In addition to operations and marketing , capital expenditures are a key component of hospitality budgeting and investment decisions . In fact , many assert that investing in capital expenditures is the most potent lever a value-add investor or developer possesses to enhance the returns on a hospitality investment .

OVERDUE FOR A MAKEOVER The current focus on investing in CapEx follows on the heels of the pandemic when , in cooperation with lenders , many ownership groups and their asset managers diverted funds from FF & E reserves and capital budgets to the more pressing

needs of making payroll and servicing restructured debts . Overall , the industry performed admirably during extraordinary times and there were far fewer defaults than many had anticipated as the pandemic unfolded .

However , many renovations were deferred far longer than planned while brand standards and consumer expectations continued to march steadily forward . The well-known series of CapEx studies released by Bjorn Hanson , now a hospitality consultant , who for years was the leader of PwC ’ s hospitality practice and is also the former divisional dean of NYU ’ s hospitality program , reflects this dynamic . Hanson estimated that U . S . lodging industry capital expenditures grew steadily from $ 3.8 billion in 2011 to $ 7.3 billion in 2019 , then plunged to $ 2 billion in 2020 .

For 2022 , Hanson forecasted approximately $ 3.4 billion in capital expenditures , still “ the lowest amount since The Great Recession more than a decade ago .” While these studies do not

include new construction , room additions or major construction to convert a hotel to another use , the data show clearly that the hospitality industry is falling behind in making necessary physical improvements via capital expenditures .

STORM CLOUDS AHEAD This far into the industry ’ s recovery , many hotel properties find themselves drained of CapEx and FF & E reserves . At the same time , substantial investments are needed as major brands are anxious to resume regular property improvement schedules .

As they ponder how to upgrade their properties , owners are further challenged to improve their guest-facing technology and to transform fit and finish . It is an expensive proposition , but there needs to be a commitment to material capital expenditure to drive future growth in net-cash flows . This will ultimately determine value for a property and the debt that it can support .

This recent fallow period

for CapEx investment is exacerbated by a common industry strategy of “ running lean ” when it comes to sizing CapEx reserves . Many owners and asset managers will agree with their lenders and franchisors to annual reserves of 4 % to 5 % when in many cases 6 % to 8 % may reflect more realistic long-term investment requirements .

How , then , does an owner bridge the gap when there are large CapEx requirements that exceed established reserves ? The answer is that for the past 40 years a long-term trend of declining interest rates that ultimately reached 0 % allowed owners to finance their CapEx shortfall by taking out bigger and cheaper loans .

Like many real estate investment classes , declining interest rates have masked some structural capitalization issues in the hotel industry that are now being uncovered as interest rates are suddenly 300 to 500 basis points higher and credit has tightened . This tempts further deferral of

58 hotelsmag . com Jul / Aug 2023