With many new factors to consider, budgeting for 2021 may appear daunting. But it also presents opportunities to re-evaluate the overall operating structure and how the hotel industry approaches the budget and forecasting process.
Hotel owners have had to contend with the severe impact of COVID-19, along with myriad challenges and related decisions in 2020.
State-imposed restrictions, limited federal aid, corporate travel moratoriums and general economic uncertainty have created an environment the likes of which have not been experienced before. Now, as many hotels continue to struggle to achieve positive cash flow amidst low occupancy levels, operators face the challenge of budgeting for a year which promises to be equally as unpredictable.
In the face of uncertainty, a reasonable owner may ask, “how meaningful will this year’s budget process even be?” From an asset manager’s perspective, the 2021 budget process will mean everything!
What’s the goal?
In a typical year, the goal of the annual budgeting process is to manage financial expectations between owner and operator while establishing specific goals that link management’s effort to investor objectives. As we sit today, the goal of managing financial expectations remains a critical aspect of the budgeting process, but in less absolute terms. The goal at present is to develop a flexible plan and memorialize assumptions that will drive the operating model at varying levels of performance, protecting downside risk and optimizing recovery efforts. This is coupled with a best effort in providing ownership with much needed visibility for cash-planning purposes.
As we approach this process, we must reconsider the formula used to evaluate performance and goals because many hotels are currently operating with very low occupancy and revenues. Much of the analysis previously used to prepare budgets, such as prior year comparisons and statistical benchmarking (percent of revenue, CPOR, CPAR), is no longer applicable. The likely result is a highly dynamic and individualized process that establishes expectations regarding the optimal operating model at varying levels of demand. Regardless of what this ultimately looks like, there are several key considerations that should be accounted for by all key stakeholders involved:
- heightened need for cash conservation;
- timing and triggers to increase staffing levels;
- fluctuations in brand and management company resources and requirements;
- impact and timing of catch-ups;
- likelihood of increased lender involvement—impact to critical agreements such as HMAs, FLAs and loan documents; and
- owner risk threshold and access to capital.
Cash at the forefront
In 2021, liquidity and cash conservation will be critically important as owners look to re-evaluate their investment goals and minimize the need for additional contribution. To achieve this, the extension of labor and expense efficiencies established in 2020 will be paramount. And alignment between owners and managers on a low cost model will be essential, as it will serve as a key benchmark from which many hotels will look to ramp up performance and costs. Demand and agreed-upon trigger metrics should be the primary consideration when evaluating any ramp-up of staffing or expense rather than relying on comparisons to prior years.
Management and brand
Layoffs, furloughs and greatly reduced revenues have led to significant adjustments in brand and management company structure. Understanding changes to organization hierarchy, potential extensions of fee/shared services relief, how bonus compensation will be structured and to what extent responsibilities have shifted from corporate to the property level will have significant implications on the budget process. Owners should engage management and brand partners early to ensure proper support and visibility is in place prior to commencing budget discussions. Reviewing expectations and timing of budget submissions, or agreeing to flexibility on the same, should also be discussed in light of thinly stretched resources and fatigued team members.
Know your catch-ups
State grants, federal programs, lender concessions, reduced brand requirements and other relief received in 2020 have been vital to hotel owners. With many agreements expiring, 2021 budgets must consider the timeline for payments and catch-ups for each source of relief received, as this will be essential to cash-planning strategy. Owners should be prepared to ask managers how these costs will be integrated and what mitigation strategies will be put in place when reviewing performance for each month.
Potential for increased lender involvement
According to a recent AHLA survey with more than 1,000 respondents, 50% of hotel owners noted they are in danger of foreclosure from commercial real estate debt lenders. In addition, two-thirds of the respondents indicated they will be unable to last more than six months at current revenue and occupancy levels. With the increase in risk, owners can anticipate that lenders may take a more active interest in budgeting and will need to consider the ramifications of delivering budgets unable to meet required debt service coverage ratios. Initiating conversations with lenders early in the budget process will be key to understanding both lender expectations and what, if any, concessions may be negotiated.
With many unknowns in 2021 (travel apprehension, timing of a vaccine, legislation, etc.) it will be difficult to determine if a budget is too aggressive or too conservative. As a result, owners will need to closely consider their appetite for risk and its potential impact on investors/partners. No matter the appetite, clear communication to management will be essential as they will be responsible for building the budget and achieving the results. Seeking alignment and buy-in from management will be crucial not only for investment purposes, but to ensure all parties remain motivated and on track to achieve expected performance.
With many new factors to consider, budgeting for 2021 may appear daunting. However, it also represents an opportunity to re-evaluate the overall operating structure and how our industry approaches the budget and forecasting process. Managers should strive to develop models that are dynamic, factoring in the considerations discussed above and utilizing agreed-upon low-cost models and trigger metrics to ramp up performance rather than relying on prior-year results. Asset managers will have the critical role of communicating owner objectives and ensuring that budgets take into account overall investment goals and strategy, and ultimately reflect an optimal path toward recovery.
Gabriel Stein is a senior associate of CHMWarnick, the leading provider of hotel asset management and owner advisory services.
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