is the Principal of the South Florida office of Pinnacle Advisory Group. This office provides hospitality consulting services to clients throughout the Caribbean, Latin America, and Southeast US.

As market analysts and feasibility consultants, the most frequent role played by those of us at Pinnacle Advisory Group is to give our client – typically a lender or potential equity investor – comfort that “the deal works”. Figuring this out in the hotel and resort development world should be considered pretty straight forward. Here, in very simplified terms, is how it usually plays out – more accurately, how it playED out (past tense) until recently:

1. A client – typically a developer, lender or investor, is faced with evaluating just how “feasible” it is to develop a hotel or resort project and, seeking sage wisdom and guidance, comes to a consulting group such as Pinnacle for help;
2. Pinnacle performs detailed research with respect to the market for the proposed project and prepares projections of performance (occupancy and average daily rate) which are then expanded into full financial projections down to the point of net operating income (EBITA) over a period of 5 to 10 years or more into the future.
3. Pinnacle – or in some cases the client independently with Pinnacle’s assistance – looks at the net income levels projected for the project and compares those income streams with development costs over the same period, formulating a cash flow model on which rates of return can be calculated.
4. If the rates of return are within the range considered acceptable – voila! – the project is “feasible”. If not, sometimes “value engineering” is called for and applying it makes the deal work. In some cases, hopefully before too much time, effort and cash has been expended, it may just be time to call it a day and look for the next project.

Sounds relatively uncomplicated, doesn’t it? And it was (sort of) until skyrocketing land and development costs changed the picture. And nowhere has the impact of this change been more at the forefront than in off-shore development projects – particularly those in the Caribbean Basin, Mexico and Central America.

Since opening a new practice office in South Florida to cater to these markets in 2004, Pinnacle has been involved in upwards of 15 very high-profile resort developments in locations such as Puerto Rico, The Bahamas, Bermuda, the Turks & Caicos islands, the British Virgin Islands, Anguilla and Costa Rica just to name a few. When we say “high-profile” we refer to the likes of resorts to be affiliated with brands such as Ritz-Carlton, Four Seasons, Mandarin, etc. With somewhat surprising frequency, the most challenging feature of these projects, may be that, simply stated, the resort hotel component is “not feasible” – at least by the standard benchmarks with which all of us that have grown up in the world of hotel feasibility measured such deals in the past. A common description of these deals is that they are “upside down” – i.e. they do not cash flow – returns can’t cover expenses for adequate return – they just “don’t work”.

So why are such developments being built – and HOW are they being financed? It seems that every time you pick up an industry journal you hear about a new resort popping up somewhere in the Caribbean Basin or some other off-shore resort area. Turn to the high-end travel ads at the back of a Sunday newspaper magazine section and you’ll see plenty more: “Just announced! – the XYZ Resort!” promising a level of luxury and cache that surpasses all others.

The answer is in the MIX. A close look will typically reveal that the new developments seldom comprise ONLY the “XYZ Resort”, but (and this is very important) they comprise the “XYZ Resort and Residences“. With all-in development costs for the resort hotel component in many off-shore locations rising into the Stratosphere (more than a few of the projects we have analyzed approach $1 million per key in development cost), developers have gone to a mixed use model to make the deals work. Such a model works something like this:

  • The hotel component cannot – no matter how well-conceived, marketed, executed or managed – generate adequate cash flow over its economic life to meet its debt obligations and provide a reasonable return on investment to the developer;
  • Owing to recent affluence and the broader horizons of not only American, but European and Asian buyers, there are a large number of people interested in owning vacation or second-home real estate in the same locations that were typically well-known (or emerging) resort hotel locations;
  • In developments completed to date, attaching a luxury or ultra-luxury brand name such as Ritz, Four Seasons, Mandarin, and the like. to a residential development built alongside a “flagship” resort hotel adds cache to the development and, in many cases, adds perceived value to the real estate. Reports vary greatly as to just how much value is added, but there is a general sense that there is a quantifiable premium attached to having such a name;
  • As we have all become accustomed to living in a more populated world, the acceptable density level of resort developments has increased. What, in the past, might have been a resort hotel with a golf course and wide open spaces around it can now (within reason and if carefully designed) be that same resort hotel, golf course and surrounding very high-end residential development;
  • When an estate home, residential condominium or other similar type of real estate is sold, the buyer of such a unit almost always pays cash or finances it independently. In either case, the cash flow to the developer is generated early on in the development process. Funds received sooner far outweigh funds received later (particularly way down the development pipeline) in terms of enhancing rates of return – a simple rule of “time value of money” economics.

So, in summary (a) the hotel by itself may not be feasible BUT (b) the fact that a flagship hotel with a luxury brand, amenities and services is part of the development adds a premium to the sale of real estate AND (c) the sale of the real estate tips the scales in terms of making the overall return on investment work for the developer.

Simple? Not really. Especially when you consider the complex nature of these types of transactions and given off-shore development climates and regulatory/tax issues and the like But, are the deals getting done? Absolutely. At least they have been until as of late . With the recent tightening in the credit markets it is hard to tell what the next chapter in the saga will be. But it should make for interesting reading. Stay tuned!