Developing An Asset Management Strategy

SHA613: Developing an Asset Management Strategy
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SHA613: Developing an Asset

Management Strategy
What you'll do
Analyze the asset manager's role in building value at both the

portfolio and the property level
Develop a strategic vision for asset management
Analyze an asset management plan for a property's long-term needs
Model sell-versus-hold decisions, the optimal holding period, and
make recommendations for individual assets
Course Description
The hotel asset manager is responsible for managing

lodging investments to meet the specific objectives of
ownership. The asset manager's role in building value is
analyzed at both the portfolio and the property level. In
this course, Professor deRoos focuses on the importance
of developing a strategic vision for asset management and demonstrates
the latest asset management techniques in pursuit of that strategic vision.
You will examine the role of the asset manager in real-estate portfolio
management and learn how to develop a strategic vision for asset
management. You will also learn how to create an asset management
plan designed to accomplish long-term financial goals, create forecasts,
and build models that analyze sell versus hold alternatives and make
optimal recommendations consistent with the asset management
strategy and plan.
Jan deRoos
Associate Professor and HVS Professor of Hotel Finance
© 2018 eCornell. All rights reserved. All other copyrights, trademarks, trade names, and logos are the sole property of their respective owners. 1
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and Real Estate, School of Hotel

Administration, Cornell University
Professor Jan A. deRoos, on the faculty of the

School of Hotel Administration since 1988, has
devoted his career to hospitality real estate, with a
focus on the valuation, financing, development, and
operation of lodging, timeshare, and restaurant
assets. He holds BS, MS, and PhD degrees from
Cornell University, all with majors in the School of
Hotel Administration. Areas of teaching expertise span the entire range of
hospitality real estate topics: real estate finance, real estate principles,
hotel asset management, real estate portfolio management, hotel and
restaurant valuation, lodging market and feasibility analysis, hotel/resort
planning and design, hotel/resort development and construction, and the
analysis of timeshare/vacation ownership projects. He teaches courses in
the School of Hotel Administration's undergraduate and graduate degree
programs and teaches extensively in the School of Hotel Administration's
executive education programs.
Author Welcome
There's an old saying in real estate that goes like this. There are only two
things you do in real estate; hunting and farming. Hunting refers to the
transaction-oriented investment, financing, disposition, and control
decisions. Farming, on the other hand, refers to decisions faced by
owners over their holding period, known in the industry as asset
management. The topic of this course.
In this course, we consider strategic asset management, the high level or

big picture management of hotel assets, and explore two key steps
necessary to assist owners in their investment objectives. First, the
development of the asset management plan. And secondly, we consider
sell-versus-hold analysis, which is built around a very strict financial
discipline that goes like this. I wake up every morning with everything for
sale everywhere, and I convince myself to continue to hold it. As different
owners have different objectives, the course focuses on an analysis
framework, not a set of prescriptive rules. Your key learning objectives
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should be a focus on the framework, not a search for universal answers.
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Table of Contents
Meet Your Class

1. Meet Your Class
Module 1: Portfolio Management
1. Module Introduction: Portfolio Management

2. Read: Real Estate and Asset Management
3. Watch: Real Estate as a Portfolio Diversifier and Risk Reducer
4. Watch: More Reasons to Invest in Real Estate
5. Read: Investors, Risk, and Hotels
6. Read: Asset Management and the Portfolio Manager's Viewpoint
7. Read: Diversifiable and Nondiversifiable Risk
8. Watch: The Efficient Portfolio
9. Watch: The Efficient Portfolio in Action
10. Tool: The Efficient Frontier
11. Risk vs. Returns
12. Module Wrap-up: Portfolio Management
Module 2: The Asset Management Process
1. Module Introduction: The Asset Management Process

2. Watch: Why Do Asset Managers Have a Role?
3. Read: Roles and Responsibilities of the Asset Manager
4. Tool: Roles and Responsibilities of the Asset Manager
5. Ask the Expert: How To Be An Effective Asset Manager
6. Read: Different Types of Asset Managers
7. Watch: The Asset Cycle
8. Watch: The Market Cycle
9. Watch: The Asset Management Process
10. Watch: Developing the Asset Management Plan
11. Tool: Monitoring Ongoing Hotel Operations
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12. Read: Thinking Strategically about Highest and Best Use

13. Read: Calculating Highest and Best Use
14. Highest and Best-Use Possibilities
15. Read: Elements of the Asset Management Plan
16. Ask the Expert: Important Features of the Asset Management Plan
17. Tool: The Midlantic's Asset Management Plan
18. Watch: Analyzing the Plan's Strategic Recommendations
19. Watch: Analyzing the Plan's Tactical Recommendations
20. Analyze the Asset Management Plan
21. Module Wrap-up: The Asset Management Process
Module 3: Sell-vs.-Hold Decisions
1. Module Introduction: Sell-vs.-Hold Decisions

2. Watch: The Disposition Decision: Who Sells and Why?
3. Watch: How Context Affects Disposition Decisions
4. Read: The Disposition Decision
5. Ask the Expert: The Most Important Reasons to Sell
6. Watch: The Basic Sell-vs.-Hold Analysis
7. Watch: Optimal Holding Period
8. Tool: Decision Rules for the Optimal Holding Period
9. Read: The Renovation Decision
10. Watch: Case Study: The Hungerford Hotel
11. Renovating the Hungerford Hotel
12. Asset Managing the Hungerford Hotel
13. Tool: Action Plan
14. Module Wrap-up: Sell-vs.-Hold Decisions
15. Read: Thank You and Farewell
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Meet Your Class

1. Meet Your Class
Back to Table of Contents
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Meet Your Class

Using the discussion below, please tell us about yourself; we’re eager to
learn more about you as well as your classmates. What do you hope to
learn from the course? What is your profession? Where are you located?
Please respond in a text format or as a video using the film strip icon that
is available once you click "Reply".
(If posting a video response, we recommend that you do not use your cell
phone as most do not use Flash software which is required to convert the
recording.)
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Module 1: Portfolio Management

1. Module Introduction: Portfolio Management
2. Read: Real Estate and Asset Management
3. Watch: Real Estate as a Portfolio Diversifier and Risk Reducer
4. Watch: More Reasons to Invest in Real Estate
5. Read: Investors, Risk, and Hotels
6. Read: Asset Management and the Portfolio Manager's Viewpoint
7. Read: Diversifiable and Nondiversifiable Risk
8. Watch: The Efficient Portfolio
9. Watch: The Efficient Portfolio in Action
10. Tool: The Efficient Frontier
11. Risk vs. Returns
12. Module Wrap-up: Portfolio Management
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Module Introduction: Portfolio Management

The purpose of investment management is helping
owners to realize their investment goals. The portfolio
manager contributes to this goal by managing the
investment portfolio and allocating capital consistent with
the owner’s objectives. The asset manager contributes to
this goal by managing individual assets consistent with
the owner’s objectives.
In this module, you will discover why real estate is included as part of an
investment portfolio and consider how real estate helps owners realize
their investment goals. Investors use several tools to build successful
portfolios, including the efficient frontier, which is used to create a
portfolio that balances risk and return. Finally, you will identify
strategies to achieve a diversified and efficient investment portfolio.
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Read: Real Estate and Asset Management

• Asset managers ensure that individual real estate investments are
meeting expectations
• Reasons to invest in real estate include diversification, returns,

inflation hedging, and the prevalence of real estate
• Portfolio managers, asset managers, and hotel managers have

different responsibilities
Why do we need asset managers? While investments in real estate can

take many forms, there is always an entity that is the owner of individual
properties. Someone has to manage the assets and make sure they are
achieving the owner’s goals over the holding period. This individual is
called the asset manager. Asset managers are charged with making sure
that individual real estate investments are meeting expectations, and they
inform the portfolio manager if the assets are not achieving the overall
portfolio objectives. Asset managers are not charged with making the
investment decision; this is the domain of the portfolio manager. However,
asset managers play a key role once the investment decision has been
made.
So why would anyone invest in real estate, especially hotels? What

benefits does real estate bring to an investment portfolio? We now
consider why real estate is included in mixed asset portfolio, consisting of
equities, bonds, debt securities, alternative investments, cash, and real
estate. The answer to the opening questions is found in four reasons.
1. Diversification. The most important reason to include real

estate is because it is a great portfolio diversifier. Real estate
brings significant risk reductions to the portfolio because of its
low correlation with stocks, bonds, and cash.
2. Returns. Real estate produces lower total returns than stocks,
and about the same total return as bonds. When the total return
is broken into its two components, the income return and the
appreciation return, we see that real estate excels in producing
income returns. Favorably, real estate provides reliable income
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returns, much higher than the dividends available from stocks

and roughly similar to the cash returns available from bonds.
Due to the low correlation with stocks and bonds, real estate
provides returns when other assets are not performing well.
3. Inflation. Real estate functions as an excellent inflation hedge,
much better than bonds, and better than stocks in the short
term.
4. Everybody does it. Real estate is an accepted part of the
investment universe. Once one starts accumulating a sizable
amount of wealth, you need to consider investments in real
estate, given that real estate is from 8% to 15% of the investable
universe in most economies. Not investing a market weight to
real estate is equivalent to betting that real estate will decline
relative to other investment alternatives.
The pie chart shows the value of the major investment classes,
worldwide. Real estate includes both residential real estate (houses) and
investment real estate.
Portfolio managers often lament that “asset managers don't understand

the big picture.” They mean that asset managers fail to think like a
portfolio manager. Concerned with the performance of individual assets,
they fail to consider how individual assets perform in the context of the
portfolio and in meeting portfolio-level goals. At the same time, hotel
asset managers often say, “The hotel manager doesn’t understand the
big picture.” Asset managers complain that the hotel manager does not
think like an asset manager. Concerned with day-to-day operations, the
hotel manager does not consider larger questions about the performance
of the hotel over the holding period. As you will see, these complaints are
not surprising once you understand that the portfolio manager, the asset
manager, and the property manager all have different responsibilities.
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Watch: Real Estate as a Portfolio Diversifier and

Risk Reducer
As you just read, real estate has become an important component in
most diversified investment portfolios. In this video, Professor deRoos
demonstrates the diversification and risk reduction benefits of real estate
using the efficient frontier. The efficient frontier charts the optimal
achievable relationship between a portfolio's return and risk.
Video Transcript
The most important reason to include real estate in an investment

portfolio is that real estate is a portfolio diversifier and a portfolio risk
reducer. Let's take a more detailed look at how this works. To begin, we
start with a mixed-asset portfolio consisting of different assets. Stocks,
bonds, real estate and cash. We need to know the returns for each asset,
each year, measured as the annual return. Real estate returns are
generally measured by the return to real estate as reported by the
National Council of Real Estate Investment Fiduciaries, known as
NCREIF. Bond returns are measured by the Barclays Government Credit
Index. Stock returns are measured by the S&P 500 and cash by the 90-
day treasury bill. We need to know the risk of each asset, which is
measured as a standard deviation expressed as a percent per year. And
then finally, we need to know the correlations amongst the asset returns.
Once we have the data, we develop what is known as an efficient frontier
using standard portfolio optimization techniques.
An efficient frontier plots the optimal achievable relationship between

returns and risk. This can be thought of in one of two ways. Let's start
with a fixed level of returns. Say we want a 10% return. An efficient
portfolio is the minimum risk or the minimum standard deviation portfolio
that provides us with a 10% return. Another way to define an efficient
portfolio is to start with risk. Say we decide that we can tolerate no more
than 10% standard deviation each year. The question now becomes,
what is the maximum return we can achieve for this level of risk? Both of
these are equivalent ways to define the efficient frontier but the way we
get there is quite different. In one method we specify returns, in the other
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we specify our risk preferences or our risk tolerance. So what do the data
and the efficient frontier tell us?
Let's take a look at real-world data. We have real estate, which has an
annual return of about 7.88%, plus or minus 4.32%. We have bonds with
a 7.15% return, plus or minus 4.97%. Stocks provide a return of 11.86%,
plus or minus 16.21% and cash provides us with a 3.60% return, plus or
minus 1.31%. This data is fed into the optimizer and the optimizer selects
that combination of assets that produce the maximum returns for each
level of risk. So let's say that our return requirement is 8%. What is the
minimum risk portfolio? Recall that we have historical real estate returns
of approximately 7.88%. We have bonds with 7.15%.
So now let's look in an efficient portfolio with an 8% return. This portfolio

has a risk of 4.1% and it is comprised of 41% real estate, 30% bonds,
18% stocks and 12% cash. Note that the portfolio has a lower risk and
higher return than bonds or real estate. The question for the portfolio
manager is which would you rather have? 8% plus or minus 4%, or just
bonds at 7.15% plus or minus 4.97%, or just real estate at 7.88% plus or
minus 4.32%. The answer is clear. Anyone would rather have the 8%,
plus or minus 4.1%. It is the combination of the assets and their work
together in a portfolio that's crucial. The magic of portfolio optimization is
that it allows us to own portfolios with a risk-return relationship with the
portfolio is better than the risk-return relationship with any of the
individual assets.
So, what is our takeaway from this? First, real estate brings great
diversification benefits to low-return, low-risk portfolios. This appeals to
conservative investors who have a need for some cash returns. Real
estate brings solid diversification benefits in medium-risk, medium-return
portfolios. And real estate drops out of the portfolio once you start to
entertain high-risk, high-return portfolios. To conclude, real estate is a
partial solution to portfolio managers' needs. But for anything except the
high-risk, high-return portfolios, real estate has a legitimate place in
anyone's portfolio.
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Watch: More Reasons to Invest in Real Estate

While the diversification and risk-reduction benefits of real estate are
important, there are additional reasons to invest in real estate. In this
video, Professor deRoos shows that real estate provides excellent risk-
adjusted returns, partly due to its low correlation with stocks and bonds.
Real estate also provides a good hedge against inflation. Because real
estate represents about 12% of portfolios in the United States, it is
important to own real estate so that your portfolio reflects the holdings in
a typical portfolio.
Note: In this video, Professor deRoos discusses the correlation between

assets. What does it mean to say that asset categories have a lack of
correlation? Correlation is a measure of the co-movement of two sets of
numbers. Do they move together, do they move independently of each
other, or do they move in opposite directions? If they move completely
together, the correlation is one. If they move counter-cyclically (one goes
up while the other goes down), the correlation is -1. If their movements
are completely independent (they don't follow any pattern or move
together at all), the correlation is zero. Any correlation below 1 provides
some diversification benefit. Correlations of zero and under zero provide
a substantial diversification benefit.
Video Transcript
As we've seen, diversification benefits are the primary reason investors
include real estate in their portfolios. There are however other reasons to
consider real estate. Let's consider three other reasons in a bit more
detail. First is returns. If your investment goal is high returns, it is difficult
to make the case for real estate. The best case for real estate is based
on risk-adjusted returns, using the Sharpe ratio, a measure of the excess
returns achieved per unit of risk.
There are some other reasons for considering having real estate in the
portfolio, even if the goal is having high returns. First, real estate
outperforms stocks and bonds in some quarters. This is due to the low
correlation with stocks and bonds. The good quarters in real estate have
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a roughly 50% chance of having higher returns than stocks and bonds.
And second, conditions could change so that there's an extended period
of excellent real estate performance. Such as the period for 2009 until
2014.
Second reason is inflation. Real estate is a good inflation hedge. The

impact of recent inflation has a positive impact on rents and room rates.
Hotel properties have two characteristics that make them particularly
responsive to inflation. First, room rates adjust very quickly to inflationary
pressures. And second, hotels have shown a remarkable ability to pass
through expenses into room rates over the long run.
Another reason to consider real estate is the investment universe itself. In

order to obtain market returns, you must own a representative sample of
the market. Portfolio managers have to defend deviations from owning
the market. Especially if their portfolio does worse than the market. Real
estate is roughly 12% of the investment universe in the US. It is a much
larger part of many Asian economies, and it's quickly becoming a large
part of the investment universe in Europe and in the Middle East.
Finally, if you want cash returns, you want real estate. Here is a chart that
shows the income returns to the major asset classes over a 30-year
period. And what you'll see is that cash returns from real estate is
amongst the highest returns that are available from any major asset
class.
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Read: Investors, Risk, and Hotels

• There are risk-tolerant, risk-sensitive, and inflation-sensitive
investors
• The natural owners of real estate are pension funds, life insurance
companies, endowments and foundations, and families
• Compared to other real estate options, hotels can be a great

investment
You have seen how real estate brings a diversification benefit to a mixed-
asset portfolio and how real estate can enhance returns and be an
effective inflation hedge. Let's put this all together. To begin, look at
different types of investors with different risk thresholds.
Risk-tolerant investors
In general, investors who can tolerate a great deal of risk derive little
benefit from unleveraged real estate in the portfolio. For these investors,
real estate plays a very small role in the portfolio. There may be a role for
high-risk, high-debt real estate strategies for real estate owners with a
great deal of debt underlying their equity position.
Risk-sensitive investors
Real estate is a partial solution to the needs of these investors. Real

estate provides significant diversification benefits, a very good cash
return, and a relative certainty of cash returns.
Inflation-sensitive investors
For investors who need cash returns to grow with inflation, real estate is a
great investment. The only alternative is inflation-linked treasuries, which
provide a much lower yield.
Given these parameters, who are the natural owners of real estate?
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Pension funds: They have a responsibility to protect their capital in the

fund and not lose the capital. Therefore, they are conservative, low-risk
investors and they have very real liabilities. They have to pay out cash to
their pension fund subscribers on a regular basis.
Life insurance companies: They look very much like pension funds in
terms of their responsibilities and their need to pay out cash returns, here
as survivor's benefits.
Endowments and foundations: They have a desire to preserve their
capital and they have very high cash needs that need to grow with
inflation.
Families: If they wish to preserve wealth for future generations, real
estate is a partial solution because of its ability to be an "infinitely long-
lived" vehicle and because its value grows with inflation.
What are other real estate owners' stories?
Real estate investment trusts (REITs):

REITs exist to provide products to
pension funds, life insurance companies, endowments, and families.
Opportunity funds: The private equity real estate funds, such as Blackstone
or Starwood Capital, invest in high-risk, high-leverage real estate
projects, generally providing very healthy returns to investors and
providing a product to the natural owners.
Commingled funds: These are generally life insurance or asset manager
sponsored funds with Prudential Real Estate Investors and Fidelity
Investments as leading examples; they invest in the low-risk, low-return
real estate and use very little or no debt. Again, they provide an
investment product to institutional investors such as pension funds, small
life insurance companies, and endowments.
We have considered when and why real estate needs to be included in

an investment portfolio. What role do hotels play in an investment
portfolio? Why include hotels in a real estate portfolio?
First, the hotel story is fundamentally a return story. Of all the asset
classes in real estate, hotels have the highest returns. There are some
ways to get higher returns than in lodging, such as investments in raw
land or timber. These are extremely risky, however, and they require
much more specialized expertise than hotels.
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Second, within a mixed real estate portfolio, hotels are much less
correlated with the other real estate than the other asset classes. A very
good diversification story would be to use hotels and retail within a mixed
real estate portfolio to bring some diversification to their real estate.
Third, hotels generally have more strategic options than other real estate.
Hotels can be converted to other valuable uses (hotel to condo, hotel to
office, hotel to apartments) much easier than other real estate classes.
Finally, hotels are fun to own. We cannot ignore the appeal of owning a
hotel, as well as the desire owners have to include hotels in their portfolio
for their non-financial rewards.
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Read: Asset Management and the Portfolio

Manager's Viewpoint
• Unlike asset managers, portfolio managers focus on:
• The risk associated with an asset

The contribution an asset makes to portfolio diversification
The portfolio manager's job is to achieve an acceptable rate of return for

the overall portfolio, while simultaneously managing the risk of that
portfolio. Doing so requires a thorough understanding of risk and an
ability to construct an efficient investment portfolio. Portfolio managers
generally don't see asset management in the same way that asset
managers do. Let's take a look at why.
Consider the contrast with stocks. Part of the investment portfolio is held
in stocks, and there is a stock manager whose job it is to watch stock
performance. If a stock such as Google or Coca-Cola or Microsoft is not
performing, the portfolio manager simply sells the stock. You call the
broker and execute your sell order. You can't do that in real estate. You
can sell the real estate if it is not working for you, but that's a three- to six-
month process. So the portfolio manager cannot afford to wait until a
hotel performs poorly to sell.
An asset manager not well trained in portfolio management might

question the portfolio manager's decision: why is the portfolio manager
selling my real estate when it is doing so well? The reason the portfolio
manager is selling your real estate asset is to systematically engage in a
sell-high, buy-low strategy. If it is doing really well, at some point in the
future it probably won't be doing really well. If the portfolio manager waits
until the real estate does badly before selling it, he or she is engaged in
selling-low, buying-high strategy, which is a wealth-reducing strategy. So
although the asset manager is often concerned solely with the
performance of the asset being managed, the portfolio manager needs to
be concerned with the risk and return contributions of each asset in the
context of the entire portfolio.
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Consider the following example to illustrate the points. A large insurance

company employs two real estate investment officers, Chris and Morgan.
Each is given a $500 million real estate investment allocation and is
charged with purchasing assets that contribute to the portfolio's overall
risk adjusted returns.
Chris is a seasoned “deal-junkie” who takes pride in her ability to identify

and purchase high return assets. The chart below reveals that Chris is
able to purchase assets with a higher return than Morgan: 10% vs. 9%
for office investments and 12% vs. 11% for retail investments. Chris
considers herself a star.
Morgan, on the other hand, is a portfolio allocator, taking pride in her

ability to pick the right asset class and allocate funds to achieve the
highest risk-adjusted portfolio return. Morgan points to the fact that her
weights are very different than Chris'; 20% of her investments are in
office and 80% in retail vs. 80% in office and 20% in retail.
Who is the better portfolio investment officer? Morgan with a portfolio

return of 10.6% beats Chris' portfolio return of 10.4% due to the vastly
different allocation weights. Note also that Morgan is able to achieve a
lower portfolio risk than Chris. No matter how you analyze the situation,
Morgan beats Chris, even though Chris purchases assets with higher
returns on average.
Office Office Retail Retail Portfolio Portfolio

Return Weight Return Weight Return Risk
Chris 10% 80% 12% 20% 10.4% 6.1%
Morgan 9% 20% 11% 80% 10.6% 6.0%
This last example demonstrates that portfolio managers can make poor
decisions if they don't stay focused on their goal and if they don't manage
the portfolio allocation while seeking an acceptable rate of return.
Portfolio managers make decisions to hold assets not only on their
absolute return levels but also by their contribution to the returns and the
risk of their portfolio.
The big takeaway for asset managers is that the success or failure of the
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portfolio (and, hence, perhaps the firm) is in large part determined by

factors outside of the asset manager's domain.
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Read: Diversifiable and Nondiversifiable Risk
• Risk management is a critical part

of portfolio management.
• Diversifiable risk can be

eliminated by owning assets that
are not correlated with each
other.
• Nondiversifiable risk is inherent

and cannot be totally eliminated.
A large percentage of portfolio management is risk management.

Pension funds, insurance companies, and other investment funds often
hold large portfolios of real estate. They are all interested in
understanding the returns per unit of risk for their real estate holdings.
Investment risk can usefully be divided into diversifiable and

nondiversifiable risk.
Diversifiable risk is risk that can be eliminated simply by owning multiple

assets that are not perfectly correlated with each other—that is, multiple
assets that do not rise and fall in value at the same times for the same
reasons. Because it is avoidable, investors are not rewarded for taking
diversifiable risk.
Nondiversifiable, or systematic, risk is the risk that is inherent in an asset

class. It can be limited, but it cannot be eliminated by holding large pools
of different assets.
Diversifiable Risk
Look at the chart below to see how diversification works to limit risk.
Example of Diversification
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Equally
Year Stock Hotel Weighted
Portfolio
1 14.0% -10.0% 2.0
2 -10.0% 8.0% -1.0
3 23.0% 12.0% 17.5
4 -5.0% 17.0% 6.0
5 8.0% -5.0% 1.5
6 12.0% 15.0% 13.5
Average 7.00% 6.17% 6.58%
Standard
12.36% 11.13% 7.37%
Deviation
Adapted from Exhibit 6.6 in Corgel, Smith, and Ling. Real
Estate Representatives, 4th edition. Chicago: Irwin
McGraw Hall-Hill, 2001.
A Note on Correlation:
What does it mean to say that asset

categories have a lack of
correlation? Correlation is a
measure of the co-movement of two
sets of numbers. Do they move
together, do they move
independently of each other, or do
they move in opposite directions? If
they move completely together, the
correlation is one. If they move
counter-cyclically (one goes up
while the other goes down), the
correlation is -1. If their movements
are completely independent (they
don't follow any pattern or move
together at all), the correlation is
zero. Any correlation below 1
provides some diversification
benefit. Correlations of zero and
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under zero provide a substantial

diversification benefit.
Note that combining the two assets into a portfolio significantly reduces
the diversifiable risk. Stocks alone attain an average return of 7.00% per
year, but at a substantial risk (12.36% standard deviation), while the hotel
alone attains a lower return (6.17%) at a lower risk (11.13%). The equally
weighted portfolio, however, achieves returns below what stocks achieve
alone (6.58%), but at a substantially reduced risk (7.37%). Driving the
risk reduction is the lack of correlation between the stocks and the hotel.
In this case, the correlation between the two is -0.21.
Examples of diversifiable risk in a portfolio of real estate include

differences in the quality of management at various properties, local
market conditions (Is the local market doing well? Is it performing
dismally?), and changes in neighborhoods.
Let's examine the basic diversification strategies that might be employed

in these cases.
Basic Diversification Strategies:
Diversify across property type by owning apartment, retail, office, and

hotel property. Combine ownership of whole assets with ownership of
shares in the "pure property type" strategies of REITs to achieve the
desired level of risk. In general, hotels and retail are the first to respond
to changing market conditions; office property lags significantly behind
due to long lease terms.
Diversify across space. Geographic diversification is rewarded by the
market. Firms with concentrations in local markets trade at a discount
to firms that are not concentrated. Recent academic research in
international diversification suggests significant benefits from
diversifying broadly across countries as well as across continents.
Combine whole assets, equity funds, and shares of real estate
securities into diverse portfolios. Each type of holding contributes to the
diversification of the portfolio in different ways and provides options to
the portfolio manager.
Nondiversifiable Risk
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Nondiversifiable risk is eliminated when one "holds the market." Strictly

speaking, this has not been possible in real estate due to a lack of fund
products available that attempt to replicate the entire real estate market.
Given the historical lack of an SP 500 for real estate, investors were
forced to construct a portfolio to achieve diversification using the well-
known principle that the vast majority of nondiversifiable risk is eliminated
by investing in as few as 20-30 assets. The continuing maturity of various
real estate fund products is clear evidence of the market's desire for
products that can help limit nondiversifiable risk by emulating the market.
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Watch: The Efficient Portfolio

Because managing risk is such a critical part of portfolio management, it
is important to have appropriate analytical tools, such as the efficient
frontier. In this video, Professor deRoos explains how the efficient frontier
is constructed and how it can be used to manage risk. The efficient
frontier, in conjunction with portfolio optimization techniques, can help
you determine what combination of assets will achieve your desired level
of risk and returns. Later in the module, you will be able to download a
tool on the efficient frontier.
Video Transcript
Portfolio managers need to efficiently manage risk. A key tool for

managing portfolio risk is the efficient frontier. For any set of assets, the
efficient frontier is the highest return possible at any given level of risk. To
construct this frontier, we need to have the periodic holding period
returns of each asset. The portfolio optimizer calculates the standard
deviation of each asset, the correlations amongst the assets, and
produces an efficient frontier.
So let's produce a frontier. On the vertical axis are returns going from 0 to
16%. On the horizontal axis is risk measured as a standard deviation of
those returns, expressed as a percentage per year. This also ranges
from 0 to 16%. And then we will add data from our individual assets.
Some high return, high risk, some low return, low risk, and all sorts of
combinations in between. We now run the portfolio optimizer to produce
the efficient frontier. The efficient frontier now appears as a boundary
within two axes. What the frontier describes is the maximum return
available for any risk level. One cannot achieve returns above and to the
left of the boundary. That is a zero risk portfolio with very high returns,
which would be nice. But it just doesn't exist in the real world.
On the other hand, an inefficient portfolio is one to the right of and below
the frontier. Here you are not achieving the highest return available for
the risk you are taking. The portfolio optimizer in addition calculates the
different combinations or the weights of the assets along the frontier. For
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example, 0.1 might comprise say, 30% real estate, 20% bonds, 40%
stocks and 10% cash. The frontier tells you exactly what combination you
need to own in order to achieve that specific risk and return combination.
So now lets look at various types of frontiers. Long frontiers or frontiers

with very long tails on the them, indicate that the assumption of more risk
is rewarded. Note that as the frontier extends out, one achieves higher
returns but additional risk must be taken as well. Short frontiers on the
other hand indicate that risk is not worth assuming. The frontier ends, you
can't achieve any higher returns and therefore you don't take any more
risk.
Now let's take a look at the relative slope of the frontier. A very steep
slope frontier indicates a very high reward for each additional level of risk.
As the slope of the frontier increases you get a much higher return for
each additional level of risk. Flat frontiers on the other hand indicate that
you may need to take huge amounts of risk to achieve additional returns.
Lastly, the amount of concavity is an important part of the frontier. The

addition of real estate to the portfolio makes frontiers much more
concave. Putting it all together, the frontier provides investors with
sufficient information to establish a real estate policy. It tells you a lot
about the relative risk and return of all assets and investments. It is a
very important source of insight for all investors.
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Watch: The Efficient Portfolio in Action

Now that you have examined how the efficient frontier is constructed,
Professor deRoos uses an example to enhance your understanding of
how the efficient frontier helps managers construct an appropriate
investment portfolio. He also discusses the constraints that portfolio
managers face that limit their ability to change the assets in the
investment portfolio at will.
Video Transcript
Now we leave the imaginary world in which everyone does everything

right all the time, and move into the real world. The portfolio manager has
been hired by a fund that is facing some significant challenges. In fact, it
is because of these very challenges that a new portfolio manager was
hired. Here we have an efficient frontier. Let's pick off some points from
the frontier. The lowest point of the frontier is about a 10% return, plus or
minus 1.5%. The highest point on the frontier is roughly a 15% return,
plus or minus 9% per year.
Then we have our portfolio. Here. So here's a portfolio which has an

expected return of 9.84% and a standard deviation, plus or minus 6.2%.
So how are we doing, is this portfolio efficient? Clearly not. An important
question is how much is the inefficiency in this portfolio costing us? Note
first that this portfolio has a standard deviation of 6.2% per year. If we
move directly north, under the assumption that we can hold risk constant
at 6.2% per year, this portfolio could be achieving roughly 14%. Not 10%.
Thus the inefficiency is costing us approximately 4% per year. We could
improve our returns by 4% simply by changing the allocation within the
portfolio by selling some assets and purchasing others.
So what can be done to solve this problem? Well, the big answer is we
need to change the portfolio. Any combination of north and west is better,
meaning that any combination of north or west is more efficient. Before
the portfolio manager buys and sells individual portfolio holdings, she
needs to have a conversation with policy makers about their risk
tolerance. Do you want to continue to embrace 6.2% standard deviation,
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or do you want to reduce it? Note that if the portfolio manager or the firm
was happy with their 9.84% return, they could reduce the risk to 1.5% per
year. Note the significant risk reduction that is achievable in this portfolio
at the current return levels.
On the other hand, policy makers could instruct the portfolio manager to
hold risk constant at 6.2% per year, and maximize the return. So before
we execute we need to step back and ask what exactly do we want.
Caution is necessary, because once we make a decision, the costs to
execute are significant. Real estate transaction cost can be two to three
times higher than the cost of transacting, and stock and bond markets.
Unfortunately, we do not live in a world in which real estate capital is
perfectly mobile or a world in which we can alter our portfolio with zero
cost.
Let's consider some of the constraints that are placed on portfolio

managers looking to alter the contents of their portfolio. First, portfolio
managers face constraints on what can be sold. This may be due to
illiquid structures of certain investments, such as commingled funds or
private equity funds. Or it may be because the portfolio contains certain
darling assets that the owner is unwilling to relinquish. Second, portfolio
managers may face limits on how much capital can be invested at any
given moment. This may be due to overall allocation targets the portfolio
must abide by or due to limits on execution capacity. And third, the
portfolio manager may face constraints on the structure of the portfolio
that the owner is willing to hold. Based on policy restrictions and/or
benchmarking restrictions. How should the manager deal with these
constraints? It may be worthwhile to try and remove these constraints.
The Portfolio Manager can quantify the cost of these constraints by
comparing the constrained portfolio with an un-constrained portfolio. A
clear quantified understanding of the cost can be the first step in
constraint removal.
This analysis provides a road map to identifying target acquisitions and

dispositions. First, identify investments that are impediments to improved
performance. Second, identify investments that will most improve
portfolio performance. Third, sell the investments that are impediments,
purchase the assets that improve performance. These are not easy tasks
but they have the potential to bring great rewards to overall portfolio
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performance.
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Tool: The Efficient Frontier
• Use this information on the

efficient frontier when you are
analyzing investment portfolios.
The efficient frontier is an important tool for building investment portfolios

that appropriately balance risk and return. Because managing risk is such
a critical part of portfolio management, it is important to have appropriate
analytical tools, such as the efficient frontier. This tool reviews how
the efficient frontier is constructed and what different frontiers can
indicate. You can use the efficient frontier, in conjunction with portfolio
optimization techniques, to determine what combination of assets
will achieve your desired level of risk and returns.
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Risk vs. Returns

In this required evaluation, consider the efficient frontier and how the
asset manager balances risks and returns.
You must achieve a score of 100% on this quiz to complete the

course. You may take it as many times as needed to achieve that
score.
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Module Wrap-up: Portfolio Management

Portfolio managers are tasked with building an investment portfolio that
maximizes the investor's return. To achieve this goal, many portfolio
managers include real estate because of its diversification and risk-
reducing benefits. Using tools such as the efficient frontier, portfolio
managers can identify the combination of assets that balances the risk
and return preferences of the owner.
In this module, you examined how real estate helps owners realize their
investment goals and how real estate can add value to an investment
portfolio. You reviewed the reasons to include real estate in investment
portfolios and explored the role of real estate in the portfolios of different
types of owners. Finally, you identified strategies to achieve an efficient
investment portfolio.
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Module 2: The Asset Management

Process
1. Module Introduction: The Asset Management Process
2. Watch: Why Do Asset Managers Have a Role?
3. Read: Roles and Responsibilities of the Asset Manager
4. Tool: Roles and Responsibilities of the Asset Manager
5. Ask the Expert: How To Be An Effective Asset Manager
6. Read: Different Types of Asset Managers
7. Watch: The Asset Cycle
8. Watch: The Market Cycle
9. Watch: The Asset Management Process
10. Watch: Developing the Asset Management Plan
11. Tool: Monitoring Ongoing Hotel Operations
12. Read: Thinking Strategically about Highest and Best Use
13. Read: Calculating Highest and Best Use
14. Highest and Best-Use Possibilities
15. Read: Elements of the Asset Management Plan
16. Ask the Expert: Important Features of the Asset Management Plan
17. Tool: The Midlantic's Asset Management Plan
18. Watch: Analyzing the Plan's Strategic Recommendations
19. Watch: Analyzing the Plan's Tactical Recommendations
20. Analyze the Asset Management Plan
21. Module Wrap-up: The Asset Management Process
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Module Introduction: The Asset Management

Process
The asset manager is primarily responsible for managing
individual assets. Though the asset manager plays
important roles throughout the investment cycle, most of
the job involves setting strategy and monitoring the
performance of the hotel.
In this module, you will identify the roles and

responsibilities of the asset manager in managing a specific property.
Because context is critical to the asset management process, you will
explore how the asset cycle and the market cycle affect the strategy for
any property. The overall process of asset management includes
gathering a great deal of data, and you will explore how this information
is transformed into the asset management plan. Using this information,
you will see how the asset manager sets strategy for a hotel including
identifying highest and best-use opportunities, which can greatly enhance
a hotel's value.
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Watch: Why Do Asset Managers Have a Role?

Asset managers play an important role in the strategic management of
the hotels in an owner's portfolio. In this video, Professor deRoos
compares the roles of the asset manager, the portfolio manager, and the
property manager. He discusses the specific responsibilities of the asset
manager and explains why they are an important part of the hotel
investment process.
Video Transcript
What is the role of the asset manager and why are they necessary? We
can begin to answer the question by thinking about it graphically. Note
the Venn diagram, the three intersecting circles that depict how the
portfolio manager, the asset manager, and the hotel manager relate to
each other. The asset managers sits in the middle acting as a conduit
between the property and the overall portfolio. All communications to the
portfolio manager flows through the asset manager. The asset manager
runs the asset strategically, consistent with the portfolio manager's vision
and the needs of the hotel manager for day-to-day operations. With this
in mind, let's return to the original question. What is the role of the asset
manager, and why are they necessary?
There are a number of answers. First, portfolios are becoming

increasingly specialized. Hotel asset managers bring specific expertise
that portfolio managers do not possess. Second, asset managers can
resolve many of the misalignment issues between owners and managers.
At times, owners see the hotel companies operating their hotels on their
hotel management agreement as frustrating their ability to maximize the
value or the cash flows from any given hotel. Asset managers help
resolve these problems by working as the owner's representative, day-to-
day, week-to-week, and year-to-year. Third, hotel asset managers, as a
discipline, was born out of the deep distress of hotel asset management
in the early '90s. This role becomes pronounced during periods of
economic distress. Asset managers play this role for owners such as
banks that own a property after foreclosure or buyers of distressed hotels
who need professional asset managers assistance. Fourth, hotel asset
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managers are the voice for the physical asset. Ownership of hotels
involves many different players. The owner, the hotel manager, and the
distribution channels all want a voice in decisions affecting the hotel. The
owners of the physical assets feel that they should have a very large
voice in many of the major decisions. Many asset managers see their
role as organizing the efforts of the hotel manager and the distribution
channels. Both of which have legitimate roles in maximizing the value of
the asset. Asset managers use their expertise to leverage, and maximize
the efforts of these participants, to the benefit of the physical asset.
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Read: Roles and Responsibilities of the Asset

Manager
• The asset manager has two key roles:
• Managing the investment
• Overseeing the physical asset and its operation
The asset manager's role can usefully be divided in half, between

overseeing operations and managing the investment. Let’s begin by
considering the responsibilities that come with managing the
investment. This role can also be usefully divided into five components:
1. Advise ownership about optimum investment strategies: It is the
asset manager's job to perform an annual strategic review,

comparing properties' expected performance to ownership's
investment objectives. The asset manager must also determine the
market value of properties and project future increments in market
value from holding, renovating, expansion, or other strategic
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alternatives.
2. Monitor the investment community: It is the asset manager's job
to track sales prices for comparable properties, to track capitalization
rates of recent hotel sales, and to continually remain apprised of
financing terms available.
3. Select and oversee operators, franchise affiliations, and
consultants: It is the asset manager’s job to advise ownership on
the appropriate brand or other affiliation for the property and the
appropriate management for property, and to retain appraisers,
environmental consultants, and engineering consultants as
appropriate.
4. Negotiate and administer contracts: It is the asset manager’s job
to ensure that franchise services are provided and billed properly.
The asset manager is also responsible for ensuring management
contract compliance and for negotiating service and other long-term
contracts that provide optimal returns to ownership.
5. Approve and monitor capital expenditures: It is the asset
manager's job to create a long-term capital expenditure plan, to
review annual budget proposals for consistency with the capital plan,
to evaluate the impact on profitability and value of discretionary
expenditures, to approve capital budgets for presentation to
ownership, and to review spending requests for compliance with the
capital budget.
Now let’s consider the asset manager’s role in overseeing the

physical asset and its operations. This role can be broken down
into five components:
1. Monitor ongoing financial performance: Asset managers

must review actual financial performance compared both to the
budget and to prior years. Asset managers must also compare
the performance to that of other comparable properties. This
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benchmarking activity helps discriminate between good and
substandard property manager performance.

2. Monitor the competitive market: Asset managers must be fully
informed about the relevant market conditions. They must 1)
track occupancy and average rate trends, 2) track new
properties being considered for development, and 3) monitor
demand generators to anticipate significant increases or
decreases in market demand.
3. Monitor the asset: Asset managers must regularly evaluate the
physical condition of the property with an eye toward
anticipating capital requirements. They need to regularly
evaluate the major building systems and other infrastructure for
appropriateness and competitiveness. Finally, asset managers
need to ensure legal compliance with health codes, life-safety
regulations, and access for the disabled.
4. Support and review the budgeting process: The asset
manager’s role in this process is multifaceted. Asset managers
must benchmark operations against comparable properties.
They are responsible for communicating ownership expectations
to the manager. Asset managers review proposed budgets,
marketing plans, operating plans, and capital expenditure plans
for their compliance with ownership expectations. Finally, asset
managers facilitate the approval of budgets, marketing plans,
operating plans, and capital expenditure plans by ownership.
5. Advise ownership on management issues: The asset
manager’s role extends to evaluating the strengths and
weaknesses of the manager. They review industry trends that
may have an impact on the hotel company charged with
management and keep ownership apprised of those trends.
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You will have the opportunity to download the asset manager's

roles and responsibilities on the next page.
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Tool: Roles and Responsibilities of the Asset

Manager
• Asset Manager Roles and

Responsibilities
The asset manager has a wide variety of responsibilities, which can be

divided into two categories: managing the investment and overseeing the
physical asset. As the role has evolved over time, you need to be familiar
with all the types of activities that professional asset managers are
expected to perform. Use this helpful tool in your work, whether you are
an aspiring asset manager or you interface regularly with asset
managers.
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Ask the Expert: How To Be An Effective Asset

Manager
The questions you ask and how you spend your time provide key insights
into the effectiveness of an asset manager. We interviewed Ken Fuller,
an experienced asset manager and Vice President, at his office at
LaSalle Hotel Properties in Bethesda, MD. He describes the strategic
questions you should be asking about your properties: What is the
potential of the asset and how do we capitalize on that potential? One of
the most effective ways to develop the answers to these questions is to
spend time at the property with the people who operate the hotels. In
addition, by spending time with hotel operators, you can share your
insights and experience, which helps to form a true partnership that can
increase the value of the property over the long-term.
Kenneth G. Fuller returned to LaSalle Hotel Properties in April 2016 as

Executive Vice President, Chief Financial Officer, Secretary and
Treasurer. Lasalle is focused on earning attractive returns through the
ownership of upscale full-service hotels located in urban, resort and
convention markets. Fuller previously served fifteen years with LaSalle as
Treasurer, from 2011 to 2015; Vice President of Finance, from 2009 to
2011; and Vice President of Asset Management, from 2007 to 2009. In
2015, he founded Vine Investment Partners, a real estate company
focused on acquiring and developing multi-family residential properties
and hotels. Fuller holds a B.S. in Hotel Administration from Cornell
University's School of Hotel Administration. (The job title listed above
was held by our expert at the time of this interview.)
What are the most important strategic questions you must answer regularly for the assets
in your portfolio?
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Video Transcript
So when thinking of the most important strategic questions that we have

to ask ourselves for the assets in our portfolio, it again starts with the
opportunities. What are the opportunities and how do we capitalize on
those opportunities? If you think of each asset as a machine, you've got
to ask again, do you have the right parts? You have the right operator for
the machine or would the machine work better if you tweaked the parts of
the machine or if you tweaked the person who was operating it or do you
tweak the way in which it's being operated? But it all starts with really
assessing the potential of that asset. If it's in a great market and it's
surrounded by other competitors who perhaps are doing a little better,
what can we do to strengthen the performance of your asset and make
sure that we're maximizing the cashflow that we're getting out of it.
Because when you're realistic about the potential of an asset, or again, I
like to use a machine as an analogy, and you're realistic about the quality
of the effort that's going into it, it's going to lead you to make good
decisions. Really to help you maximize the output of that asset and/or
machine.
As an asset manager, what are the most effective uses of your

time?
Video Transcript
Let's see, so effective uses of my time as an asset manager and what

items feel like they don't add a ton of value but they're important
nonetheless. I'll start with what are the most effective uses of time. Asset
management, in conjunction with the hotel business in general, it's a
people business. So spending time, and quality time, with the folks that
are operating our hotels is critical. We're a real estate investment trust.
We're not permitted to operate hotels directly. But as asset managers,
we're stewards of capital, you know on behalf of our investors. And the
people that are on the ground every single day, operating the hotels are
having a momentary impact. Every single thing that they do is having an
impact, positive, negative, or neutral, on the hotel and so the extent that
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we could positively influence what they're doing, uttilize our information,

our data, our common sense, our knowledge, our experience, to help
them perform better to be partners with our operators, anything that we
do that contributes to that, I think is probably the most useful use of our
time as asset managers.
I use benchmarking to try to get smart before any time, before I ever
even spend time with our operators. Before I sit down with the GM or
Director of Sales and Marketing, I like to start with, what's going on in the
market? What's going on with their competitors? What's going on with
other properties within our portfolio? And how will that impact my
assessment of how they're doing and where the opportunities are, and
then armed with that data, I'm sitting down and I'm building a rapport and
a relationship and trust, and a reputation of good counsel with those
teams. Good, healthy relationships so that they can execute. We can
help them to execute with the ideas that we bring to the table. We have a
number of different operators that manage our hotels. And different
operators have different great ideas. We're sharing best practices from
one operator to another just to make sure that they're all benefitting from
some of the smart ideas that come from our operating teams.
So really the best thing that we can do is spend time with the folks that
are overseeing our properties, give quality time. And then the question of
what feels like it's a time suck if you will, but it's valuable and important
nonetheless. It's really back to the benchmarking that I started out
discussing. At our company we're constantly analyzing everything. Every
sort of line of the P&L gets analyzed and benchmarked and we come
together as a group. And when we leave those meetings we may not
always feel like we've advanced the ball, but the discipline of doing that is
very valuable. And we've seen the fruit of that labor year over year and
really reflected in our margins relative to a number of our peers.
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Read: Different Types of Asset Managers
• The three types of asset

managers are investment
managers, troubleshooters, and
owner-operators
We can identify three archetypical asset managers. A number of factors

determine the type most appropriate to a given asset, owner, or situation.
Let's look at the three types.
Investment Managers
These asset managers are big-picture managers, involved heavily in

strategic and long-range planning for the asset. They produce input on
the cycles (buy vs. sell), they perform sell-vs.-hold analyses, they model
and determine the optimal holding period, they perform refinancing
analyses, and they provide input on the proper capital structure.
Troubleshooters
If the investment manager is a big-picture manager, the troubleshooter is

focused on the small picture, often a small picture in a cracked frame.
The troubleshooter is often responsible for turning around floundering
hotels. Historically, a great number of asset managers fell into this
category because asset managers were often used as "salvage artists,"
whose job it was to rescue struggling or failing hotel properties. The
troubleshooter often manages the turnaround process, works on building
hotel revenues, establishes appropriate expense levels, implements
strategic repositioning, and positions properties for sale.
Owner-Operators
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This is the most strategic of the three categories. This type of asset
manager specializes in reconciling the competing objectives of owner-
operators. Wearing the owner hat, they want to maximize the value of the
individual investment, the hotel. Wearing the operator hat, they want to
maximize the value of the management company. Reconciling these two
goals is at the heart of this type of asset manager's job.
The type of asset manager or asset management skills needed varies

over the life cycle of the asset. It depends on the owner's investment
objectives. Finally, it has a great deal to do with the current situation
faced by the property.
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Watch: The Asset Cycle

Now that you understand the asset manager's role, it is important to
consider the broader context in which the asset manager operates. In this
video, Professor deRoos introduces the the asset cycle and the market
cycle. First, he focuses on the asset cycle, which indicates the relative
age and condition of the hotel. He demonstrates that asset managers
must consider the location of a hotel in the asset cycle before taking
action in a given situation.
Video Transcript
Let's consider the context for asset management by examining the asset
cycle and the market cycle. The first thing one learns as an asset
manager is that the correct action in any situation depends on where the
hotel is in each of the two cycles. The proper course of action depends
on the hotel's relative age and condition, known as the asset cycle and
the state of the economy, known as the market cycle. Let's begin with the
assets cycle. Consider a newly opened property at the beginning of the
cycle in the six o'clock position. In this introductory stage, the property
needs to establish its occupancy and its position within the market. This
phase is characterized by a focus on marketing and building market
share. Revenues should build quickly as the property establishes itself.
Next is the growth stage. The property continues to increase its revenue
but the rate of revenue growth starts to slow. However, as the property
starts to exhibit higher occupancies and realize its operational efficiencies
both profits and cash flows increase rapidly. The property then enters a
mature stage. If the owner has done a great job as a hotel investor, the
hotel's success has excited potential competitors, and they start coming
into the market with new properties to compete with yours. The mature
stage is characterized by falling revenues, as competitors take portions of
the existing hotel's business. The property is also becoming a bit older
and will need increased capital expenditures to remain competitive within
the market.
In the last quadrant of a cycle many properties now enter a period of
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decline. The existing customer base has eroded due to the property's
poor condition or relative to location, which may call for accelerated
marketing to buy replacement customers. At the very bottom of the
decline stage, there is a decision to either dispose of the property or to
conduct a full renovation. A thorough renovation will transform a property
into a brand new property, meaning the cycle begins all over again.
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Watch: The Market Cycle

Along with the asset cycle, the market cycle is critical to the asset
manager's decision-making process. In this video, Professor deRoos
describes the market cycle, which indicates the current state of the
economy for a particular hotel. Using several scenarios, he shows how
asset managers need to consider both the asset cycle and market cycle
when making sell-vs.-hold decisions, capital expenditure investments,
and other strategic decisions about the hotel.
Video Transcript
Now, let's consider the market cycle. Again, we start at six o'clock, the
bottom of the cycle. Bad things have happened to the economy, but now
it's starting to pick up. The initial stage of a rising market is characterized,
again, by barely quickly growing revenue. And there's a growth stage,
where revenue growth begins to slow down, and at some point the
market peaks. Which is generally only obvious in the hindsight. The
decline stage like the mature stage is characterized by falling revenues.
Revenues fall at an increasing rate and finally the rate of drop slows until
you're at the bottom of the market again.
The exciting side of the market cycle is when revenues are increasing.
This period is characterized by very high levels of transacting. Investors
are looking to sell their assets to harvest increases in value. The mature
and decline stages are characterized by an asset management
paradigm. The emphasis here is on managing the assets because sellers
of assets won't achieve their intended sale prices. So how should and
asset manager respond to the cycles? The answer is to consider a
hotel's asset cycle along with the market cycle. Imagine a six year-old
property scheduled for its first cosmetic renovation at the very bottom of
the market cycle. This is the absolute best time to renovate. You know
that you are emerging from the bottom of the market cycle. Revenues are
beginning to recover. The renovation will pay huge dividends because a
fresh renovated hotel in its market can command both a rate and
occupancy premium.
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Contrast that with this same asset, at six years old, and is scheduled for
its first rooms refresh. But now it's 12:30 in the market cycle, we know
that we are past the peak and that revenues will be declining. At this
point, the return on investment from doing a great job on a renovation just
doesn't add up. The return on investment is very low. Given this situation
the asset managers best response maybe to do a minimal renovation,
because the returns simply aren't there. While both situations have an
asset, in which the furnishings are in need of renovation, the response in
terms of how we would execute the renovation is completely different,
because of the position in the market cycle.
Now another scenario, consider a brand new property opening at the

bottom of the cycle. We know that we'll have to spend some money to
achieve an occupancy and average daily rate goals. But if it is opening
into a rising market we would expect this property to very quickly achieve
its budget and occupancy rate and quickly mature into the expected
bench marks. This is a hotel in which the asset manager would challenge
the properties management team to meet the bench marks very very
quickly.
Contrast this to a situation with a brand new hotel, six o'clock in the asset
cycle, opening into a market that is at one o'clock in the market cycle.
The owner has opened this property at exactly the wrong time. The asset
manager knows the property will have a difficult time achieving its
occupancy and average daily rate benchmarks as the market declines.
Management will struggle to meet the benchmarks in terms of profitability
and overall efficiency. The hotel is not only struggling to find its place
within the market, the market itself is struggling. This is a very difficult
asset management assignment and it is unfair to hold the property
manager to the same standards in a falling market as in a rising market.
The conclusion from all these examples, context matters, and it matters a
lot. Asset managers need to be sensitive, not only to where their assets
are in the physical cycle but also to where their assets are in the market
cycle as well.
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Watch: The Asset Management Process

Now that you understand the importance of a particular hotel's place in
the asset cycle and the market cycle, we can step back and consider the
overall process of asset management. In this video, Professor deRoos
discusses the four-step asset management process and describes the
asset manager's role in this process.
Video Transcript
The asset management process for a single asset is a four step process.
It starts with determining the owner's objectives for the asset. Next the
asset is acquired and integrated into the owner's systems. Third, there is
an extended period of monitoring the ongoing performance of the asset.
And lastly, the asset manager facilitates the conclusion of the investment
in an orderly fashion.
Let's take a look at each one in turn. Step one is determining the owner's
objectives. It is vital that the asset manager truly understand the owner's
objectives. Is the owner interested in fully funding the capital
expenditures for the long-term needs of the property? Or does the owner
have little interest in investing beyond the initial acquisition? Looking to
flip the property in a short time frame. Is the owner's investment driven
solely by returns? Or does the owner have different reasons to own?
Perhaps the hotel is an anchor for a mixed use development. And the
owner uses the hotel to sell a lifestyle, with an interest in an extraordinary
physical and service product at the hotel. Without a thorough
understanding of the owner's objectives, the asset manager cannot
perform their role effectively. Step two. It is best practice to have the
asset manager become involved the instant an owner decides to acquire
an asset. In this step, there is a pre-acquisition phase, and an absorption
phase.
In the pre-acquisition phase, the asset manager supports the transaction

team as the asset is purchased and integrated into the portfolio. The
asset manager's concern with strategic considerations, such as highest
and best use, and also tactical considerations, such as capital
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expenditures, a physical review and a product improvement plan if the

property has a franchise license. The result is a pre-purchase asset
management plan that organizes the action steps for the property once
the purchase is complete. This plan is based on both an assessment of
past performance and is a guide for future action, a dynamic document
through which the asset manager charts the course of the investment.
The remainder of this discussion focuses on how an asset manager
devises their plans and how they use them.
The absorption stage takes place once the sale is closed and the owner
takes possession. At that point, the hotel is in the asset manager's
domain. During the absorption process, the asset manager works very
quickly to integrate the property into the owner's systems. The quicker it
is integrated, the quicker the asset manager can accurately measure the
returns and implement the strategic vision. The asset manager
establishes communication protocols, imposes the owner's systems on
the property, and implements the pre-purchase asset management plan.
Step three, the asset manager monitors ongoing operations. This is the
phase where the asset manager has the largest role. It is really the day-
to-day work of every asset manager. In the end, an asset manager must
be able to answer a key strategic question. Is it more profitable to
continue to operate the hotel or should we sell it and redeploy the capital
to other opportunities? In other words, do we sell or do we continue to
hold the hotel?
In the concluding phase, step four, asset managers help position the
asset for sale, including any expenditures needed to facilitate that sale.
They serve as a resource at the closing table by helping to assemble
many of the documents necessary to affect the closing. And lastly, and
probably most importantly, the asset manager is responsible for
determining the holding period returns at the conclusion of the
investment. They calculate both the cash-on-cash returns and the overall
internal rate of return achieved by owning this investment.
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Watch: Developing the Asset Management Plan

As you just saw, a critical part of the asset management process is
creating and maintaining the asset management plan. In this
video, Professor deRoos presents a diagram that shows the enormous
amount of information needed to develop the plan. The asset
management process requires ongoing monitoring of the hotel's
performance, in addition to in-depth research on the internal and external
conditions that can affect the hotel. All this information is evaluated in
consideration with the owner's investment criteria, resulting in a sell-vs.-
hold decision. You can download this diagram on the next page.
Video Transcript
As we have seen, an asset manager must be able to answer a key

strategic question. Is it more profitable to continue to operate the hotel?
Or should we sell it and redeploy the capital to other opportunities. To
answer this question, you need an annual asset management plan.
Creating and updating the plan is a key part of the asset manager's job.
To create the plan, you need an enormous amount of information. First,
you need to know the asset's position within the asset cycle and within
the market cycle. This means you need to know the condition of the hotel
and the remaining life of its component parts. You need to know the
conditions within the overall market cycle, and the conditions of the
financing markets. You must also take into considerations the overall
portfolio strategy and the place of this asset in pursuit of that strategy. All
of these influence the asset's relative position and must be accounted for
in the asset manager plan.
Next, consider the owner's investment criteria and their influence on the
asset management plan. These influences include: Is the size of the
investment relative to other investments in the portfolio proper? What is
the desired holding period? What is the desired equity returns? What are
the desired returns from cash versus returns from appreciation? And
what is the relative risk of this asset? All of these must be reflected in the
asset management plan. Lastly, the asset management plan is informed
by an extensive research and analysis effort which results in an
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assessment of the property's performance.
Let's look at what goes into assessing the performance of a hotel

property. First there's a Physical Plant Evaluation. The asset manager
needs to understand both current and long-term capital expenditures for
the property. We evaluate the building, the furniture, the fixtures, the
equipment, the mechanical systems, life safety systems, accessibility,
and environmental impact. Secondly, the asset manager evaluates the
operation and the management. This includes analyzing historical
performance and the strengths and weaknesses of the manager. The
latter includes considering how well the manager is supported at the
corporate level. Third, the asset manager needs to perform a market
analysis. Here we analyze the competitive supply in the market, the main
generators in the market, and the overall economic environment in which
the hotel operates. The market analysis evaluates the property in context,
looking at it's relative location, relative facilities, amenities and quality.
Fourth, depending on the circumstances, you may need to perform an
affiliation analysis. If independent, is a property suitable for a brand? If
branded, is a different affiliation or no affiliation warranted? What services
could a brand or other distribution channels provide? Answering these
questions entails analyzing the distribution systems in place, the sales
and marketing support and what services can be provided outside the
brand that are beyond the capacity of the current management.
All of these evaluations feed into an overall assessment of asset

performance which is anchored by a benchmarking effort. We need to
understand both the existing and desired market positioning of the hotel,
how well it performs relative to competitors, its overall financial
performance — both in comparison to itself over time and in comparison
to other hotels. Benchmarking metrics include occupancy, average daily
rate, total sales, operating profit, net cash flow. Collectively, this analysis
provides a thorough understanding of whether the property reaches, or
achieves, or exceeds benchmarks in terms of cash flow and market
share.
Now we have all the information necessary to create the asset

management plan. Our research analysis, our knowledge of the owner's
investment goals and our understanding of the hotel's position in the
investment cycle. The plan we create synthesizes all the information into
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a statement about property positioning, an operating strategy, financial

projections, a capital expenditure plan and finally, evaluation of the
property. The asset management plan provides the foundations for the
projection of financial performance in the future. This is turn, allows us to
produce reasonable estimates of the value of the hotel.
Now we can properly evaluate whether to sell or hold this hotel. If we

decide to hold, we run the process all over again next year. If we decide
to sell, we move to the final step in our four step process, the conclusion
of the investment. As we have just seen, the bulk of the asset manager's
job is devoted to ongoing monitoring of the hotel's performance and
analysis. But it is crucial to frame that ongoing work in a larger
framework. By centering the strategy on achieving the financial needs of
ownership, the asset manager keeps their ongoing analysis focused on
whether the hotel should be sold or should be held.
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Tool: Monitoring Ongoing Hotel Operations
• Use this diagram of creating an

asset management plan when
you develop your own plan.
You need a great deal of information to create an asset management

plan. This diagram shows how the asset manager constructs an asset
management plan to monitor the ongoing operations of a hotel and to
produce an investment recommendation for the owner. Use this helpful
diagram to guide your own asset management activities.
Note: Drawn from Exhibit 11-9 in Chapter 11 "The Hotel Sector,"

from The Handbook of Real Estate Portfolio Management. Chapter
authors are Mr. David Johnstone of Miller Global Properties, LLC, and
Mr. Jeffrey Duni of HVS.
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Read: Thinking Strategically about Highest and Best

Use
• Creatively transforming a property can result

in significantly higher returns
• You should consider whether the asset

can be reconfigured into more a profitable or
beneficial use
You have seen how to produce an asset management plan for a single
hotel. The process results in a strategic plan that addresses a basic
question: How can the asset be better managed to increase the overall
value of the hotel? A part of the asset management job that is frequently
overlooked is what might be called "highest and best-use benchmarking."
Much asset management takes the physical asset as a given and then
proceeds with an evaluation and analysis of that physical asset. Highest
and best-use thinking asks the asset manager to think outside of the
asset's physical box and consider whether it is possible to reconfigure the
asset into a more profitable or beneficial use. It is important to ask this
question because significant value can be added via creative
redevelopment of the property. Such a redevelopment may mean building
a larger hotel, or it may mean replacing the hotel with a different use,
perhaps with residential apartments or condominiums. The owner and the
asset manager working on behalf of the owner have a substantial interest
in such highest and best-use questions because they can significantly
increase the value of the property.
The best way to illustrate highest and best-use possibilities is through a

number of examples. Consider the following stylized situations drawn
from the recent press reports.
Other examples are not so extreme and include:
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Co-locate another brand from the franchisor’s brand family on the same
site
Convert hotel rooms to residential condominiums
Develop a spa
Create neighborhood restaurants in urban markets
What do these stories have in common? In each, the hotel ownership is

boldly reconfiguring the use of the physical space, to change the
properties “envelope.” The examples also illustrate the financial range
encompassed by highest and best use strategic thinking. In the first
example, an underperforming hotel is being transformed into two hotels
through a large expansion of the physical space (the nine-story addition).
In the second, a valuable property (the Sheraton Bal Harbour) is being
demolished to create a $1 billion combination of hotels and
condominiums. Finally, in the last example, a purely functional hotel
laundry facility is being moved off site to facilitate the creation of a
valuable spa.
Consider the final example in more detail. The value of highest and best
use strategic thinking is clear. The renovation was not the result of a
problem. The laundry facility was necessary, as it was efficient and it was
well run. Conventional asset management might have passed over the
laundry quite quickly and looked to address problems elsewhere. The
asset management of the hotel, however, employed highest and best use
thinking. They were able to look at an efficient laundry facility and see a
more profitable spa. They recognized the laundry was occupying space
that could be put to a higher and better use.
Done well, highest and best use benchmarking holds the promise for
dramatic improvements in hotel property returns.
April 2nd
ABC Hospitality has filed plans with the city of Chicago to

redevelop the existing 122-room Garden Inn and add a second
320-room hotel. AA wants to demolish part of the existing hotel to
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rooms. ABC bought the Garden Inn out of foreclosure within the
past two years.
July 11th
The flag at the Sheraton Bal Harbour was lowered for the final
time on Wednesday. The hotel has been closed in order to be
demolished so that the new St. Regis Resort Residences, Bal
Harbour, can be developed. The owner plans to raze the old
Sheraton Bal Harbour this fall to make room for the $1 billion St.
Regis, which will include nearly 270 condominiums, 182 hotel
rooms, 36 hotel-condo units, and a presidential suite.
July 30th
Omnificent Real Estate announced the opening of the 10,000
square foot spa at the Five Star Palm Desert Hotel. The spa,
costing $4 million, replaces a laundry facility and will take
advantage of the views and sunlight available at the site. The
addition of the spa will add $10 million to the value of the
property.
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Read: Calculating Highest and Best Use
• Asset managers need to evaluate the

financial benefits of highest and best-use
possibilities
• An important metric for analysis is the floor-

to-area ratio (FAR)
• Asset managers must also consider zoning

laws and all the costs involved in any change
to a property
Highest and best-use analysis begins with identifying the development,

redevelopment, and infill opportunities available for a specific property.
The asset manager must identify a higher and better use, identifying the
changes in floor-to-area ratio (FAR) that will bring concrete benefits to the
property greater than the estimated costs. The asset manager must also
be able to deal with local zoning laws that can make it difficult to calculate
the benefits from changes in the FAR. They need to understand the
entitled FAR, transferable development rights (TDRs), and FAR that might
be available via a variance process.
In practice, evaluating different highest and best-use possibilities comes

down to a financial analysis of the potential benefits. Let’s take a look at
two examples:
In this example, we illustrate the basic concept of highest and best use to
provide a context for its application in an asset management setting.
Imagine you have a vacant parcel to develop and are considering
apartments, a hotel, or an office building. The highest and best use for the
parcel is the use that produces the highest economic rent to the land,
after deducting a fair return to the building. This use produces the highest
value for the land parcel and is considered the highest and best use. Let’s
look at the numbers:
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Possible Uses
Apartments Hotel Office
Cost of $400.00 per $360.00 $320.00
Construction SF per SF per SF
$100.00 per $80.00 per $80.00 per
Total Revenues
SF SF SF
Operating $50.00 per $32.00 per $35.00 per
Expenses SF SF SF
Net Operating $50.00 per $48.00 per $45.00 per
Income SF SF SF
Return to Building $40.00 per $36.00 per $32.00 per
@ 10% SF SF SF
$10.00 per $12.00 per $13.00 per
Net Income to Site
SF SF SF
In this simple example, the office use is the highest and best use
because it produces the highest returns to the site. While the office use
does not produce the highest gross income or the highest net operating
income, due to its low operating expenses, it produces the best net
income at $13.00 per square foot. As an extension of this example,
consider an existing property where you want to determine if a change of
use or significant changes in the intensity of use are appropriate. The
analysis proceeds in a similar fashion, but here we need to consider the
costs of demolition and lost income during construction as part of the
redevelopment costs.
Now let’s consider an example in an asset management setting. You

asset manage a 3-star hotel in a downtown area very close to a recently
opened riverboat casino. The hotel performs well and has a profitable
coffee shop that is scheduled for renovation. The coffee shop works well
for the hotel and for the increasing amount casino-driven pedestrian
traffic. However, the asset manager notes that a growing elite national
steakhouse chain has been performing very well in other markets. The
asset manager approaches the chain and proposes changing the existing
coffee shop into a steakhouse under a lease. The coffee shop can be
relocated to an underutilized second floor catering space. The asset
manager knows that to make this change work the steakhouse needs to
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provide net rents that are in excess of a fair, unleveraged, cash-on-cash

return. The benchmark in this case, if net rents are more than 10% of the
gross per square foot, makes sense.
Let's look at some numbers for the steakhouse in this property:
Rent Calculation
Steakhouse gross sales per SF $550
Times: Rental rate—percentage of
6.0%
sales
Equals: Net rent per SF $33
Return Calculation
Hotel Owner’s Cost to

Prepare Space for
Steakhouse $200
(Includes cost of relocating
coffee shop)
Times: Net to Gross

multiplier (1.2 Gross SF per 1.2
Net SF)
Equals: Total cost
$240
per Gross SF
Implied cash-on-cash = $33/$240
return = 13.8%
Contrast this to continuing with the coffee shop under a lease:
Rent Calculation
Coffee shop gross sales per SF $150
Times: Rental rate—percentage of
6.0%
sales
Equals: Net rent per SF $9
Return Calculation
Renovation Cost per Gross
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Square Foot to Remain $100

Competitive
Times: Net to Gross
Multiplier (1.2 Gross SF per 1.2
Net SF)
Equals: Total cost per GLSF $120
Implied cash-on-cash = $9/$120 =
return 7.5%
The cash-on-cash return for the steakhouse is 13.8%, which is

substantially better than the asset manager’s 10% target and
substantially better than continuing with the coffee shop. The asset
manager should now verify that the uses anticipated are allowed under
the zoning code, or if not allowed as-of-right, that there is a process by
which the use could be entitled. The asset manager should also look at
long-term supply and demand trends, keeping in mind that today’s hot
restaurateur may be tomorrow’s “so last year.”
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Highest and Best-Use Possibilities
Discussion topic:
Consider a hotel property with which you are familiar. Thinking about it
creatively, create a post that discusses the following:
1. What highest and best-use possibilities can you propose?

2. What are the likely benefits of your proposal? Try to quantify this as
an annual cash flow.
3. What are the likely costs?
4. What are the probable risks?
5. What would you need to do to determine the desirability and
feasibility of following through on your proposal?
Submit a brief description of your property and your proposal to the

discussion. You are encouraged to respond to the proposal of a
classmate. What are the strengths and limitations of your classmate's
proposal? What other information would you need before issuing a
recommendation on the proposal? Would you endorse the proposal?
Why or why not?
Instructions:
Click Reply to post a comment or reply to another comment. Please

consider that this is a professional forum; courtesy and professional
language and tone are expected. Before posting, please review
eCornell's policy regarding plagiarism (the presentation of someone
else's work as your own without source credit).
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Read: Elements of the Asset Management Plan
• The asset management plan is a 10-20 page document, a tool to

understand the hotel
• The plan includes strategic and tactical recommendations to achieve

the owner's objectives
• It is used to communicate to both the owner and the property

manager
The asset management plan is a key tool for the asset manager. You've
seen the process for gathering the enormous amount of information
required to develop the plan. Now, we present the plan in detail and
describe the important components.
A well-produced plan presents a clear overview of the property and a plan

of action to realize the ownership's investment goals. It should contain
both a strategic vision and tactical recommendations to realize that vision.
Let's take a look at the components of an asset management plan. It is

often remarked that a strong asset management plan should be like the
Cliffs Notes version of a good book, only shorter. It should be clear,
concise, and analytical: a tool for understanding the hotel. A well-
designed asset management plan allows the asset manager to
communicate up to ownership and down to the property manager.
Asset management plans include the following features:
Property summary: Most plans start with a property summary, including

a great deal of physical data about the hotel, including the date it was
built, the nature and date of renovations, etc.
Executive summary: Following the property summary is a brief summary

of the plan. This tells the reader what is in the plan and where it can be
found. In general, the property summary and the executive
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summary should appear on the first page of the report. The remainder of
the items need not appear in any particular order.
SWOT analysis: A classic strategic planning device, carefully naming

and analyzing the strengths, weaknesses, opportunities, and threats.
Major plans and actions: Here the asset manager generally picks a
short list of things that are deemed of top importance for the coming year.
This only includes the major plans and actions; it is not a laundry
list. Clear articulation of each item and the goal are imperative.
Exit strategy: How long do we intend to continue to hold this asset?

What is the expected outcome of a hold-versus-sell analysis?
Next comes a wealth of data that supports the plan itself, including:
Market overview: Answers to key questions, including how is this

market? Where is the market headed? What are the relevant supply and
demand trends?
Competitive supply overview: Analyzes the competitors, describing

what they look like and their strengths and weaknesses relative to this
property.
Performance overview: A historical overview of the subject property,

including financial and guest service outcomes. This may also include a
one- or two-year projection of expected performance.
Capital overview: Capital expenditures historically followed by a concise

5-to-10-year summary of the anticipated capital needs of the building in
the near and medium term.
Key data overview: This includes a great deal of detail about number of
food and beverage (FB) outlets, number of seats within those FB outlets,
number of square feet of meeting space, other facilities of the hotel,
contact information for key personnel on property, an abstract of the
management contract, abstract of the debt, and financing. These should
be abstracts of data you like to have at your fingertips so that you don't
have to pull out the actual documents every time you need the
information.
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All of this should add up to a 10-to-20-page asset management plan. A

longer document becomes cumbersome, and a shorter document will not
provide the needed level of detail. You will have the opportunity to
download a sample asset management plan on the next page.
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Ask the Expert: Important Features of the Asset

Management Plan
As you have seen, there are many features that comprise an effective
asset management plan. In this video, Ken Fuller discusses those
features that he finds are most useful in his work at LaSalle Hotel
Properties. He focuses on identifying the opportunities for a particular
hotel, then ensuring that you have identified the team, the product, the
equipment, and the plans to capitalize on those opportunities.

What are the most important features of the annual asset

management plan at LaSalle?
Video Transcript
So when thinking about the most important features of an asset plan, it all
starts with the identification of the identification of opportunities, okay?
You've got to figure out whether or not you've got the right equipment.
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Meaning to capitalize opportunities, meaning you have the right product

at the property level, you have the right team. People are always critical
when it comes to an asset management program. Do you have the right
people in place, you have to assess and make sure you have the right
people, doing the the right job at the right time. Then once you think of
either changes that you need to make with respect to the property or the
people, it's a question of what are the steps that we need to take that will
lead to success. Sometimes that may lead to developing many goals.
You might say all right, I think if we follow this plan, through three or four
steps we get to success but let's measure how we progressed through
each step of the way.
For example, let's say you've got a hotel and you want to grow RevPAR
index by five points because it would be really lucrative to do so.
Question might be, if we develop 2000 more rooms of group base, would
that help us to improve our RevPAR index. And if it would, do we have
the right Director of Sales and Marketing in place. Do we have the right
number of suites? Do we have the right meeting space? The right
alignment of meeting space or the right product? So it's really again, it
starts with an assessment. Where's the opportunity, what are the tools
that we have in place? What are the steps that we need to take in order
to get ourselves to success?
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Tool: The Midlantic's Asset Management Plan

• Use this sample asset
management plan as a guide
when you develop your own
asset management plan.
You learned why and how the asset manager creates an asset
management plan. Now it is time to see what one of these plans looks
like. Consider the Midlantic Hotel, a fictional chain hotel located
somewhere along the middle of the eastern seaboard in the United
States. The Midlantic is 13 years old, the current ownership having taken
possession 12 years ago. It is a 400-room hotel with 14,000 square feet
of meeting space.
The hotel is located in the suburbs of a growing metropolitan region,

though the hotel is clearly adjacent to, not in, the region's major growth
corridor. The hotel is operated by a respected brand. The hotel's
performance has been troubling over the last couple of years due to poor
economic conditions, with overall performance trending downward.
Measures have been taken by hotel management to reverse this trend.
The asset manager has spent considerable time compiling an asset

management plan for the Midlantic. Aware of the declining performance,
he set out to discern the causes and to devise a plan of action to insure a
performance correction. In creating the plan, he takes into consideration
a thorough analysis of the asset's performance, the investment goals of
ownership, and the asset's position within the investment cycle. All of this
is designed to inform a sell-vs.-hold recommendation to the owner, and
the asset management plan must provide evidence to support the final
recommendation.
Review the plan before proceeding to the next page, where Professor
deRoos will analyze key components of the plan.
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Watch: Analyzing the Plan's Strategic

Recommendations
A good asset management plan should include both strategic and tactical
recommendations for achieving the owner's investment objectives. In this
video, Professor deRoos explains how to read and analyze the strategic
aspects of an asset management plan, using the plan for the fictional
Midlantic hotel that you can download on the previous page. He
discusses the performance of the hotel, the main objectives of the asset
manager, and the actions required to meet these objectives.
Video Transcript
Let's begin our critique of an Asset Management Plan. As you open the
plan you want to know how is the hotel performing, what are the top
goals of the asset manager, and what courses of action the asset
manager advocates to achieve these goals. All of this should be laid out
in the executive summary. So let's take a look. how was the hotel
performing? The answer is in the first sentence of the executive summary
on page one. The hotel's operating performance has trended downward
over the past two years. This is due to the property's position in a
secondary location to the more desirable suburban metro center,
combined with a poor overall market. So, while there are signs of
improvement there are clear problems with the hotel's performance.
Second and third question, what are the asset manager's goals? And
what are the asset manager's recommended courses of action? The
asset manager considers this property a short-term hold candidate.
Because of the hotel's position in a secondary location, the market
growth away from this hotel and an underfunded capital expenditure
reserve and the owner's numerous other hotels in the region. All of this
suggests that the hotel will never become the lead hotel in its market and
it should be sold regardless of its overall performance. If this is the case
why not simply sell the hotel now? The last two paragraphs of the
executive summary provide the answer.
First, the asset manager wants to wait for the hotel to recover from the
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income drop of the past few years. Second the asset manager sees
operational and return on investment opportunities that can elevate the
hotel's value. Holding the property for the short term should produce
improvements in performance that will boost the property's value,
providing a better return when it is sold. Now, we have a good overview
of the asset managers evaluation. Let's dig into the plan and see how the
asset manager has reached these conclusions.
We'll begin with performance. Turning to the operating overview on page

eight, we see the evidence that the hotel's poor performance. Revenues,
or sales, had grown to $27 million two years ago but now they have
declined to an estimated $22 million for next year. Over the same years,
cash flows have fallen from $6.4 million to $4.4 million. Occupancy levels
declined sharply and the rate measured of the ADR, or average daily
rate, has fallen as well. Unsurprisingly, the return on investment has
plummeted as the hotel has struggled. What is the probable cause for
this performance trend? One clear factor has been the state of the
market. A review the market outlook on page four reviews. The local
economy has struggled and that a prolonged downturn in the tech
industry has led to mushrooming office vacancies in the area. The market
outlook can also contains hopeful use however, as the economists
predict coming growth in the market. If the hotel's poor performance is
primarily driven by the poor position in the market cycle why plan to sell
the property?
The SWOT Analysis on page two suggests the answer. Under

weaknesses the asset manager notes the hotel's poor location, in a
secondary fill location away from the more desirable metro center, as a
major weakness. In the Disposition Target Date section on page three,
this is the primary reason for considering the property a short-term hold.
The asset manager notes the owner's goal of owning only the best-
located and best quality hotels in the market and says, "the hotel's
location is the largest hinderance to this hotel being the lead hotel in the
market."
The asset manager concludes, again, "a characteristic that will not be
overcome by any amount of capital dollars." Furthermore, the hotel is
located away from major growth in the market, which is the stretch from
suburban metro center to the airport. And finally, "the aggregate
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investment that the owner has in the mid-Atlantic" region convinces the
asset manager to reduce the owner's exposure in this market. So the
owner is looking to sell some properties, and the Midlantic is a good
candidate. So, again, why not sell now if the asset manager concludes
there are good reasons to not hold this hotel? One reason would be to
avoid selling at the bottom of the market when properties are generally
under valued. Another reason is the room for improvement that the asset
manager has seen. As we will see the asset manager makes a number of
recommendations designed to improve the performance of the hotel and
put it in a better position to be sold.
Looking ahead, the Midlantic hotel faces a number of upcoming capital

expenditures. Guest rooms with original furniture need attention. Both the
roof and the cooling tower will need replacement in the coming years.
And the FF&E reserve is significantly underfunded to undertake these
projects. The asset manager hopes to sell the property before many of
these capital expenditures need to be made. The goal is to strike a
balance between holding long enough to improve the properties
performance while not holding too long and having to make significant
capital investments. Throughout the plan the asset manager has
provided a clear overview of his strategic vision for the Midlantic Hotel.
You are now ready to consider as tactics for improving the hotels
performance, in preparation for selling it in the near term.
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Watch: Analyzing the Plan's Tactical

Recommendations
After reviewing the strategic aspects of Midlantic's asset management
plan, we turn to the tactical parts of the plan, using the sample plan you
downloaded earlier. How does the asset manager intend to achieve the
strategic objectives for the hotel? As Professor deRoos discusses in this
video, the asset manager has several tactical recommendations to
improve the hotel's performance.
Video Transcript
We have already seen that the asset manager considers the Midlantic
Hotel a short-term hold. The goal is to significantly improve the hotel's
performance over the next two years to increase its value. How does the
asset manager intend to improve the hotel's performance? Let's take a
look at the plans and actions on page two. The first recommendations are
operational and the most important is the second bullet. The hotel needs
to group up. That means to increase the number of rooms sold to groups.
Basically, the asset manager is calling for a shift in the hotel's business
mix, away from lower-rated discount business into higher rated group
business. This recommendation comes from the asset manager's
analysis of occupancy and rate.
Flipping to the operational outlook section on page five, we see that

begin quote, room nights have shifted away from higher-rated premium
and special corporate segments into lower-rated other discount and
wholesaler segments, end quote. Basically, the hotel has compensated
for declines in premium and group sales with increased discount sales.
The asset manager knows this tactic needs to change for the property to
return to profit and profitability levels of the past. She addresses this
need directly when she notes that, quote, group booking pace will be
supported by the addition of a new sales manager to the team.
Note the language, a new sales manager will be added. She also notes
that the Midlantic's benchmarks poorly in group room sales. She believes
this is due to local catering taking a disparate share of meeting space.
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She wants to assure that groups that require both meeting space and
guest rooms are the first priority of the hotel's sales force. With catering,
filling in the meeting space when there are gaps available. The asset
manager is making a fairly strong critique of the sales department, saying
that they're selling strategie is exactly backwards to the detriment of the
hotel's profitability.
Looking back at the plans and actions, the asset manager identifies two
return on investment opportunities. First, we will introduce branded coffee
in the hotel's gift shop, boosting other revenues. Second, we will convert
the hotel's nightclub into meeting space, which should improve the
property and aid the group sales effort, especially since the nightclub
could be used as a catering space. The asset manager also notes two
other possibilities for bolstering the property's value.
First, a highest and best use possibility exists. There is 10,000 square
feet of land available for development at the rear of the property. The
asset manager notes the hotel's possible plan for this land but
significantly, does not endorse any development plan. Clearly, the asset
manager does not envision a redevelopment as contributing to the value
of the property before the forthcoming sale.
Second, the asset manager recommends converting the hotel to a brand

not currently represented in the market. This will mitigate the impact of
existing hotels on the market that share the Midlantic chain's operator
and can be expected to elevate the pricing position of our asset. In other
words, a different chain affiliation could lead to a better sale price for the
Midlantic. In the end however, as the body of the plan makes clear, the
dominant effort to improve the position of the hotel for sale is in the effort
to increase occupancy and rate through better group sales. The
operational outlook on page five drives this point home with its
recommendation for changes. New sales manager, refocus sales
department, decrease local catering, all of these will yield increase group
sales.
Overall, a well-produced asset management plan presents a clear picture

of the hotel's performance, including its place in both the asset and the
market cycles. It presents the owner's investment goals and the asset
manager's strategic vision to realize these goals. And finally, it presents
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the operational and asset management tactics needed to realize this

vision.
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Analyze the Asset Management Plan

In this required evaluation, answer the following questions about the
Midlantic's asset management plan. You will need to refer to the plan
throughout the evaluation. If you have not already downloaded the plan,
please do so now by clicking here.
You must achieve a score of 100% on this quiz to complete the

course. You may take it as many times as needed to achieve that
score.
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Module Wrap-up: The Asset Management Process

The asset manager's role is focused on monitoring the ongoing
performance of the hotel, while considering both the asset and market
cycle and the owner's investment criteria. The asset manager must
perform a thorough analysis, which results in an asset management plan.
Ultimately, the asset manager needs to produce a recommendation on
whether to sell or hold the hotel based on their analysis.
In this module, you identified the roles and responsibilities of the asset
manager in managing a specific property. You considered the importance
of analyzing the highest and best uses of a property as an important
evaluation in managing the asset. You examined the key elements of an
asset management plan and analyzed the plan's strategic and tactical
components.
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Module 3: Sell-vs.-Hold Decisions

1. Module Introduction: Sell-vs.-Hold Decisions
2. Watch: The Disposition Decision: Who Sells and Why?
3. Watch: How Context Affects Disposition Decisions
4. Read: The Disposition Decision
5. Ask the Expert: The Most Important Reasons to Sell
6. Watch: The Basic Sell-vs.-Hold Analysis
7. Watch: Optimal Holding Period
8. Tool: Decision Rules for the Optimal Holding Period
9. Read: The Renovation Decision
10. Watch: Case Study: The Hungerford Hotel
11. Renovating the Hungerford Hotel
12. Asset Managing the Hungerford Hotel
13. Tool: Action Plan
14. Module Wrap-up: Sell-vs.-Hold Decisions
15. Read: Thank You and Farewell
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Module Introduction: Sell-vs.-Hold Decisions

A key part of the asset manager's job is to provide a sell-
vs.-hold recommendation for the hotel asset. This
involves carefully considering the investment goals of the
owner, the condition of the hotel, and the behavior of the
market. It also involves the use of tools designed to
determine the optimal holding period in a variety of
circumstances.
In this module, you will examine how the type of investor, the type of
asset, and the condition of the market influence decisions on whether to
hold or sell an asset. Using specialized spreadsheet tools, you will
examine the optimal holding period based on several decision rules.
Beyond the simple sell-vs.-hold calculation, you will also consider how
renovating the hotel affects the decision of whether to sell the asset.
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Watch: The Disposition Decision: Who Sells and

Why?
The asset manager must take many different perspectives into account
when developing the asset management plan and making sell-vs.-hold
decisions. In this video, Professor deRoos focuses on the owner's
objectives and considers three types of investors. Then, he explores how
each investor might respond to different types of assets in different
kinds of markets.
Note: Adapted from "Hold versus Sell Decisions," Chapter 3 in "Modern

Real Estate Portfolio Management" by Hudson-Wilson, et. al., 2000,
Frank J. Fabozzi Associates.
Video Transcript
As we've seen, the asset manager is responsible for compiling an asset

management plan that includes a recommendation on whether the
property should be sold or continued to be held. And if it's held, for how
long and under what conditions. Let's take a strategic view of the
decision that outlines a framework for these decisions. In making a
recommendation of sell versus hold, the asset manager must first
consider the goals of the investor or owner. Let's take a look at three
stylized types of owners.
First, we have a Return Maximizer. This investor takes two main

approaches. In the first approach the Return Maximizer buys individual
assets that are so called distressed assets or assets at the bottom of the
market cycle. The investor makes efforts designed to allow the asset to
make gains in occupancy and rate and thus increases in value. In the
case of a down market, the only action that may be necessary is having
the patience to wait for the market to improve.
In the second approach, the investor develops assets in markets with

healthy or recovering fundamentals. The goal is to capture the difference
between the cost of construction, and the market value of a least and
somewhat stabilized building. When the sources of value creation are
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mostly exhausted, the investor sells the asset. Essentially, a Return

Maximizer is a flipper looking to hold short term and realize the greatest
returns possible. John, our equity fund investor from Black Hall is a
Return Maximizer. A Portfolio Risk Manager is a second prototypical type
of owner. This investor buys a collection of assets that taken together are
expected to exhibit a particular cyclical path. The Portfolio Risk Manager
actively manages the combination of assets within the portfolio, so that
this goal continues to be achieved even as real estate markets cycle.
This investor happily rides the cycle in a risk-managed fashion. Sophie,
our insurance investor for AIGH, is a Portfolio Risk Manager.
A third type of investor is an Inflation Hedger. This investor desires

investments with cash flows that increase with inflation. The investor
identifies assets and markets with characteristics that enhance the
likelihood of effective and favorable transmission of inflation. The Inflation
Hedger invests in these assets and markets actively to ensure that the
ability of the portfolio to provide an inflation hedge does not diminish over
time.
So now let's consider what our investors might do with different types of
assets in different kinds of markets. Consider three different kinds of
assets. First, to revitalize hotel, purchase at the bottom, and now
producing above-market returns. Second, a hotel leased under a very
long-term lease. And third, a dwindling hotel, facing increased
competition from newer, better-located hotels. And then secondly, we'll
consider three different kinds of market conditions; a stable market with
rising fundamentals, a rising market, and a falling market.
So now, who wants to sell and why? The Return Maximizer as we've
seen, the Return Maximizer's strategy is to buy low and sell high.
Unsurprisingly, this investor sells the revitalized asset. They also sell the
leased asset, especially when they create the conditions for a market
lease. And finally they sell the dwindling asset. There is one possibly
caveat though. The investor may hold revitalized or dwindling assets in
the swiftly rising markets, because in this case the returns from holding
until the markets improved could dominate the transaction cost adjusted
returns from redeploying the capital.
Now a Portfolio Risk Manager has a strategy to look at the contribution of
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individual assets of achieving the portfolio goals. For this investor, assets
are held if they provide at least market returns, and the market or
property type provides a diversification benefit. With this in mind, the
portfolio risk manager holds revitalized assets as long as the property
type or location meets the current allocation criteria. They will sell the
leased assets. In fact, they are unlikely to ever invest in leased assets as
the returns are not volatile. And thirdly, for dwindling assets, they need to
be sold, even if they are desirable, because the Portfolio Manager needs
assets that make at least market average returns.
For Inflation Hedgers, as we've seen, the Inflation Hedger is interested in

holding property, such as hotels, that respond well to inflation. They
would be the least likely of our investors to sell. They are particularly
attracted to assets, leased to high quality tenants with indexed triple net
leases. For this investor, asset type and marketing conditions are
completely secondary to the asset's inflation hedging qualities. The
takeaway? Context counts. While the investment goals of the owner are
one of the key factors that influence the sell verus hold decision, two
other factors need to be considered; the condition of the asset, and the
condition of the market. Put another way, the position of the hotel in the
asset cycle and the market cycle both significantly influence our analysis.
We'll take a closer look in a future video.
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Watch: How Context Affects Disposition Decisions

We've examined how a hotel's position in the asset and market cycle has
a critical impact on the sell-vs.-hold decision. In this video, Professor
deRoos explores the market cycle in greater detail and describes the key
factors that influence the disposition decision at each quadrant in the
market cycle.
Video Transcript
Now let's consider how the context has an impact on disposition

decisions. Imagine a property that is just emerging from a down period in
the market. It's 6:30 in the market cycle just pass the bottom, with the
market just beginning to rise. The question is, should we hold or sell the
hotel? Unless there are other compelling reasons to sell the property, it
makes absolutely no sense to sell at the bottom of the cycle. But what
about when we move a little bit past 6:30? Say, to 8:30. Here, we are in
the fat part of the cycle. and everybody knows that we haven't hit the
peak. Certain assets that might be short-term holds, such as the
Midlantic Hotel we analyzed earlier, would be ideal candidates for sale at
this point. Sell the assets and immediately turn around to buy assets that
you would like to hold long term. As a matter of fact, most firms would
pre-identify assets that would be candidates to sell under the right market
condition and target those assets they would like to buy for the long term.
On the other hand, if we are dealing with a hotel that is considered a

long-term hold, or a hotel that is not yet grown into its potential, even the
fat part of the cycle would be unlikely to tempt you to sell. The returns
from holding would be more promising. The calculus becomes quite
different once we move to a 11:30 on the market cycle. Here, we are at
the top of the market. There still may be some up side, but we don't know
how much. This is typically, time when one obtains the best market
pricing. The strategy is to sell and harvest the equity from hotels
identified as short or medium-term holds, because there won't be another
opportunity to sell at these prices for a very long time. The property that
was growing into its potential at 8:30 in the market cycle now becomes a
more likely candidate to sell. As soon as the market starts to decline, one
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o'clock in the market cycle, the market completely breaks down. Sellers
offer their hotels at last year's high price, buyers make purchase offers at
next year's low price and the spread between the ask and the offer prices
becomes extremely wide and the transaction market falls apart. In each
of these scenarios, the decision to sell or hold the property is influenced
by the condition of the asset and the timing of where you are in the
market cycle.
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Read: The Disposition Decision

"I wake up every day with everything
for sale everywhere
and convince myself to hold."
—Sam Zell, real estate guru
You are an asset manager who has been asked to make a

recommendation on the future of a hotel. It may seem like the logical
way to proceed would be to begin with the hotel "as is" then consider
whether it makes financial sense to sell the hotel. Indeed, this is the way
many asset managers perform their jobs.
It makes more sense, however, to begin the analysis from the other
end. Asset managers should begin with this question: should I sell this
hotel property now and redeploy the capital in other investments, or do I
get a better return by continuing to operate the hotel as it is? Posing the
question this way challenges the asset manager to regularly consider
whether the capital tied up in a hotel is capital wisely invested. So the
sell-vs.-hold analysis should always begin with the benefits of disposing
of the hotel now.
An effective sell-vs.-hold analysis must go beyond a simple sell-or-hold

calculation. You must also consider a number of other possible
situations. Consider these four different scenarios.
First, should the hotel be sold now? Does it make sense to sell the
hotel and redeploy the capital elsewhere? The analysis of sell-today
provides a benchmark for all subsequent analysis. Properly done, the
asset manager goes beyond estimating the sale price of the property
and estimates the owner’s equity cash flow from selling the property.
One starts with the gross selling price and deducts the remaining
mortgage balance, fees, and taxes to arrive at the net cash flow that
equity would expect from a sale in the near future.
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There may be a number of reasons to sell the hotel, some of them driven
by considerations that have little to do with the hotel's financial
performance. Maybe the owner has immediate cash flow needs or the
hotel no longer meets the diversification needs of the owner's portfolio. But
the analysis here is concerned with the financial performance of the hotel.
Can the capital invested in the hotel achieve a greater return invested
elsewhere? If the answer is yes, sale of the hotel may be indicated.
Second, should the hotel continue to operate as is? Here the analysis
is focused on the equity cash flows from continuing to own the property for
a finite number of years plus the equity cash flow from selling the property
in the future. The analyst compares the present value of the equity cash
flow from continuing to hold with the equity cash flow from sale today.
Properly done, the comparison is now very easy: the larger of the present
values indicates the preferred course of action. If the cash flow from selling
exceeds the present value of the cash flows from continue-as-is, selling is
indicated. If not, continue to operate as is.
Third, should the hotel be repositioned? The analyst compares the

estimated cash flows from selling with the value of the asset if it is
repositioned. For example, what if the hotel invests in meeting the needs
of upscale guests and alters its marketing accordingly, seeking a different, l and rede
upscale customer base? What would be the likely financial impact of this uent analy
repositioning? If the repositioning improves returns, it may change the perty and e
asset manager's sell-vs.-hold recommendation. ss selling p
et cash flo
Fourth, should the hotel be redeveloped? This scenario compares the
estimated cash flows from selling with the value of the asset if it were
redeveloped. What if the hotel undertakes a substantial redevelopment,
altering the physical structure and possibly even the purpose of the asset?
What would be the likely financial impact of this redevelopment? If the
redevelopment improves returns, it may change the asset manager's sell-
vs.-hold recommendation.
A thorough sell-vs.-hold analysis begins with the benefits of selling the
property and compares those benefits with the benefits of operating as is,
of repositioning, or of redeveloping the hotel.
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Ask the Expert: The Most Important Reasons to Sell

A great deal of analysis and thought goes into any sell-vs.-hold decision.
From his office in Bethesda, MD, Ken Fuller discusses the most
important considerations when making this critical decision. As he
explains, for LaSalle Hotel Properties, it is all about capital allocation.
Considering the current property, do you have the opportunity to do
something better with the money given the current business plan, the
market, the required capital investment, and other potential
opportunities? By analyzing these critical questions, you can come to the
right decision for any asset in your portfolio.

When you consider selling a hotel at LaSalle Hotel

Properties, what are your most important considerations?
Video Transcript
There's a thread that goes through the way that we think about
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everything. You asked what the most important reason is to sell a hotel
and it really it is that you've got an opportunity to do something better
with the money, right? Either today or in the future. Selling a hotel is all
about capital allocation. We're not a company that's in distress. We don't
sell a hotel because we're in trouble, and we really need the money. We
have a very strong balance sheet. It's a matter of capital allocation. Is
there something better that we can do with the hotel now or in the future.
And when you're trying to determine that, you're really asking yourself, A,
what are our opportunities with this existing hotel, B, what are our
opportunities with other hotels that we might be able to buy? And the
reason why we might be out of opportunities with an existing hotel is is
really that we've exhausted the business plan. Excellent execution of the
business plan, we've maximized margins, we've maximized RevPAR
index, and at this point given what we do, we don't feel like there is any
place we can take the hotel. Or is there something changing structurally
in the market place? That might be another reason to sell a hotel.
For example, you look at a market and let's say a lot of the business
comes from the convention center. And let's say a number of the other
convention centers have become more competitive. through expansions,
renovations, the markets have gotten stronger. People just aren't
structurally coming to this market as much for conventions. Well, if we
think that, you know we're not able to influence something about the hotel
like the amount of convention business that comes to the market and that
item is kind of going negative, that might be a reason to get out,
something going on in the city. Getting a really high price you know, what
we call a stupid price, is a fine reason for selling a hotel. And another
thing to think about when selling hotels is again how much capital you
might have to put in to that hotel. So an example is the Indianapolis
Marriott which we sold earlier in 2016. We were looking down the barrel
of a major property movement plan, we were going to have to invest
significantly in that market, and there was nothing wrong with the hotel or
market. But, it wasn't a core market where we expected tremendous
growth. So we said, you know what? I think we've kind of exhausted the
business plan here. We're not ready to invest more into the hotel as
investors.
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In a sell-vs.-hold analysis, what are the most critical scenarios to

evaluate?
Video Transcript
So when we're approaching the sell-versus-hold analysis, there's a

number of ways that we could do it, you know, a number of different
scenarios that could be simply, do we sell it or hold it? Or do we renovate
it, or do we change management, what are the types of things that we can
do when we're looking at a sell-versus-hold analysis, and that really
depends on the asset and again, what the opportunities are with respect
to that asset. For example let me step back a second and talk about how
we look at a sell-versus-hold analysis. The question first is, how much do
you think you could sell the hotel for, what's the price of the hotel. And we
might obtain a broker opinion of value in order to determine that, we might
do our own analysis based on what the income is and what the cap rate
ought to be. But we start with, what could we sell the hotel for?Reason
why we do that is because we then run projections on the property, and
ask ourselves would we buy this hotel for this price? If we wouldn't buy
the hotel for a price that we could sell it for now, then we should probably
sell the hotel right now, right?
So we start with those two factors, and that generally takes you a couple
of different places. One, should we renovate the hotel? We might do an
analysis and say this is what we think the current projections are, but
what happens to those projections if you perform a renovation? You know
two, do we change management, or really change the business plan in
some other way? Is there some other way in which we should develop the
hotel? So it really depends on the asset and what you think the
opportunities are before you can kind of figure out exactly what needs to
be embedded in that sell-versus-hold analysis. But again, either way, it
comes back to, would we buy this hotel for this price right now, based on
the price that we could sell it.
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Watch: The Basic Sell-vs.-Hold Analysis

The asset manager has a critical role determining if a property is more
valuable if sold or if it is held. In this video, Professor deRoos explains
that an asset manager should analyze the costs and benefits of a range
of sell-vs.-hold options. He reviews the reasons to sell a property and
considers the analysis required for three different scenarios: hold the
property, hold the property and reposition it, and hold the property and
redevelop it.
Video Transcript
The sell versus hold analysis, should always begin with the reasons to
sell. Good asset managers continually challenge themselves to answer
some questions. Why should I keep this property? Is it more valuable to
redeploy the owner's capital elsewhere? Let's review the reasons to sell
or dispose. First the cash flows or appreciation may not meet our current
investment criteria. Stated another way, we may not be achieving our
investment goals. Second, we may know that there are opportunities to
deploy capital elsewhere to earn higher risk-adjusted returns. Third, the
owner may have tax motives. It may make sense to realize the capital
gains or losses this fiscal year. Fourth, the property may not be a good
portfolio or geographic fit in the property. It may not meet the owner's
diversification needs. Fifth, the owner may be a real estate private equity
fund with a defined life, say five years. The five year period is up and it's
time to provide liquidity by selling. And lastly, number six, the owner may
have cash needs that selling the property can meet.
Any of these reasons may compel a disposition but it's for the first three
that the asset manager's role is important. Here the asset manager must
decide if the property is more valuable at sold or held. In analyzing this
question the asset manager must consider all of the costs and benefits
from sale including the capital gains taxes or other transaction taxes,
transaction cost, and avoided expenditures. Especially avoided capital
expenditures. But this either/or scenario is too simple. The asset
manager generally considers three scenarios as alternatives to sell. Hold
the property, continue as is. Hold the property and reposition it. Hold the
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property and redevelop it.
For each of these scenarios the asset manager needs to undertake an

analysis. We'll start with the most simple, sell versus hold the property
and continue as is. First, we estimate the net sale proceeds if the hotel
were sold today. Second, we estimate the cash flows over the holding
period, including any required capital expenditures over and above the
reserves required by the contract. Third, we estimate the net proceeds
from sale at the end of the holding period. And then lastly, we value these
flows using an appropriate discount rate and compare this value to the
proceeds from sale today. If the value from selling today is greater than
the value of continuing as is, the property should be sold. So what if the
asset manager initiates a significant change in the hotel's marketing
direction - a repositioning?
Contemplating a repositioning the asset manager should: perform a

SWOT Analysis - the strengths, weaknesses, opportunities and threats, a
good evaluation will provide a road map for the repositioning efforts,
Evaluate market trends, explore any highest invest use opportunities,
consider how the repositioning might influence the contractual obligation
of the brand or manager. And consider the impact of any repositioning on
the capital structure. All of this must be factored into the financial analysis
of the cash flows and of the appreciation the property can be expected to
realize in the future. Those expected returns can then be compared to
the value of holding as is or selling as repositioned. As before if the value
from selling today is greater than the value it was repositioned, the
property should be sold. What about redeveloping the property?
Here, the highest and best used analysis moved front and center. The
redevelopment must be consistent with the owner's objectives that drove
the acquisition in the first place. Contemplating a redevelopment, the
asset manager should perform an analysis similar to repositioning. The
difference is, here, the asset manager is interested in evaluating market
potential, considering where customers for the redevelopment are likely
to come from. After completing these analyses, the asset manager will
have support for a decision. Continue to operate as is? Fine. The asset
manager's job continues as usual. Reposition the property? The asset
manager monitors the repositioning efforts and measures the results
against projections. Redevelopment? The same as repositioning but on a
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much larger scale. If the decision is to sell the property, the asset
manager has other responsibilities. They must produce a post-sell audit
determining actual holding period of returns, looking at the risk incurred
and reflecting on the lessons learned from the investment. The post-audit
requires a thorough quantification of project cost project benefits, and a
consideration of the indirect cost that went into the property.
As we have seen, a thorough financial analysis of sell versus hold

focuses on the strategic options that must be considered. The important
things to remember are; the analysis should always begin by considering
sell today as the base case and two, the benefits of selling must be
compared with the benefits of continuing as is, of repositioning, and/or of
redeveloping the property.
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Watch: Optimal Holding Period

You've seen how important it is to perform detailed analyses when
determining whether to sell or hold a property. In this video, Professor
deRoos introduces the marginal rate of return, which is another tool to
help to perform useful sell-vs.-hold analyses. The marginal rate of
return is calculated as the year-to-year returns from continuing to hold the
property for one additional year. Calculating the marginal rate of return
allows you to determine the optimal holding period in a number of ways
depending on your investment goals. He also reviews several decision
rules, which you can download on the next page.
Video Transcript
At its simplest, the sell versus hold analysis comes down to this: if the
return from holding the property is above the rate available on alternative
investments of equal risk, one should continue to hold. One caveat is that
investors should have real alternatives for the investment if the hotel is
sold, not some hypothetical hurdle rate. Let's illustrate this with some
numbers. Take a property that has been held for five years, the investor
is convinced the return of 15.5% can be obtained on similar investments.
The hotel can be sold today for $25 million. Deducting selling costs and
the remaining mortgage balance gives us before-tax cash flow of $9.26
million. Calculating and deducting capital gains and other taxes leaves an
after-tax equity cash flow from sale of $7.1 million. This is the expected
total from selling the hotel today. Now let's consider the cash flow from
operating the hotel for an additional five years if we don't sell.
Here we have the after-tax cash flows for your six through ten of the
holding period. In addition, at the end of the tenth year we can sell the
hotel for $28.98 million. Deducting fees, the remaining mortgage balance
and capital gains taxes, we obtain an after-tax equity reversion of $9.92
million. We now have the cash flow for each year, the foregone sale
today, the equity cash flows form holding, and the equity reversion at the
end of the holding period. Calculating the internal rate of return on this
set of cash flows results in a 15.6% return. This 15.6% return is higher
than our hurdle rate of 15.5%. We should continue to hold the hotel. This
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answers the basic question. Should we sell the hotel now or should we
continue to hold for five years? We should hold. But for how long? What if
we want to know the optimal holding period?
To find the answer we need to be able to calculate the marginal rate of

return which is calculated as the year-to-year returns from continuing to
hold the property for one additional year. How is the marginal rate of
return calculated on an annual basis? Here we go. We add the annual
appreciation return to the annual cash flow return and express these
returns as a percentage value at the beginning of the year. The equity
appreciation return is equal to the equity value at the beginning of the
year subtracted from the equity value at the end of the year. Add to this
the coming year's equity cash flow to obtain the total cash return for the
year. Divide this total by the value at the beginning of the year to express
the figure as a percentage return. This calculation is performed each year
for the holding period. Note that we are performing these calculations on
an after-tax equity basis. Once we have calculated the marginal rate of
return each year over the holding period, they can be interpreted using a
variety of holding period decision rules depending on the investment
criteria.
So decision rule one: Hold the investment until the marginal rate of return
equals the desired rate of return or hurdle rate. Decision rule two: Hold
until you maximize the marginal rate of return. When the marginal rate of
return begins to decline, sell. Or, decision rule three: You may decide to
hold until you reach the maximum internal rate of return. Let's take a look
at how this works with some numbers. Here we have calculated the after-
tax equity cash flow from continuing to operate as before. This time,
we've extended the analysis from five additional years to ten additional
years. We have also calculated the after-tax cash flow from sale in each
year, assuming that the property is sold at the end of each year.
To show how we determine the marginal rate of return for each year,
consider year eight. In year eight, if we continue, we give up the $8.096
million we could have obtained if we sold the hotel at the end of year
seven. In exchange, we obtain the $705,000 in cash flows for the year
eight, plus we obtain the after-tax equity reversion of $8.658 million. So
here is the MRR calculation. The appreciation return is $8.658 million
minus $8.096 million. Add the $705,000 in cash logs, then divide by the
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$8.096 million and we have a marginal rate of return of 15.65%. Here you
see the same marginal rate of return calculation made for each year of
the holding period. Note that the marginal rate of return is fairly consistent
- around 15.5%. It peaks in year 10 at 15.71%. We also have the internal
rate of return over the same period. The internal rates of return are also
fairly consistent though with less of a drop off than the marginal rate of
return. Plotting the marginal rate of return and the internal rate of return
on a graph, you see how each develops and how each compares to the
hurdle rate.
Here we can see the three different optimal holding period decision rules,
depending on our decision criteria. If our goal is to hold for as long as the
marginal rate of return is above the hurdle rate, the optimal holding
period is 14 years. On the other hand, if the goal is to sell at the highest
marginal rate of return, the optimal holding period is 11 years. And thirdly,
if the goal is to sell at the highest internal rate of return, the optimal
holding period is between 11 and 13 years. Calculating the marginal rate
of return and the internal rate of return allows us to determine the optimal
holding period in a number of ways depending on our investment goals. It
is a crucial tool in performing useful hold versus sell analysis.
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Tool: Decision Rules for the Optimal Holding Period
• Use the decision rules for the

optimal holding period when you
make sell-vs-hold
recommendations.
The sell-vs.-hold analysis is an important part of the asset manager’s job.

There are several metrics available for this analysis, including the
marginal rate of return and the internal rate of return. Using these
metrics, there are three holding period decision rules that you can apply,
depending on your investment criteria. Use these decision rules as you
make sell-vs.-hold recommendations for your own hotel investments.
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Read: The Renovation Decision
• One analysis for renovation compares the

after-tax equity cash flow if you hold the
property with no renovation vs. the after-tax
equity cash flow if you renovate
• You can also compare the cash flows from

selling today vs. renovating and holding the
hotel
• You compare the IRR in the incremental

cash flows to the hurdle rate to determine
whether the renovation is justified
Now let’s add some complication to our financial analysis. Instead of

considering the return from selling versus the return from continuing to
hold, let’s consider a renovation. Your base case is to hold the property
and continue to operate it as is. Alternatively, the property can undergo a
substantial renovation for $20 million, financed with a loan of $15 million
and an additional equity investment of $5 million.
Continue "As Is" vs. Renovate
Compare the after-tax equity cash flows without the renovation to the
after-tax equity cash flows assuming the renovation is completed. Note
that the year 10 figures include both the cash flow from operations and
the cash flow from the sale at the end of the year.
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The incremental cash flows show the change. As you can see, it takes
time after the renovation for the cash flows to catch up, but they
eventually surpass the cash flows without renovation. The cash flows
from the final sale are substantially greater. All told, the IRR on the
incremental cash flows is 17.6%. If this is above the equity hurdle rate, it
makes sense to pursue the renovation. Note that this 17.6% IRR is the
IRR for the incremental funds invested for the renovation, not for the
entire property.
Sell Today vs. Renovate and Hold
To determine whether holding the property with the renovation is a good

alternative to selling the property, the asset manager needs to compare
selling today with hold-renovate. Here you see the cash flows for that
analysis. Note that this decision is framed differently than the Continue
“As Is” vs. Renovate scenario outlined above. Here the decision to hold
not only gives up the ATCF from sale today, it also involves investing
additional funds to renovate the hotel. The returns from holding are the
cash flows from operations of the renovated property and the greatly
increased cash flow from sale five years in the future.
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The IRR on the incremental cash flow is now 16.5%. If this is above the
equity hurdle rate, it makes more sense to hold and renovate than to sell
today.
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Watch: Case Study: The Hungerford Hotel

Now we consider the sell-vs.-hold analysis and the optimal holding period
using an example. In these videos, Professor deRoos uses the fictional
Hungerford Hotel in the research triangle area of North Carolina as a
case study to demonstrate a sell-vs.-hold analysis. The Hungerford's
asset manager needs to provide a recommendation: should the owner
sell the Hungerford now or should it continue to hold the hotel? If the
recommendation is to hold, what is the optimal holding period for the
hotel?
Initial Decision
Different Markets
Video Transcript
We will use the example of the Hungerford Hotel in the research triangle
area of North Carolina as a case study. Tarheel Development a small but
growing hotel developer opened this hotel five years ago. It's now five
years after the opening and Tarheel's owner, Brendan Chang has
requested that Tarheel VP for asset management- Christopher Trottman,
provide a recommendation. Should we sell the hotel now, or should it
continue to be held? If the recommendation is to hold, Ms. Chang wants
Trottman to recommend an optimal holding period for the hotel.
Trottman's first task is to perform a sell versus hold analysis. This
analysis will need to compare the returns from selling the Hungerford
now versus operating the Hungerford as is.
To determine the optimal holding period, he will need to be able to

calculate the marginal rate of return. And finally he will have to perform
these analyses in different types of market conditions. Trottman is now
ready to analyze the optimal holding period for the hotel. He calculates
the marginal rates of return and makes a holding period recommendation
for for the Hungerford under different market conditions. To date, the
Hungerford has performed well. It is now a stable asset and a stable
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market. The returns from the property are beginning to show a slow
decline, indicating that action may be called for in the near future. Chris'
most likely forecast is for a stable occupancy with both revenues, and
expenses growing, and inflation at 3%. Computing the after-tax cash
flows and the after-tax equity returns, Chris then calculates marginal
rates of return and the internal rates of return for each year the
Hungerford is held.
Here are the marginal rates of return and the internal rates of return
plotted on a graph. Chris can see that both the holding period IRR and
the marginal returns are projected to slowly decline over the next five
years. Although the internal rate of return Will remain above Tarheels
fourteen percent hurdle rate through out the five year period. The
marginal rate of return dips below the hurdle rate by the fourth year.
Chris' analysis suggests that the Hungerford is a good candidate to be
sold soon.
Video Transcript
So how would Chris' analysis change in different market circumstances.

Let's explore a number of scenarios. We begin by looking at a fat market
cycle, a period characterized by growing demand and growing rates. This
might be due to a growth in the national economy or it could be a local
story. The local market could be entering a period of growth with new
demand generators driving both increased demand and increased
average daily rates. Here we see occupancy and rate both growing
healthily, while expenses grow at the assumed inflation rate of 3%. The
result is extremely strong returns over the next three years, though both
the IRR and the MRR decline over time.
To maximize the returns from the Hungerford, Chris could recommend

the sale in two years as returns decline. But, can such returns be
achieved elsewhere? With a hurdle rate of 14%, Chris clearly wants to
continue to hold and continuing to earn returns well above the hurdle
rate. Now let's consider the opposite, the thin part of the market cycle.
The market has now passed its peak and declining. Supply has caught
up with the expanded demand. and many new hotels are opening in the
market, just as a national recession cripples demand.
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Here, we have a decline in occupancy that drives a decline in cash flows.

Clearly this results in poor returns with only a slight recovery later in the
holding period. Chris should sell the Hungerford now, as both the internal
rate of return and the marginal rate of return are below the 14% hurdle
rate for all years. They should use the money and invest it elsewhere,
perhaps not even in hotels. In both of these scenarios market conditions
directly influence the performance of the hotel.
Now let's consider a different situation. A capitalization rate compression

scenario. Here the hotel's performance does not change. There are no
changes in occupancy, in rate or in cash flows. The capitalization rate
however is declining perhaps due to a period of extended national
economic expansion. The result is that value is increasing at a faster rate
than the growth in cash flows, providing a significant increase in both the
marginal rates of return and the holding period IRRs.
When you look at how this changes our returns, you see that though the
trajectory of the IRR and the MRR are similar to the base case, both lines
begin with much higher returns. The hotel is worth much more in this
scenario. Although the hotel, I'm sorry, although the hold versus sell
observation is much the same, the internal rate of return and the marginal
rate of return are both declining. However, the hotel's returns remain far
above the 14% hurdle rate, indicating a recommendation of continued
hold. Lastly, we have a capitalization rate expansion story. Perhaps debt
is becoming more expensive and investors expect asset prices to fall
slightly over time. This case is flat for both the marginal rate of return and
the holding period IRR curve. Although the cash flows have not changed
from the base case, as the capitalization rates increase, the equity
reversion is growing at a slower rate than the growth in cash flows.
Here, the Hungerford's returns are poor. Unlike the thin cycle however,
here the returns are closer to the hurdle rate and they are flat. Since the
firm can earn 14% on their investments elsewhere, the analysis suggest
selling. This sale could be time for other reasons however, as the
marginal rate of return is virtually the same for any holding period. The
big take away is that the internal environment exerts a great influence on
sell verses hold decisions. Investors and asset managers need to take
account of expected future performance and the capital markets when
considering whether to hold or sell their hotels.
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Renovating the Hungerford Hotel

Project instructions:
Owners of the Hungerford Hotel are considering whether or not they

should hold the hotel or renovate it, as well as when they should consider
selling the hotel. Based on two scenarios for the Hungerford Hotel, you
will answer five questions using data provided in the project document.
The first scenario is the base case, which Professor deRoos analyzed in
the video on the previous page. The second scenario is the renovation
case, which assumes that the renovation has been completed. For both
scenarios, you can assume that the hurdle rate is 14%.
To complete this project:
Download the project and answer all five questions.

Save your work.
Upload your completed course project here for instructor review and
credit.
Before you begin:
Before starting your work, please review the rubric (list of evaluative
criteria) for this assignment and eCornell's policy
regarding plagiarism (the presentation of someone else's work as your
own without source credit).
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Asset Managing the Hungerford Hotel
Discussion topic:
Consider the two scenarios presented in the project on the previous

page. The owners have decided to renovate the Hungerford Hotel, with
the intention of selling the property when the marginal rate of return
peaks two years after the renovation.
Before acting on this decision, consider two rumors about the local
market. The first concerns a major new industry relocating its
headquarters to the market. If true, this will spark a major boom in the
local hotel market. The other rumor, however, suggests quite the
opposite. According to this rumor, the major local employer is relocating
overseas. If true, the second rumor means a difficult period ahead for the
local hotel market.
Create a post that discusses the following:
1. If either of these rumors is true, do you think it would change the

owner's renovation decision? Provide a clear rationale for your
answer.
2. What factors would you need to consider before going ahead on the
renovation? Provide an explanation for each factor you list.
In addition to creating your own posts in this discussion, read through the
other students' posts. We encourage you to respond to at least one post:
seek clarification, raise a question, or expand on the current topic.
Instructions:
Click Reply to post a comment or reply to another comment. Please

consider that this is a professional forum; courtesy and professional
language and tone are expected. Before posting, please review
eCornell's policy regarding plagiarism (the presentation of someone
else's work as your own without source credit).
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Cornell University
Tool: Action Plan
• Use the Action Plan to guide your

efforts on the job.
You are now able to create a strategic vision for asset management and
use the latest asset management techniques in pursuit of that strategic
vision. You understand an asset manager's role in building value and you
can model the optimal holding period for an asset.
This action plan provides a valuable opportunity for you to consider how
you might apply your new skills to real-life challenges. Can you use what
you have learned about developing an asset management strategy in
your own career? Use the Action Plan template provided to map out your
approach.
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Module Wrap-up: Sell-vs.-Hold Decisions

The disposition decision requires a thorough analysis that considers the
owner's objectives, the condition of the asset, and the state of the
market. This cost-benefit analysis must also consider alternative
scenarios to selling the property, including holding the property, holding
the property and repositioning it, and holding the property and
redeveloping it. To complete the analysis, the asset manager must
determine the optimal holding period for a property using the marginal
rate of return and the internal rate of return.
In this module, you examined the factors that influence decisions on

when to dispose of a property. You also explored the tools used to decide
whether to hold or sell a property. Finally, you modeled the optimal
holding period and made recommendations on selling versus holding the
asset.
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Read: Thank You and Farewell
Jan deRoos
Associate Professor and
HVS Professor of Hotel Finance and Real Estate
School of Hotel Administration
Cornell University
Congratulations on completing Developing an Asset Management
Strategy. You examined the many factors that can influence the sell-
vs.-hold decision, including the performance of the hotel, the condition
of the asset and the market, and the owner's investment objectives.
Developing a strategic vision for a hotel property is a critical part of
the asset manager's job, and you now have the tools necessary to
help different owners realize their investment goals.
I hope you found this to be a stimulating and informative introduction
to hotel asset management. I hope the material covered here has met
your expectations and prepared you to better meet the needs of your
organization.
From all of us at Cornell University and eCornell, thank you for
participating in this course.
Sincerely,
Jan deRoos

Developing An Asset Management Strategy

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SHA613: Developing an Asset Management Strategy

SHA613: Developing an Asset

Analyze the asset manager's role in building value at both the

The hotel asset manager is responsible for managing

and Real Estate, School of Hotel

Professor Jan A. deRoos, on the faculty of the

In this course, we consider strategic asset management, the high level or

should be a focus on the framework, not a search for universal answers.

Meet Your Class

Module 1: Portfolio Management

1. Module Introduction: Portfolio Management

Module 2: The Asset Management Process

1. Module Introduction: The Asset Management Process

12. Read: Thinking Strategically about Highest and Best Use

Module 3: Sell-vs.-Hold Decisions

1. Module Introduction: Sell-vs.-Hold Decisions

Meet Your Class

Back to Table of Contents

Meet Your Class

Back to Table of Contents

Module 1: Portfolio Management

Back to Table of Contents

Module Introduction: Portfolio Management

Back to Table of Contents

Read: Real Estate and Asset Management

• Reasons to invest in real estate include diversification, returns,

• Portfolio managers, asset managers, and hotel managers have

Why do we need asset managers? While investments in real estate can

So why would anyone invest in real estate, especially hotels? What

1. Diversification. The most important reason to include real

returns, much higher than the dividends available from stocks

Portfolio managers often lament that “asset managers don't understand

Back to Table of Contents

Watch: Real Estate as a Portfolio Diversifier and

The most important reason to include real estate in an investment

An efficient frontier plots the optimal achievable relationship between

So now let's look in an efficient portfolio with an 8% return. This portfolio

Back to Table of Contents

Watch: More Reasons to Invest in Real Estate

Note: In this video, Professor deRoos discusses the correlation between

Second reason is inflation. Real estate is a good inflation hedge. The

Another reason to consider real estate is the investment universe itself. In

Back to Table of Contents

Read: Investors, Risk, and Hotels

• Compared to other real estate options, hotels can be a great

Real estate is a partial solution to the needs of these investors. Real

Pension funds: They have a responsibility to protect their capital in the

What are other real estate owners' stories?

Real estate investment trusts (REITs):

We have considered when and why real estate needs to be included in

Back to Table of Contents

Read: Asset Management and the Portfolio

• The risk associated with an asset

The portfolio manager's job is to achieve an acceptable rate of return for

An asset manager not well trained in portfolio management might

Consider the following example to illustrate the points. A large insurance

Chris is a seasoned “deal-junkie” who takes pride in her ability to identify

Morgan, on the other hand, is a portfolio allocator, taking pride in her

Who is the better portfolio investment officer? Morgan with a portfolio

Office Office Retail Retail Portfolio Portfolio

portfolio (and, hence, perhaps the firm) is in large part determined by

Back to Table of Contents