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F-957-E
June 2020

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AZA Group. Investment in a Hotel
Investment in Times of Crisis
Eduardo Martínez Abascal
Alejandro Franco

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Introduction
In January 2014, the AZA Group had to decide definitively whether to undertake the construction

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of a hotel in the center of Valencia, for its subsequent rental or sale, or if it opted for other real
estate investments on the same site. Multiple doubts arose about the methodology to decide the
investment and even more about the criteria to decide this or other alternative investments1.
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The AZA Group
The AZA Group has been dedicated to transportation for more than 80 years and that continues
to be its core business. Over the years, the group has diversified its activity entering the logistics,
real estate, parking and nautical businesses.
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The AZA Group was chaired by its president and founder, Alfonso Zamorano Aguado (62 years old)
and the Board was made up of his four children plus an external director. Each of the directors was
in charge of a company as CEO. The president insisted on the need to develop business, so as not
to become mere rentiers.
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In 2007, at the peak of the economic boom in Spain, AZA Group had reached a turnover of
37 million euros, with assets of 52 million, a bank debt of 17 and an EBIT of 5 million. In 2013,
and after 6 years of deep economic crisis in Spain, AZA billed 30 million, with an EBIT of
0.5 million; total assets of 93 million and bank debt 50.
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1 This case is based on real events. Some numbers and names have been changed for confidentiality or for pedagogical reasons.

This case was prepared by Professor Eduardo Martínez Abascal and Alejandro Franco, MBA 2000. June 2020.
IESE cases are designed to promote class discussion rather than to illustrate effective or ineffective management of a given
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situation.

Copyright © 2020 IESE. This translation copyright © 2020 IESE. To order copies contact IESE Publishing via www.iesepublishing.com.
Alternatively, write to publishing@iese.edu or call +34 932 536 558.
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No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form
or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of IESE.

Last edited: 27/10/20

 F-957-E AZA Group. Investment in a Hotel

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Despite the crisis, AZA began to prepare an ambitious investment plan, especially in real estate and
logistics, which explains the increase in the group's total assets from 52 to 93 million (72 of them in
real estate). The president’s motivation was twofold: to take advantage of the crisis to get better
prices, and also the responsibility as a businessman of creating employment in hard times for
society.

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The Colón (Columbus) Project
The Colón project consisted of developing several lots on Calle Colón in Valencia to build
20,000 square meters dedicated to parking, a shopping area, a hotel and a public school2. The
estimated investment was 35 million euros (17 for land and 18 for construction).
AZA Group had been working on this project for years, with the purchase of plots of land, permits
from the city council, search for tenants for commercial premises, etc. The projects concerning

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the commercial premises, parking and school were already decided in all their detail (necessary
investment, financing, expected cash flows, etc.). Now it was time to make a decision about
investing in the hotel. The data (forecasts) and alternatives that the Board was considering to

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make the decision are shown below.

The Hotel Investment

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The land for the hotel had been purchased previously (in 1996, 2005 and 2010) at a price of
6 million. This cost, updated with the Housing Price Index gave 7.7 million. An appraisal carried
out at the end of 2010 gave a value of 13 million, which in 2014 seemed very optimistic. The
strong economic crisis since 2008 had deeply affected real estate prices3. A more reasonable
value would be between 8 and 10 million.
The 4-star hotel would be located on Calle Colón, in the commercial and tourist center and one
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of the best premium locations in Valencia. It would have 100 rooms and a built area of
3,750 square meters. It was aimed at “executive” clients and/or tourists, with a medium-high
price. The idea was to rent it to some large chain, like NH, AC Marriott, Hotusa, etc.
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The construction cost of the hotel was estimated at 7.0 million (4.8 construction, 1.2 equipment,
1.1 fees and taxes). 75% of construction was expected to be completed by the end of 2014
(year 0 of the project) and the rest (up to 7 million) by March or May 2015 (year 1).
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A relevant question was what price to assign to the land:

a) The acquisition cost: 6 million.
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b) The acquisition cost, updated with the Housing Price Index: 7.7 million.
c) The 2010 appraisal value of 13 million, or perhaps the most realistic 8 or 10 million.
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2 The public school was a favor requested by the City Council and was seen by AZA as a way to help in the development of

the neighborhood, from which no monetary return was expected. The estimated cost was about two million euros.
3 The Spanish economy had zero or negative growth from the fourth quarter of 2008 to the first quarter of 2014. Real
estate asset valuations were down from 20% to 40%.
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 AZA Group. Investment in a Hotel F-957-E

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d) One of the directors suggested that the cost of the land was a sunk cost, which should
not be considered. In his opinion, only future cash flows were relevant for the analysis
and decision.

Hotel Financing

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The main obstacle to progress in the Colón project had been the lack of financing. The economic
crisis in the first place (2008), followed by the sovereign debt crisis and the crisis of the savings
banks (2012) had closed the credit market and even more the credit to any real estate
operation4. However, the decisive action of the ECB from September 2012 and the bank rescue
undertaken by the Spanish government had brought the Euribor to 0% and the credit market
was beginning to open for quality and low-risk operations.
Alfonso Zamorano spent a lot of time (years) negotiating with several banks, in very adverse

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circumstances. Finally, he obtained (at the end of 2013) an 11-year mortgage of 7 million at 1.5%
(Euribor + 1.5%). The guarantee provided by the group companies that, despite the crisis
generated a reasonable cash flow, were paramount to getting the deal. The loan would be

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available, against construction certifications, at the same speed as the investment made:
approximately 75% in 2014 (year 0) and the remaining 25% in 2015 (year 1). Loan repayment
would be made with annual payments of 0.778 million over 9 years, beginning in 2016.
With these 7 million of debt they intended to finance construction, furniture and equipment,
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while the equity to invest would be the value of the land. The project could not be leveraged
more, since the bank would not agree to finance part of the land.
Mr. Zamorano wanted the “hotel project” to be self-financing and not to be a financial burden
on the group. He sensed that a longer loan was necessary to comfortably face the repayment of
the debt. But for now he had what he had, in a take-it-or-leave-it negotiation. The calculations
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had to be made to see if the principal of the debt could be repaid5. In the future, with a more
favorable economic situation, they could renegotiate the debt for a longer term. To prevent
possible liquidity shortages, he had also managed to negotiate a credit line of 1.2 million euros,
also at 1.5% and renewable annually.
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Hotel Rental Agreement

In 2007, AZA began conversations with the main hotel operators in Spain, in order to rent the
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hotel. There was a lot of interest among the operators, which proposed a fixed rent of around
750 thousand euros per year. In the following years and with the rampant crisis, the scenario
changed completely: interest in new hotels disappeared and, in addition, operators no longer
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accepted a fixed rent, but a moderate fixed one (around 450 thousand euros per year) and a
participation in the operating profit of the hotel.
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4 In the summer of 2012, the sovereign debt crisis shot up the interest rate of the Spanish 10-year bond (B10) to 7.61%
(450 basis points –bp- above the German bond). Bank delinquencies were at their all-time high (13% per year on total bank
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loans), largely due to excess real estate credit. Half of the financial entities (savings banks) ended up disappearing.
5 Alfonso Zamorano argued: “in an investment project the first key is the quality of the asset; that is, the profitability that
it can reasonably produce; the second key and sine qua non condition is to have financing; and the third is to be able to
repay the debt comfortably and without burdens. If this is so, I am sure the IRR will be OK”.
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 F-957-E AZA Group. Investment in a Hotel

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After many conversations, AC Hotels6 had presented its definitive rental offer, in these terms:
a) Fixed rent of 480 thousand euros per year, updated annually for inflation, plus a variable
equal to 80% of the GOP7 minus the fixed rent8. In 2015 no fixed rent would be paid,
only variable.
b) Contract for 20 years.

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c) AZA should deliver the building fully furnished, according to AC standards.
d) Maintenance was carried out by AC, but AZA should replace furniture and machinery
damaged by use. AZA estimated that the capex would be similar to the annual
depreciation (of approximately 0.35 million), to keep the hotel in good condition.
The good relationship between both company presidents (Antonio Catalán and Alfonso Zamorano)

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had made it possible to reach this agreement.
For AZA, variable rent radically transformed the nature of the investment, which went from
being a real estate investment to an investment in the hotel business. This obliged AZA to analyze

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the income statement expected for the hotel in the following 10 years, as if they were the
owners. They also needed information on the urban hotel sector in Spain and specifically in
Valencia. A summary of the study is in Exhibit 1.
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P&L of the Hotel Investment
The hotel sector in Spain (both urban and tourist hotels) is highly developed. It is a mature sector,
with a lot of competition and plenty of information available. The key variables of the business
(price, occupation) are well known and similar among the various operators, with equal quality
and location. In addition, the P&L of hotels follows the same format, the so-called uniform
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system9, which facilitates comparisons. With the advice of AC Hotels, the AZA Board handled the
following variables for the new Colón-Valencia hotel.
Number of rooms: 100.
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Average price per room. It is a variable that depends on market conditions and is very similar
between all the chains (for the same location and quality). A good location allows higher prices.
The large chains enjoy slightly higher prices, due to the quality guarantee they offer.
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In 2013 the average price per room in Valencia was around 90 euros. Due to the quality and the
unbeatable location of the hotel, AZA estimated a starting price of €80/day, the first year
(promotional prices), rising to 90 the second year and €100 the third year. From there, they
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estimated that the price would rise with inflation (around 2% per year). They also estimated that the
income per room would be 20% higher than the price, due to restaurants, bar, and various services.
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6 AC Hotels was the second largest chain of urban hotels in Spain (after NH) with 73 hotels. It had been founded by Antonio

Catalán, once he left NH (also founded by him). Since 2011 it had operated as a subsidiary of Marriot, with the commercial
name of AC Hotels by Marriot.
7 GOP or gross operating profit: income less direct costs, less general, marketing and management expenses. It is the
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standard that the hotel sector uses to measure the profitability of a hotel.
8 Variable rent = 80% x (GOP - fixed rent).

9 USALIor Uniform System of Accounts for the Lodging Industry is the accounting plan used in the hotel sector. See an
example in the Excel doc: AZA Group SUPPLEMENTS.
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On the other hand, they were aware that in 2014, they were starting from a very negative
scenario. Pre-crisis room prices were €120. In the moderately optimistic scenario they could put
a base price of €110, knowing that it would take some time to reach that price. In the negative
scenario, they could set a price of €90, but assuming that price for more than 10 years was the
same as assuming that they would never come out of the crisis.
Occupancy. The average occupancy of executive hotels in Valencia was around 61% in 2013.

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At its peak, it had reached 70%. AZA estimated an occupancy rate of 70% due to the unbeatable
location of the hotel and the fact that sooner or later the crisis would end. In addition, the recent
inauguration of the high-speed train (AVE) between Madrid and Valencia could attract
occupation during the weekends. Management estimated 55% occupancy in year 1, 65% in
year 2, and 70% (cruising speed) in year 3 (2017). In the negative scenario the occupation would
be 65% and in the optimistic 75%.
Direct expenses were well known and around 37% of income. They included staff, cleaning,

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food, etc.
Indirect or structural expenses were estimated at around 370 thousand euros a year, growing

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with the expected inflation of 2% per year.
Marketing and sales costs were estimated at 4% of sales and the operator's (AC Hotels)
management fee at 3.5% on sales.
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The result of these previous assumptions gave the Gross Operating Profit or GOP. From this, the
variable rent was calculated. From the total rent received by AZA, the amortization plus financial
expenses and taxes had to be subtracted.
The hotel could start operating in July 2015, although with any luck it could be finished in March.
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Hotel Investment Decision: Return, Risk and Other Criteria

The Hotel project was well underway and all the key hypotheses in the case were already
available. Construction of the Colón complex had begun and a decision had to be made whether
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to build the hotel and lease it to AC, as construction should follow the hotel operator's
requirements.
Mr. Zamorano wanted to have the numbers to make a decision. For this, he had requested that
the following information be prepared:
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a) Forecast of income statement and balance of the hotel project10. Horizon: 10 years, year
0 in 2014 and year 10, 2024.
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b) Expected return for the shareholder on money invested, which in this case was the land.
The question was, what price to put on the lot in the spreadsheet. The return that the
AZA Group required of its real estate investments was 6%; but was the investment in the
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hotel a real estate investment? Should they ask higher return to the hotel project?
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10 For the calculations requested here, we recommend to use the Supplements in Excel corresponding to this case, available

in the Virtual Campus or at iesepublishing.com.

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 F-957-E AZA Group. Investment in a Hotel

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c) Risks. AZA wanted to measure how sensitive the shareholder return would be to
variations in the assumptions used. Above all, he wanted to know if the debt could be
repaid with certain security.
d) What other criteria, other than return and risk, should they consider for the investment
decision? How did the investment in the hotel fit within the AZA Group business structure?

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Methodological Doubts
When applying the methodology, important doubts were raised that might have a relevant
effect (or not) on the expected return and therefore on the investment decision:
a) Valuation of the land, which was the equity contributed by the shareholder.

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b) Term of the loan. Would a longer term be necessary to face the repayment of principal
more comfortably?
c) Final value in year 10. Was it necessary to use a perpetuity, assuming that the hotel

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would continue operating for another 15 or 20 years? Wouldn't it be more practical and
even more realistic to use the estimated value of the property in year 10?
d) What return should they require from the hotel, 6% of the real estate investment, or
more?
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Other Investment Alternatives
As usually happens in investment projects of a certain size and that are not repetitive, when the
final decision has to be taken, the project is already so advanced that it is difficult to back down.
Even so, Mr. Zamorano asked the Board to analyze other alternatives, since it was “better to
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stop on time than to embark on a bad investment.” In addition to alternative A (renting the
hotel), these others were considered.
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B. The person in charge of the AZA Group's real estate division suggested that the hotel
could be built and sold rather than rented. The 2010 appraisal gave a sale value of
20 million (too optimistic). A more realistic sale value could be around 17 or 18 million,
vs. the almost 15 million estimated investment.
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C. Along these same lines, one of the directors asked if it would not be more profitable,
and above all easier, to sell the plot and avoid construction problems, search for tenants-
operators, etc. He argued: “In the end, we are carriers, not real estate developers”.
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The land appraisal in 2010 was 13 million; a more realistic estimate gave a 2014 sale
value of about 8 to 10 million.
The cash inflow in case of sale would help the other large real estate project that the AZA
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Group had underway: the 20 million Ruzafa project. On the other hand, Mr. Zamorano's
mentality was patrimonial (growing the AZA group), rather than making quick money in a
real estate operation. In addition, bank financing for the Ruzafa project was already half
settled.
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D. Another alternative was to build apartments and to rent or sell. The constructed area
would be about 3,000 square meters, construction cost was estimated at around
€1,500/m2 and a sale price between €3,000 and €4,000. The estimated rental price could
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 AZA Group. Investment in a Hotel F-957-E

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be €200 per square meter per year. No detailed calculations had been made for this
alternative. Furthermore, the strong real estate crisis that had dragged on since 2007
(especially in the Valencia region) was not very encouraging. It was necessary to crunch
the numbers and think about it.
E. There was also the possibility of building offices to rent. Calculations had not been made
for this alternative either. An estimate at first glance, gave a construction cost and rental

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price similar to that of the houses. On the other hand, at the present time and due to
the crisis, there was an excess of supply of offices in Valencia, even in premium locations
such as Colón.

Assume that you are the independent director of the AZA Group Board. What would you answer
to the various questions they raise? What do you advise them?

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Exhibit 1
Hotel Sector in Spain and Valencia

In 2012, some 17,000 hotel establishments operated in Spain, with a capacity of around
900,000 rooms. The sector had barely grown since 2000.

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More than 5,000 hotels (some 400,000 rooms) could be considered as tourist hotels, generally
located on the Mediterranean coast and the Canary Islands. They only open in the high season
and compete on price, negotiating complete packages with large tour operators that guarantee
100% occupancy but at moderate or low prices.
City hotels (about 500 thousand rooms) are open all year round and are mainly aimed at executives
or company employees. They compete on price-quality and location. The average occupancy rate
does not usually exceed 70% because on weekends and holidays (Christmas, summer, etc.) the

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occupation drops a lot. Hotels located in more touristy cities (Valencia, Barcelona, Malaga,
Alicante, etc.) could combine both types of clients: executives during the week and tourists on
weekends and holidays, although at a lower price.

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The hotel sector in Spain is highly developed and highly competitive. The large chains (about 120)
represent 12% of the total (about 2000 hotels), mostly 4-star and growing quite a bit. They are
mainly concentrated in “tourist hotels” (Riu, Meliá, Iberostar, Barceló), but they are also very
present in “urban hotels” (NH, Hotusa, AC Hotels, Husa, Hotels Catalonia)11.
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There are 2,200 4-star hotels (13% of total hotels) and this is the segment that is growing (9%
annually from 1999 to 2012).
In the city of Valencia, 72 hotels (8,000 rooms) operated, of which 95% were 3 stars or more. In
the 4-star segment there were 34 hotels (4,866 rooms). The 4-star hotels had almost doubled
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from 2001 to 2008; but with the onset of the crisis the number of hotels remained the same
since 2009. The crisis and the strategies of low price propensity had made 4 and 3 star hotels
compete openly; even some 5-star hotels had dropped to 4-star.
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The annual occupancy rate (% of rooms occupied) depends a lot on the city where the hotel is
located, and on the category of the hotel. For example, in Barcelona the average occupancy rate
was around 73%, in Madrid 66% and in Seville and Valencia 61%. The occupancy rate had
dropped 5 percentage points since the start of the crisis in 2008. In addition, occupancy is
seasonal (in almost all cities), with a minimum in January (for Valencia 37%) and a maximum in
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August (76%). This seasonality is more pronounced in tourist cities (Barcelona, Seville, Valencia)
and less in cities with more executive clients, such as Madrid.
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The price level since 2008 (beginning of the crisis) had fallen by 10% and for 4-star hotels it was on
average €90/room per day, but with strong fluctuations depending on the season. It is increasingly
common for hotels to have a revenue manager that establishes prices on a continuous basis, based
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on expected and actual demand at any given time.

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11 https://www.hosteltur.com/110520_ranking-hosteltur-cadenas-hoteleras-2013.html.
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