The largest and most prominent challenge resort financiers face is the variability of the project’s income, which has a number of ramifications. It is based on a number of factors, including seasonality, the attractiveness of the location of the resort, the target market’s access to the resort by air, rail or road, the resorts own unique facilities, services and guest proposition and the efficacy of its marketing and distribution channels, amongst many others. This article considers some of the consequences that resorts’ variable income has on their financing and explores some possible solutions.
The direct consequence that variable, or uncertain, income has on the financing of a resort is the ability to gear its balance sheet, meaning the extent to which debt can be used in proportion to the overall funding programme. City hotels, by contrast, have relatively predictable incomes, as well as expenses, which translates into stable profits from which to service their debt. The reason they have relatively stable profits is that the flow of business and, to a lesser extent, leisure travellers to cities is known and can be forecast with a relatively high degree of accuracy. Added to this, the city hotel’s competitors are known and their occupancy and Average Daily Rate (‘ADR’) figures are published and used for benchmarking purposes.
The occupancy and ADR performance of a resort and its profits are likely to be less certain than that of a city hotel. Furthermore, the income a resort derives from non-room revenue makes up a larger portion of its total income than that of a city hotel and, therefore, plays a much larger role in its success. Revenue per Available Room (‘RevPAR’) is commonly used as the primary Key Performance Indicator (‘KPI’) for comparing city hotels to one another and for measuring and tracking their performance. However, it only accounts for room revenue.
Hence, for resort projects, Total Revenue Per Available Room (TRevPAR) plays a far more important role as the primary KPI for measuring and tracking their performance. Therefore, it is important to pay a lot of attention to TrevPAR when planning a resort project and focus on the non-room revenue drivers that will deliver reliable income streams and that will help stabilise the overall financial performance of the resort and the Free Cash Flow (‘FCF’) from which its debt is serviced.
Another factor to consider is that revenue forecasts are based largely on historical data, which means the income of mature hotels and resorts that have stabilised, as well as that of hotels and resorts that can be benchmarked against other, similar properties that have been operational for a number of years, are far more predictable than the income of new resorts with little or no available benchmark data.
Of course, the more obscure the resort offering is, the more unstable its income and the more unpredictable its FCFs will be. This applies to location, guest proposition and a range of other factors. For example, the income of a resort on the island of Rhodes that is located in close proximity to other, similar resorts with similar and tried and tested guest propositions, will tend to be more stable and predictable than a resort in Timbuktu with a unique guest proposition and a relatively weak marketing and distribution organisation.
The corollary of this is that gearing is largely dependent on the certainty of FCFs and, if FCFs can somehow be stabilised, financiers will be able to use more debt to finance resort projects. The most obvious way of achieving this is for either the operator or the project sponsor to guarantee the profits of the project, or at least a large enough portion to be able to service the desired project debt. This can be achieved with a Gross Operating Profit (‘GOP’) guarantee or a lease covenant. There are also several other mechanisms, such as the operator subordinating their management fees to the service of debt.
Because the resort’s expenses are known upfront with relative accuracy and can be modelled, a lease, whereby the property is effectively rented from the owning entity by the sponsor or the operator, can give lenders the predictability of profits that they require. In the context of project financing, the resort owning entity is normally a Special Purpose Vehicle (‘SPV’). A GOP guarantee requires the guarantor to top up, or contribute towards the profits, should be profit guarantees not be met. This ensures that sufficient FCF is available to service the debt and, thereby, gives lenders the security they require.
Another, and more fundamental, way of improving the gearing potential of a project is to make its profits more predictable and show that they can, therefore, be forecast with greater accuracy. While city hotels can often be geared as highly as 70% or 80%, it is common for resorts not to be geared by more than 40%. Of course, this is based on the certainty of FCFs that will be generated and, as a consequence, the resort’s ability to service its debt. So, if it can be shown, for example, that a particular guest proposition or resort concept that has worked elsewhere can be emulated at the planned resort, an argument could be made for more stable and predictable profit forecasts.
In conclusion, resorts can increase their gearing levels if they are able to stabilise their profit forecasts. Broadly speaking, there are four methods for achieving this, including:
- Finding suitable benchmarks from which historical performance data can use. In so doing, the resorts financial performance characteristics will become more akin to that of city hotels.
- Using lease covenants or GOP guarantees underwritten by the operator or the project sponsor in order to guarantee minimum profits, ensuring its debt service requirements will be met.
- Emulating tried and tested guest propositions or resort concepts to improve profitability and the certainty of profits.
- Ensure that TRevPAR is properly addressed when assessing the viability and planning (feasibility) of a resort both conceptually and financially.
The methods a financier chooses should depend on the resort’s particular circumstances, in terms of its location and its characteristics, as well as parameters imposed on them by the operator and the project sponsor. The use of these methods should also depend on how aggressively they wish to gear their resort project.
About the author: Dr. Richard von Kalmar, RLA Global's Director of Hospitality Investments & Board Member
Richard von Kalmar has been involved in the development and financing of many hospitality projects and also worked across a number of other industry sectors, including power, FMCG, banking, shipping and aviation. He has an MBA from Edinburgh Business School and a Doctorate from Cranfield University’s School of Management.