Tackling Obsolescence

The 1,750-room Sheraton New York Hotel and Towers on 7th Avenue in the heart of midtown Manhattan has a yellow, brick exterior that wasn't uncommon when it was built in 1962. Today's hotels aren't typically built with such exteriors because architects consider the look dated. Yet the Sheraton's yellow, brick skin has remained even though the hotel has been renovated over the years, including a major, $142.6-million redo in the 1990s. The yellow exterior on the Sheraton New York is what real estate appraisers commonly refer to as incurable obsolescence.

Incurable obsolescence is worthy of a discussion because it affects a hotel's value, though many hotel owners and operators don't completely understand it. Incurable obsolescent aspects of a hotel aren't called incurable because they can't be cured; they're called incurable because it's economically infeasible to correct them.

Economically infeasible means any return on the investment to correct the obsolescence will almost certainly be less than the expense of curing it. In other words, a prudent investor would not take it on, and to the extent a hotel owner possesses capital dollars, those capital expenditure funds would best be allocated elsewhere on the hotel's physical plant.

One example of obsolescence with which I've seen hotel managers wrestle is an unprofitable hotel restaurant that appears in need of renovation. While such a dining room may be tired, some hotel managers, particularly in the midscale with food & beverage hotel segment, intuitively know such an upgrade is unlikely to result in a profitable operation. That's probably why so many such hotel restaurants have been leased to local and regional restaurant operators over the past few years.

As hotel industry performance improves, hotel reserves for the replacement of fixed assets (i.e., capital expenditure funds) typically swell because they're often funded as a percentage of hotel revenues. Ultimately, it's important for hotel managers to be able not only to recognize obsolescence in hotels but also to be able to realize which obsolescent features are curable and which are not, with the important point being that incurable aspects are incurable because remedying them isn't economically feasible.

In my experience, I've found many hotel managers believe they're inadequately trained and/or experienced to make such determinations. That may explain why we've seen such growth in hotel asset management as a field over the past several years. Asset managers have the training, knowledge and experience to analyze hotel physical plant problems. Today's improved financial performance of many hotels means it's time once again for hoteliers to tackle such situations.

Now, on to the latest edition of the Penn State Index of Hotel Values, which uses econometric modeling to project future U.S. hotel values. This year, average U.S. hotel values are expected to increase 8.5 percent to $79,358 per room. Luxury hotels are expected to experience the greatest increases in value per room, or $19,283, to $290,335 per room, while economy hotels are expected to register the highest percentage increases, or 15.2 percent, to $21,163 per room. In 2006, overall U.S. hotel values are expected to increase by another 7.8 percent.

John W. O'Neill, MAI, CHE, Ph.D., is a professor in the School of Hospitality Management at The Pennsylvania State University and a licensed real estate appraiser. He previously held unit-level, regional-level, and corporate-level management positions with Hyatt and Marriott. He can be reached at jwo3@psu.edu or 814-863-8984.

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