CAPEX, compliance and star rating: the effect on hotel value

Two hotels with the same earnings are not worth the same if one must refurbish its rooms and fire safety systems in the coming years and the other does not. A buyer reasons in terms of total investment: the price paid plus the works it will have to fund. This guide explains how CAPEX, regulatory compliance and star rating enter that reasoning, and what the seller can prepare. It covers principles only: detailed obligations are assessed case by case with inspection bodies, the architect and the lawyer.

How the buyer accounts for works

Two kinds of works

The buyer distinguishes two categories.

• Maintenance and compliance CAPEX: what must be done to operate the hotel in its current condition and category, safely and within the rules. Roof, façades, boiler room, lifts, fire safety system, furniture and bedding at the end of their cycle.
• Value-creating CAPEX: what the buyer chooses to undertake for its own project. Repositioning, moving upmarket, adding rooms, converting under-used space, changing brand.

Deducted from the price or built into the business plan

The first are imposed: the buyer costs them and deducts them from the price, more or less explicitly. A hotel valued on an EBITDA multiple or a capitalisation rate sees the cost of maintenance works subtracted from the resulting value, often with a margin of caution where the estimate is uncertain.

The second are built into the business plan: funded by the buyer and repaid through the expected improvement in trading. They are not deducted from the price, but the seller is not paid for them either.

The buyer also reasons on an EBITDA, or EBE, net of a reserve for replacing furniture, fixtures and equipment, a common practice in the hotel industry. A hotel that has not refurbished its rooms for a long time shows earnings that ignore this coming outlay. Valuation methods are covered in the guide how a hotel is valued.

Fire safety: public-access buildings and the safety commission

In France, a hotel is a building open to the public (ERP), subject to fire and panic safety rules. Its category depends on its capacity. Smaller establishments fall under a lighter regime. Depending on the category, the safety commission inspects the premises periodically and issues a favourable or unfavourable opinion. Any works project also requires authorisation.

Three documents matter to the buyer: the latest commission report, an up-to-date safety register and evidence that the commission’s requirements have been met. An unfavourable opinion does not automatically lead to closure, which is a decision for the administrative authority. But it weighs heavily in the negotiation: the necessary works are costed, often cautiously, and may become a condition precedent. The seller has every interest in knowing the exact position of the hotel before any approach.

Accessibility

Public-access buildings must be accessible to people with disabilities, with requirements specific to hotels, notably regarding adapted rooms. Non-compliant establishments may have entered into a scheduled accessibility programme (Ad’AP), and the authorities can grant exemptions on technical, heritage or economic grounds.

The buyer asks for the accessibility certificate or the status of the Ad’AP, any exemptions obtained and the public accessibility register. Accessibility matters all the more in older buildings: compliance may require installing a lift, reworking circulation or reconfiguring rooms, with an effect on capacity.

Energy performance

Energy performance has become an acquisition criterion in its own right, for three reasons.

• Regulation. In France, commercial buildings above a certain floor area must progressively reduce their energy consumption (the scheme known as the “décret tertiaire”), with annual reporting and targets at successive deadlines. In Belgium, the rules are set by the Regions. The exact scope is assessed building by building, at the time of the transaction.
• Operating costs. Energy is a significant cost for a hotel. A poorly insulated building or ageing installations increase the exposure.
• Buyers’ criteria. Institutional investors and some hotel groups apply their own environmental requirements. An asset that does not meet them sees its pool of buyers shrink, or its price reflect the cost of bringing it up to standard.

The seller benefits from having the consumption history, the available surveys and, where relevant, the reports already filed.

Star rating and what it means

The hotel star rating in France is voluntary. It runs from one to five stars, with a Palace distinction, and is awarded after an inspection by an accredited body against a grid of criteria. It is granted for a limited period and must be renewed. In Belgium, hotel classification is also a regional matter.

Its weight should be judged accurately.

• It does not create value. The buyer values the trading business and the property, not the stars. A four-star hotel whose average daily rate belongs to the category below is valued on its rate.
• It sets a framework. The rating shapes distribution, the target clientele and some obligations, such as the tourist tax scale. A rating that has lapsed, or might not be confirmed at the next inspection, is a risk the buyer will price.
• It limits repositioning. Moving upmarket means meeting the criteria of the higher category: room sizes, equipment, services. What the existing building allows is part of the analysis.

For a branded hotel, the brand’s standards come on top: a change of ownership may trigger a review of those standards by the franchisor, with a works programme attached. The agreement and its timetable should be read before going to market.

Recent refurbishment: the evidence

A recent refurbishment supports value only if it is documented. The buyer expects:

Without these documents, the buyer cannot tell a structural refurbishment from a cosmetic refresh, and values it accordingly.

The pre-sale technical audit

Commissioning a technical audit before going to market lets the seller see the building through the buyer’s eyes. The audit covers the structure and building envelope, the technical systems (heating, ventilation, air conditioning, electrical, plumbing, lifts, fire safety, kitchen), fire safety and accessibility compliance, and energy performance. It produces a costed multi-year works plan.

This document changes the nature of the discussion. The buyer starts from costings prepared by a professional rather than building its own, which will necessarily be cautious. Issues are disclosed rather than discovered: an issue found in due diligence costs more in negotiation than one disclosed upfront. The audit and its supporting documents then go into the technical section of the data room.

Key point: the buyer always deducts maintenance works. The seller’s only choice is whether to cost them itself, with evidence, or leave the buyer to do it.

Should you carry out works before selling?

There is no single answer. Three options are available, to be weighed with the sell-side adviser and the accountant.

1. Carry out urgent compliance and maintenance works. This is generally the recommended option when the timetable allows: a safety non-compliance or end-of-life equipment is deducted with a margin of caution, and sometimes turned into a condition. Once completed and documented, these works drop out of the negotiation.
2. Have works costed and authorised, without committing. For heavier works, obtaining the audit, quotes and, where needed, authorisations makes it possible to present a ready-to-launch project without disrupting operations or tying up cash. The buyer keeps control of its choices.
3. Do not start a repositioning. An upgrade programme launched just before a sale disrupts trading, temporarily weakens the accounts the buyer will examine and rarely matches the buyer’s own plans. It is usually better to leave that lever to the buyer and present it as documented potential.

The choice depends on the condition of the building, the desired timetable and the profile of the target buyers. It starts with a reasoned valuation that takes these works into account, which is the purpose of the hotel valuation page. Overall preparation is described in the guide preparing a hotel for sale.