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Real Estate Case Study – 60-Minute Hotel Acquisition & Renovation Modelling Test

Gwelo Group, a leading property developer in Darwin (in the Northern Territory of Australia),
has recently put a mixed-purpose building consisting of a 4.5-star hotel (Elan Soho Suites) and
residential apartments up for sale. Your investment firm is considering acquiring and renovating
the property.

The property has 27 stories, including a freehold component of 168 hotel rooms, management
rights to 133 investor-owned apartments, and 259 car parks. Amenities include a restaurant
(“Seoul Food”), a conference facility, and a swimming pool and fitness centre.

Your firm plans to spend approximately AUD $54 million to acquire the property (the
apartments are investor-owned and not included in the price) and another ~$7 million on the
renovation. The total price per room in both phases will be approximately $360,000.

You plan to fund the deal at an 85% LTV Ratio, with an Acquisition Loan at 75% and Mezzanine
for the remaining 10%. No other groups besides your firm will contribute equity.

The renovation will begin in FY 19 or FY 20, and you could complete the process in one year or
distribute it over 2-3 years. Upon completion, you will refinance the Acquisition Loan and
Mezzanine with a Permanent Loan at a 75% LTV Ratio.

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In the distant past, the Darwin hotel market had average Occupancy Rates up to 80%, with
Average Daily Rates (ADRs) of nearly $200. But with the end of the commodities boom, the city-
wide Occupancy Rate fell to 67% last year, and the ADR declined to $155.

However, your firm believes that the market will return to growth in the next several years,
driven by increased domestic travel and international visitors from China and Southeast Asia.

Once the renovation is complete, you believe that the property’s ADR and Occupancy Rate will
rise from $210 and 75%, respectively, to $250 and 80% over the next 5-6 years.

You plan to hold the hotel for five years, start the renovation in FY 19 or FY 20, and then sell the
property based on prevailing Capitalisation Rates at the end of FY 22.

Please use the following assumptions to complete the provided Excel template. You have 60
minutes to make the calculations and respond to the case study questions:

Part 1 – Acquisition, Financing, and Exit Assumptions

Use the following figures to set up the key model assumptions:

• Acquisition Date: 2017-12-31

• Acquisition Price per Key: $320,000 (ignore the apartments and car parks)
• Renovation Start Date: Allow for either 2018-12-31 or 2019-12-31
• Renovation Completion Years: Allow for 1-3 years, with 33%, 50%, or 100% of the
rooms renovated each year depending on the time frame
• Renovation Costs per Key: $40,000
• Acquisition Costs & Stamp Duty: 6.0% of acquisition price

With these assumptions, the Implied Passing Yield based on FY 18 NOI should be 8.79%.

The Australia-wide Passing Yield is currently 6.76%, down from 8.30% in 2012, and the
Australia-wide Acquisition Price per Room is $250,000, up from $150,000 in 2009.

Use the following assumptions for the Acquisition Loan and Mezzanine:

• Acquisition Loan – Loan-to-Value (LTV) Ratio: 75.0%

• Interest Rate: 6.00% (fixed)
• Issuance Fees: 1.5%
• Amortisation Period: 30 years

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• Maturity: 10 years

• Mezzanine – Loan-to-Value (LTV) Ratio: 10.0%

• Cash Interest Rate: 8.00% (fixed)
• Paid-In-Kind (PIK) Interest Rate: 4.00% (fixed)
• Issuance Fees: 1.5%
• Amortisation Period: N/A – Interest-only
• Maturity: 10 years

For the Permanent Loan refinancing upon renovation completion, please assume:

• Refinancing Date: This will vary based on the renovation completion date, but it should
always be the final year of renovation
• Loan-to-Value (LTV) Ratio: 75.0%
• Annual Interest Rate: 5.00% (fixed)
• Issuance Fees: 1.0%
• Amortisation Period: 30 years
• Maturity: 10 years

The Permanent Loan investors are seeking a minimum Interest Coverage Ratio of 2.00x and a
minimum Debt Service Coverage Ratio (DSCR) of 1.50x.

You do NOT need to build in variable exit years; always assume a sale at the end of FY 22.
Assume Selling Costs of 2.00% and the following trend for Cap Rates:

FY 18 FY 19 FY 20 FY 21 FY 22
9.20% 9.50% 9.30% 9.00% 8.70%

Part 2 – Operating Assumptions

The key revenue drivers for a hotel are its number of Rooms (“Keys”), Average Daily Rate, and
Occupancy Rate. Hotels also earn revenue from food & beverage sales, telecom fees, parking,
and management fees or rent from other units, such as apartments and office/retail space.

Expenses are split into “Departmental Expenses” – operating costs and payroll for each revenue
category – and “Undistributed” and “Fixed” expenses. Undistributed Expenses represent items
such as sales & marketing and repairs & maintenance that vary based on the property’s

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occupancy level, while Fixed Expenses include insurance, property taxes, reserves, lease
expenses, and anything else that is incurred regardless of the Occupancy Rate.

You may assume the following trends for the ADR Growth and Occupancy Rate (with initial
values of $210 and 75% in FY 17):

FY 18 FY 19 FY 20 FY 21 FY 22 FY 23
ADR Growth (4.0%) (2.0%) 10.0% 7.0% 4.0% 3.0%
Occupancy Rate 72.0% 70.0% 74.0% 77.0% 79.0% 80.0%

For the rest, please use the following figures:

• Food & Beverage Revenue per Occupied Room Night: $25.00; 3% annual growth
• Telecom Revenue per Occupied Room Night: $2.00; 3% annual growth
• Management Fees per Apartment: $2,000 per year; 3% annual growth
• Fees per Occupied Car Park: $1,500 per year; 3% annual growth

For the Departmental, Undistributed, and Fixed Expenses, please assume the following:

• Room Margin: 77.5% increasing to 78.0% over the holding period

• Food & Beverage Margin: 25.0%
• Telecom Margin: (200.0%) (Hotels almost always lose money here)
• Apartment Management Fee Margin: 50.0%
• Car Park Margin: 31.0%

• Administrative & General % Revenue: 5.0%

• Sales & Marketing % Revenue: 7.0%
• Repairs & Maintenance % Revenue: 3.5%
• Management Fees % Revenue: 3.0%
• Utilities per Occupied Room Night: $2.00; 3% annual growth

• Insurance per Available Room: $450; 3.0% annual growth

• Property Taxes per Available Room: None (The Northern Territory is the only region in
Australia that lacks Land Taxes; Stamp Duty is paid only for property acquisition)
• Reserves per Available Room: $2,100; 3.0% annual growth
• Ground Lease: None (Freehold property)

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Finally, link the Renovation Costs to the assumptions for the Renovation Start Date and Years
Required and distribute them properly.

Part 3 – Property Pro-Forma

Use the figures above to calculate everything down to Adjusted NOI on the Pro-Forma. Be
careful with the drivers for each revenue and expense line item, as they differ substantially.

Also, pay attention to whether or not the hotel is currently undergoing renovation. If it is, and
50% of the rooms are being renovated, then any numbers linked to Occupied Room Nights
should be 50% lower.

It’s easiest to account for this by modifying the “Occupied Room Nights” line item to reflect the
Renovation Factor each year.

Part 4 – Debt Service, Permanent Loan Refinancing, and Equity Returns

Project the Acquisition Loan Interest and Principal Repayments with the IPMT and PPMT
functions; the Mezzanine is interest-only, so you can calculate Cash and PIK Interest manually.
Use the beginning balances to avoid all circular references.

Make sure that your model is flexible enough to support different refinancing dates for the
Acquisition Loan and Mezzanine, and check the current year against the Renovation End Date
to ensure that you’re reflecting the proper payments for each type of Debt.

Your model should support refinancing dates of 2019-12-31 through 2022-12-31.

When you’re done, calculate the returns to equity investors, including the leveraged IRR, the
cash-on-cash multiple, and the annual yield on initial investment. You do NOT need to calculate
the unleveraged IRR or create any waterfall structure.

Part 5 – Case Study Questions

Once you’ve completed the model, please respond to the following questions:

1) If your firm is targeting a 15% IRR, would you do this deal? Why or why not?

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2) In which year do you recommend starting the renovation, and how many years should it
last? What are the trade-offs of earlier vs. later start dates and shorter vs. longer
durations?

3) What’s the maximum size Permanent Loan that can be used to fund the deal once the
renovation is complete? Are the ratios or the LTV the biggest constraint?

4) Are the operating assumptions realistic? If they are, why? If they are not, what would
you change?

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