Getting feasibility – or deal analysis – right is critical to your success as a serviced accommodation operator. You need profitable properties in order to scale successfully, and detailed feasibility reports will ensure you can identify which properties will be profitable and which should be avoided!
The areas you need to cover in a feasibility report fall into three categories: market analysis, key assumptions and financial projections. We’ve broken this article down into these headings and sub-headings, to help you get started.
1: MARKET ANALYSIS
1.1: Market Demand
Market demand is dictated by a number of factors driving short stay guests to the area.
One of the biggest drivers of short stay guests are local businesses. What types of employment dominates the local area? Unskilled jobs like factory work are unlikely to generate much short stay demand, whereas “white collar” type work such as financial services will. Visiting consultants, clients, strategic partners and suppliers will always produce a steady stream of short stay requirements.
Transport is another major driving force behind short stay demand. Good road and rail links will encourage businesses to the area, travellers to break their journey locally and tourism. Airports and ports will bring in shipping and haulage companies, international-focused businesses and airlines, ferry and cruise companies.
Finally, tourism may drive short stay accommodation in the area. Is the area somewhere people come to visit and explore? Are there local attractions, areas of outstanding beauty or venues running large events nearby?
By building up a picture of the local market based on these factors, you should begin to understand both the overall market demand in the area, and the specific customer segments present.
1.2: Market Supply
Researching the market supply is relatively straight forward, as most short stay providers will be looking to promote themselves in some way online. You can use Google, booking.com, airbnb and other platforms to look at providers.
When considering the potential competition, you should look at not just serviced accommodation providers, but also hotels, guest houses, B&B’s and any other accommodation options available. What type of accommodation dominates the local area? Is there mainly high-end hotels, or a large independent guest house market? Are there many serviced accommodation operators in the area, and are they mainly independent or larger national chains?
1.3: Market Positioning
By combining your knowledge of the market demand and supply, you can identify potential opportunities. You should look for customer segments in the market which are under-supplied, or that would be better served by a different type of accommodation. Your market positioning should consider the value proposition to the customer – both the product you intend to offer, and the price.
For example, there might be a buoyant contractor market currently served by a number of tired guests houses, that you feel would be better served by 3 to 4 bedroom properties. This would allow groups of contractors to stay together in the same property, for less than it would cost to stay in a guest house. You will ensure properties have large living areas, so that they find the properties more comfortable than a guest house, furnish and dress the houses to a comfortable standard and ensure there is off-street parking suitable for large vans.
The key to market positioning is that rather than just putting a property on the market with little thought, you are considering who you are targetting, what their needs are and how you will stand apart from your competition. By taking this approach, your chances of a successful and profitable property are greatly improved.
2: KEY ASSUMPTIONS
Many people doing deal analysis jump straight into a spreadsheet to plug in figures to see how a property might perform. While there is nothing wrong with this once you are experienced, very careful consideration should be given to what estimated figures you put in a deal analyser. As we discussed with the “Buy, Test, Scale” model in Episode 16, the biggest risks in your business lie within the assumptions you make. So the more time and effort you put into making accurate assumptions, the less risk there will be that your property will not perform as expected.
2.1: Daily Rate
If we consider that the assumptions we make for deal analysis form the risks for the property, then by far the biggest risk is contained within your projected daily rates. Most markets are constantly fluctuating – weekday and weekend, summer and winter, high demand and low demand – so to predict accurately a single, consistent daily rate can challenging to say the least!
If instead we consider the daily rate to be an average, and look at the range for all possible situations, this will lead to a much more accurate snapshot of performance. This will also help to avoid the number one mistake which is consistently made with deal analysis: over-estimating the projected daily rate. This is by far the most common reason people operate unprofitable properties, and often comes from a lack of thorough research into the range of rates achievable in different market conditions.
These market fluctuations are also why we use long term monthly projections, as this will lead to a much more accurate picture of real world performance.
2.1.1: Per Unit Pricing v Per Person Pricing
In short stay accommodation, there are two main models for pricing: per unit pricing, and per person pricing.
Typically, hotels operate on a “per unit” pricing model. For instance, a double room will be a fixed price whether there are one or two people staying.
Apartments often operate on “per person” pricing, due to the range of guests they can accommodate. Often a 2 bedroom apartment can accommodate up to 6 people, and would charge a lower price for 3 people staying in the apartment than for 6 people.
How will your core customer segments look at your price? Will they be considering it from a per unit or a per person basis? Families will probably consider the total cost of their stay, while contractors will divide it up to a “per person per night” price. This is important to bear in mind when you set your pricing model.
When researching pricing, you should consider what size groups you are looking to attract, and ensure you research pricing for all of these groups. For instance, for a two bed apartment you might want to research the pricing level for three, four, five and six person groups to make sure you know and understand how the market is operating.
2.1.2: Weekday v Weekend Pricing
Very often, weekdays and weekends are virtually independent markets. Due to the different customer segments attracted, this can mean pricing and occupancy vary substantially.
Some areas with strong local business will perform well during the week and be quiet at the weekends. Similarly, tourist areas without strong business fundamentals could be quiet during the week but busy at weekends. It’s important to understand the weekday and weekend markets in your area, so that you can accurately model the pricing and occupancy.
2.1.3: Seasonal Pricing
Every area has some degree of seasonality in the demand for short stay accommodation. Some areas like London will have relatively small dips in demand over winter, while other rural tourist areas might have virtually zero guests.
Understanding the seasonality of your area is key to producing accurate long term forecasts. Depending on how seasonal your area is, you might want to project high and low season rates and occupancy, or even high, mid and low seasons.
Rates and occupancy are a product of one another – they are inextricably linked. It is clear that reducing pricing to just £1 per night would result in near 100% occupancy, while pricing most properties at £1000 per night would result in 0% occupancy.
When deciding upon rates, you should look to choose pricing that will result in 70-85% occupancy (depending on your area). If your pricing generates more than 85% occupancy, the chances are your prices are too low – while if its less than 70%, your prices are probably too high.
PwC UK Hotels Forecast shows that in 2016, average occupancy rates in London were 81%, and outside London 76%. When making projections, using 75% occupancy inside London and 70% elsewhere should provide safe and conservative figures to use for average occupancy.
2.1.5: Deciding Your Pricing Model
When deciding your pricing model, you should pull together all of your research on the supply and demand, competition and pricing, while considering your market positioning – e.g. how does your product and price make you stand out from the competition?
Typically, the best solution for apartments is a “base price” for up to x people, followed by additional pricing per person up to the maximum capacity for the property. This way, you are able to remain competitive for different sized groups, while maximising revenue.
For example, with a 2 bedroom property you might want to price at £120 per night for up to 3 guests, with £20 per additional guest up to a maximum of 6. Additionally, you might want to vary rates by day of the week or season. Using the example above, perhaps you are able to charge £140 as your base price at weekends, and want to reduce to £90 per night on a Sunday night. Or maybe in low season you will charge £100 as your base price, while in high season it can go up to £120.
2.2: Single Let Rent
The single let rent is an important reference point in your deal analysis. For purchase or development deals, it shows you how much more (or less!) you would make than operating the property as a single let. For rent-to-rent or joint venture deals, it defines your profit margin. And for management deals, it shows you how much the landlord would make compared to single let.
In some circumstances, you might want to reduce the single let rental by an appropriate amount (typically 8-12%) to accommodate the letting agent fees you would otherwise be paying. This ensures a fair comparison when comparing the net income from single let to serviced accommodation.
2.3: Business Rates
As your serviced accommodation will quality as a Furnished Holiday Let as defined by HMRC, you should pay business rates as opposed to council tax. Although the VOA usually take a while to get back to you with a valuation, you can project your rateable valuable by multiplying the number of single bed spaces in the property with the rateable value per unit for the area. We cover this in detail, as well as small business rates relief, in our episode on Business Rates.
You will need to account for the cost of electricity, gas, water supply, water drainage, TV license and internet connection. If you have extras such as a Your Welcome tablet or Sky TV, you should also include these.
If you have more than one apartment in a block, you can apply for a hotel TV license which will cover up to 15 properties and one address (after this, you need to purchase an extra license for each additional 5 properties). You may also be able to reduce costs by having a single high speed internet connection shared between apartments.
2.5: Cleaning and Laundry
Cleaning and laundry costs are one of the key risk areas of the deal analysis, as the figures are often under-estimated.
In order to accurately project figures, you must decide how you will structure the operations of the property. Are you going to use employed cleaners, self-employed cleaners or a cleaning company? Are you going to purchase the linen and ask the cleaners to clean it or use a commercial laundry, or hire the linen? Once you have answered these questions, you will be able to model the costs based on your projected rate of changeovers.
For example, you have a 2 bedroom property with a self-employed cleaner and hired linen. The linen hire will cost £35 per week, the cleaner is paid £10 per hour for 2 hours on changeover, with 2 projected changeovers per week. The projected cost will be £75 per week, or around £330 per month.
Maintenance costs are heavily influenced by the age and condition of the property, along with the type of guests.
Clearly brand new properties are unlikely to need large amounts of maintenance, and some snagging issues may even be covered under warranty. On the other hand, older properties will have more problems and so you need to leave a larger percentage for resolving issues.
Similarly, while corporate guests are likely to cause low levels of wear and tear and accidental damage, you cannot say the same at the opposite end of the spectrum with stag and hen parties!
Depending on the age of your property and the type of guest, you probably want to project a maintenance cost of between 2 and 5 percent, with 3 percent a happy medium for many properties.
2.7: Booking Fees
One of the big costs involved in serviced accommodation can be the booking fees. In order to accurately project the amount of booking fees you will be paying, you must first project the “market mix” of booking sources. Your market mix is the percentage you anticipate of bookings from booking.com, airbnb, direct bookings and any other portals.
For example, if you anticipate getting 50 percent of bookings through booking.com (15% booking fee) and 50 percent direct bookings (0% booking fee) then you’d pay average booking fees of 7.5 percent.
2.8: Card Processing
In most cases, the majority of your guests will pay by credit or debit card.
Using your projected market mix, you can also calculate the projected card processing percentage. Multiply the percentage of bookings for which you will take card payment – e.g. include OTA’s like booking.com, but exclude airbnb and any direct bookings you expect to take bank transfer from – by the percentage your card processing provider charges. Stripe is widely used, as they integrate well with most software systems, and they charge 1.4% + 20p for European cards, and 2.9% + 20p for non-European cards.
The cost of managing properties is something which often gets forgotten about during deal analysis. Speaking to guests, arranging payments, liaising with operations staff – all important tasks which need to be taken care of regardless. On top of that, your business will have overheads such as software and telephones which should be taken into account when calculating the management cost percentage.
If managing yourself, you need to take account for the value of your time, if you have staff you need to account for their wages, and if you pay a management company then you need to take account of their fees. Too often operators begin by doing all of the work themselves, and by the time they scale their operation they realise there is no margin left after employing staff to manage their properties!
For self-managed properties (e.g. by staff within your own company) in London and other high value areas, the management cost can be as low as 5 percent while lower value areas can mean costs of around 10 percent. If using a management agency, just use the fixed percentage they charge for management (but don’t forget to add VAT if applicable!).
3: FINANCIAL PROJECTIONS
Once we have a full set of assumptions, creating financial projections is simply a matter of entering the assumptions into your deal analysis spreadsheets. It’s critically important to consider the VAT status of the property, however. How are you structuring the deal, and what will the eventual VAT status be once you have scaled your business? A mistake many operators make is not taking VAT into account from day one – which can mean a large but unprofitable portfolio after scaling!
3.1: Monthly Snapshot
Monthly snapshots give a good indication of the performance of the property, and how profitable it is likely to be. This is a basic tool however – for detailed and accurate projections, you should rely on the long term projections.
3.2: Long Term Projections
Long term projections will take your key assumptions and give you a broader perspective to the performance of the property. Seasonal fluctuations of occupancy, rate and cost can all be taken into account, along with longer term trends.
Often, as a business grows its VAT status will change over time. You can use the long term modelling to project VAT status changes, and see the impact on your net profit.
You now have the tools to structure and assemble a feasibility report for a serviced accommodation property or project. Always remember that the risks lie within the assumptions you’ve made, and if you need assistance you can ask us directly on our Facebook Group, “The Serviced Accommodation Podcast Community”.