Our managing partner, Mike Patel, was recently in interviewed by the general manager at Live Oak Bank, Jamie Bourgeois, about feasibility studies, read on to learn how a study may be something for you.
What is a study?
A feasibility study requires taking a concept and testing viability of it using certain elements and matrix, required by industry standards. To answer the question “can the business be sustained long term?” critical factors are focused on such as debt coverage ratio (DCR), economic growth or decline, market competitor set and much more.
What are the critical components?
First, the project cost is reviewed and makes the basis for the study, then, we determine if the project can be supported (DCR and returns projected by developer), Our job is to determine if the assumptions made by the developer can be used, determining whether they are correct, we take an unbiased approach by rooting our findings with market research and nuanced knowledge of certain markets that may be more sensitive (eg. two blocks can make a huge difference in cities like New York.) Overall, we validate if a project is feasible or not.
Do seasoned hoteliers still need to have feasibility studies done?
This depends on two key factors, first, has the hotelier done a development before, and secondly whether the developer has owned which haven’t been developed but instead a gone with the purchase and operation route.
We use live data from multiple bids to cross reference the codes and market costs, even seasoned investors with a construction department are required to produce a feasibility as it may be part of the compliance with lenders or private equity.
Certain markets take a lot of time from purchasing the property to breaking ground, do successful ones update the study?
Feasibility studies take into account current market trends and growth for future and are good for a specified amount of time and are usually about a year.
When looking at dynamics, which is more important, supple or demand?
Do to the symbiotic relation between the two a balance must be found, if demand is high and supply is low, you can build, but then you have to worry ab out other investors entering the market and overfilling.
Can over saturation create more demand?
Absolutely, we have seen some situations (eg. JW Marriott) in which the market may seem saturated but there is still growth for unique brands, but when a copy-paste hotel is built it will take from demand and lead to further over saturation.
How many demand drivers are needed?
Depends on the market, some deals have worked in a small market with one demand driver, but you cannot underwrite without understanding demand and future growth, and economic issue, trends, employment trends., All together this helps create a larger picture of the true costs and profitability of the project.
Eg. BMW in Greenville made a plant for X5 model, this business is good for long term growth as they business is expected to stay for a while.
Visibility vs accessibility?
Accessibility is the most important, even if you can see it and google maps can help, it’s better for accessibility in real world as customers will want to opt for the easiest route to the property.
Some factors to account for are; If the business is on a busy road? Are there medians on the road? Will the customer have to make a U-turn?
Does this mean if there is an ideal location it will be a good investment?
No, we would need to determine how much business is f drive by or walk in, with many OTAs, ecommerce doesn’t seem to be affected by accessibility. Although, Drive by traffic folks may not want to turn around and could likely see another business and go there.
Which is the most important factor?
ADR, 20-30 years ago the market was reliant on prices, more recently we have had a huge pressure from brands to understand product, designing has been done just to increase ADR. Franchisees and owners have matured, (many are opting to reduce OCC, raise price and have a better product and image)
Has this proliferated more brands? (Avid, Tru, ect…) is this due to need to drive ADR?
Historically, when the emphasis was on rate concentration, the consumers took charge of exactly what they want, research firms were hired to help understand the markets and through this process, a need had arisen. (Eg. We want to see a lifestyle brand)
What are some top mistakes made?
We have dealt with client that underwrote the project themselves, which they shared with us, when going through we asked whether x and y had been factored? No, they were looking at true construction costs only, this Fairfield project was under accounted for by a few million.
- Unrealistic value for construction
- Assumptions may be correct, and then the project owner will go back and force the numbers to fit the values they want. (which won’t work, the dev eloper doesn’t want to miss out on money invested prior to getting numbers done)
Three main hurdles of underwriting?
- Developer, they’re the first underwriting hurdle
- Appraiser and company compiling the feasibility
- Bank underwriter
If all three don’t add up, and there isn’t enough confidence in the project and might be best to reassess.
When should you get a feasibility?
Depends on the client, we try to understand the need and whether the client is a first timer, small developer, or if they are a well-seasoned developer, and if they have staff to work on development projects.
In many cases the client is a small business owner, and do not have the level of resources for a large project. They may have a concept and we work with them or their team to get a feasibility up front in order to limit costs, ideally even before buying the land.
Larger projects which exceed $50MM must have a feasibility before going to equity market.
Do people rely too much on feasibility?
Unfortunately, it’s the opposite, many people do not see it for the huge benefit this type of study can bring. Some may not understand the numbers or know what to do with it beyond a requirement from lenders. New owners are more in the know and are really using it for not only understanding the project but also using the market studies to help garner more business and demand for the project.
We are excited to work on your next project with you and use our large resource base to help make your next project as successful as it can be.