In a high interest rate environment, hotel investors are pivoting to value-add investments to underwrite the same level of returns previously more simplistically achieved through low-interest rates and high leverage. Investments of this nature are also called transitional assets, particularly by financiers.

Common value-add strategies include:

  • Change of operator (in the event vacant possession is available on sale)
  • Asset enhancement through significant capital expenditure
  • Change in an operating business model.

What could go wrong with a value-add strategy? Plenty! The investment model may show exceptional returns, but does it definitively identify all the risks? Let’s examine some:

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The notion of “vacant possession on sale” is typically offered by vendors and hotel brokers as a panacea for immediate value-add. This feeds on investors thinking they can deliver better performance simply with a change of operator. Potentially this is true, but there is a myriad of risks and business issues to consider, including:

  • Operational disruption
    • Disruption of partnerships with booking agents such as Virtuoso, OTAs and government or corporate clients. Rebranding generally results in a change of trading name and therefore a loss of hotel-specific booking codes on online booking platforms. Once the name/code is changed the hotel needs to commence the re-education journey to re-establish itself. Certain booking channels (e.g., Virtuoso) will not be able to recommend/find the hotel under a new brand as they may not be familiar with the new operator. To offset this negative impact, the hotel’s marketing budget must be escalated significantly in the first year post-rebranding to allow re-education of the market. This will involve engagement of specialised marketing agencies to improve the hotel’s market presence to ensure increased subscription to new programs, meeting with agents and re-establishing relationships.
    • Change of trading name makes it difficult to find the hotel in Global Distribution System (GDS) platforms such as Sabre, Amadeus and Travelport as each hotel (based on name) carries a unique code, which changes when the trading name is altered.
    • Online search engines such as Google, will no longer recognise previous searches on the asset, hence the revised hotel website will have to again build up a ‘clicks’ history.
    • The overall change of operational, accounting and banking systems to meet the new brand standards will likely cause certain disruptions and increased cost of training and set-up costs.
  • Transition costs incurred by the owner
    • If all employees do not transfer to the new manager, the hotel owner will be liable for redundancy payments which can be substantial. For example, an employee with at least 9 years but less than 10 years of service will be entitled to 16 weeks of redundancy payment (if staff are over 45 years of age they received an additional 1 week of notice, in NSW).
    • The owner needs to account for the cost and time associated with training staff on new systems, processes, reporting and compliance regimes. This will involve external training plus the salary cost of internal training.
    • It is an unfortunate trend but a business reality, that the incoming operator will experience loss of demand due to the previous operator not enthusiastically taking future bookings or not transferring bookings to the new operator. Hence post-transition, the business on the books may be minimal.
    • As the hotel would generally not align the timing of rebranding with the corporate business tendering process (RFPs), which takes place once a year, the hotel may not be contracted for large corporate accounts during the first year. This generally results in the hotel competing for short lead transient business, which comes at a large rate discount.
    • Cost associated with recruitment, relocation, and rehoming staff members to replace senior management that chooses to stay with the incumbent operator. Also, the cost associated with the employment of new staff members recommended by the incoming manager to represent the new ‘brand’ can be significant.
    • The owner will fund all costs associated with the rebranding of the property from operating supplies such as note pads, rooms product to signage and change of uniforms.
    • As previously noted, in the first year of the new brand, the hotel will have to endure an increased cost of marketing to re-establish and re-position the hotel’s new name and brand. Ideally, the incoming operator contributes to the marketing as ultimately, part of the marketing cost will be spent on promoting their brand.
    • Most hotel operators will ask for a Technical Services Fee ranging from $75,000 to $250,000 to assist with the cost of new systems implementation. This one-off fee will fund connection to the group’s systems and oversight of the various systems installations.
    • Under typical hotel management agreement terms, an operator terminated on sale will be entitled to a termination fee. The incoming operator may contribute to this termination fee with payment of ‘Key Money’. However key money comes with its own obligations including but not limited to stricter tenure provisions so it should never be considered as ‘free money’.
    • Last but not least is the capital expenditure to facilitate compliance with the brand standards of the new operator. This is often underestimated particularly when the rebranding involves an escalation in star rating or if back-of-house infrastructure is to be addressed. One of the most expensive areas is compliance with global standards when it comes to items such as fire compliance. Due to the global nature of international operators, some standards go above and beyond local requirements.
  • Customer loyalty & staff retention
    • A new owner may see merit in a change of operator, but the incumbent operator will have developed over time a level of customer loyalty that may not easily transfer to a new brand. This will be particularly true for customers that accrued loyalty points that are no longer tender with a new operator.
    • Loss of key employees. The majority of staff generally transfer on change of operator but certain senior, long-standing employees may opt to stay with the incumbent brand which will create a gap in operational IP.

The extent of the above issues demonstrates there is a high execution risk on change of operator even when transitioning to a global chain from an independent operator of modest capability. The incoming operator generally underwrites five-year projections, potentially noting a strong escalation in average room rates (ARR). However, it is important the new operator is tested on the impact of all the above operational issues that will substantially impact trading in the first year. Secondly, owners should not be seduced by a forecasted higher ARR without demanding full transparency on all fees, charges, and recoveries that will be incurred with the new operator. This is particularly important when it comes to replacing a local manager with an international operator. An exercise needs to be undertaken to demonstrate the cost of customer acquisition based on fees and charges imposed by the new operator.


Change of hotel ownership or brand typically involves some level of capital expenditure. However, in the context of significant value add spend, this involves a proposed expenditure of +15% of the purchase price. All expenditure of an offensive nature should be supported by an agreed rate of return. This is particularly important when considering changes to the food and beverage operation.

Prevailing supply and builder issues are a clear risk on major refurbishment, but more specific operational risks relate to the key stakeholders:

  • Financier
    • Ensure the financier understands the impact on trade from building disruption. If trade is significantly impacted to the extent the interest cover ratio cannot be met, seek a waiver. This will generally be positively received if the works are of a compliance nature, or if there is a genuine value-add (supported by a return-on-investment analysis) that enhances the loan-to-value ratio.
  • Customers
    • Major customers need to be forewarned of refurbishment disruption. In some cases, such as aircrew, this will be a contractual obligation. Depending on the extent of the disruption certain customers will elect to stay at an alternate hotel.
  • Operator
    • A third-party operator will clearly want to understand the impact of capital expenditure on brand standards and the existing operation. Therefore, it is important to engage early with the operator on design development allowing sufficient time for discussion on design, not to impede the scheduled build’s commencement. During the build phase, there will need to be strong alignment between builder and operator to work around certain events that may require a temporary shutdown of the building works.



This typically involves repositioning a hotel to a higher brand standard which usually involves moving from three-star to four-star. This strategy sits at the top end of the risk profile for value-add investment as it involves a change of brand (and typically a change of operator), significant capital injection and a proposition to existing customers that instead of paying say, a $150 room rate they should now pay say $180. Many loyal customers to the hotel might find this underwhelming unless there has been significant capital expenditure on rooms, the food and beverage offering and guest facilities plus an increase in the level of service (noting that service equals more staff which equals more cost).

An uplift in brand will involve all the operational issues detailed above but it may also involve a major change in the business model. For example, a collection of three-star hotels is well suited to be managed under a cost-efficient centralised operating structure where on-site management is minimal and the roles for accounting, sales and marketing, and revenue management are consolidated at the head office.

Whilst the centralised operating model works well for a three-star product there are certain adjustments required for a four-star offering and particularly the requirement to have more sales and marketing staff on-site, 24-hour front desk manning, free amenities and more.

The investment thesis for an upgrade in standard therefore must account for:

  • The cost of capital expenditure
  • The cost of operational disruption
  • The cost of increased marketing to position the new brand relative to the new room rate
  • The cost of increased staff to satisfy the higher service requirement and the dilution of the benefits of a centralised business model.

 If all the above are diligently taken to account in the investment model the required increase in rate will be closer the 30%. Using the base rate nominated above of $150, it will in fact need to move to $195 within a reasonable time frame. This will be difficult without introducing a substantially new customer base.

Considering the above risks, the decision to upgrade the standard of an existing hotel should be considered with caution unless the hotel has a room size and location that will adequately support a significate increase in room rate under a new elevated brand.



Financiers are wary of transitional assets, particularly those involving substantial capital expenditure that will be disruptive to trading. Certain banks not mandated to lend on development assets will commonly treat major capital expenditure as development therein prohibiting lending.

For financiers willing to lend, margins will be risk-adjusted as will the loan-to-value ratio. Therefore, the pool of financiers will be smaller for investors looking to implement a transitional strategy.


Undertaking value-add hotel investment requires a comprehensive understanding of the technical risks involved and the necessary solutions. The execution risk is often underestimated, making it crucial for investors to carefully evaluate the technical aspects, align with the right stakeholders, and develop a robust investment model that accounts for potential challenges. With thorough planning and risk mitigation strategies in place, value-add hotel investments can yield favourable returns.