Hotel PIP: Negotiate a Perfect Property Improvement Plan
December 16, 2019
As a hotel investor, owner, or buyer, you need to know all about how a Property Improvement Plan (PIP) works. Therefore, we offer you this blog article about a hotel PIP, starting with a hotel PIP definition. After the hotel PIP definition, we clarify the difference between PIP and hotel flipping.
Next you’ll learn how to negotiate a “perfect” hotel PIP and how to finance a PIP. Finally, we’ll conclude by describing how Assets America® can help and we’ll answer some frequently asked questions about PIP.
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What is a PIP in the Hotel Industry?
In the hotel industry, a hotel PIP allows you to bring your property into compliance with brand requirements. Basically, it’s a long-term plan to upgrade and improve your hotel to provide customers with the experience they expect.
With a good PIP, you can increase market share, propel revenues, defeat competitors, boost customer satisfaction, and swell profits.
If you own a flagged hotel, you probably already agreed to a property improvement plan during the purchase negotiation. Hotel brands jealously guard their reputations for value, luxury, cleanliness, and service.
The last thing the hotel corporation executives want is for a new buyer to muck up their brand name. Rather, owners and managers must revere brand standards or face substantial penalties.
Elements of a Property Improvement Plan
The guts of a Hotel PIP is an action plan to improve a hotel’s physical plant. For example, this can include:
- Plumbing and electrical systems
- Mechanical systems
- Guest rooms and corridors
- Elevators and stairways
- Meeting rooms
- Fitness centers/swimming pools
- Security, safety, and communications systems
- Food and drink facilities
- Landscaping
- Interior and exterior lighting
- Parking
Obviously, a hotel would have to be in a sorry state to require expenditures for all of these elements. However, older properties that reek from neglect may come close. From the brand’s viewpoint, your expenditures for a property improvement plan increases the asset value of the hotel.
By making your property more efficient, your PIP should boost your operating profits. By making it more attractive, you can improve important metrics regarding rates and occupancy. A good PIP is a win-win!
How Assets America® Can Help
When you are looking for hotel financing starting at a minimum loan amount of $20 million, Assets America® is prepared to satisfy all your needs. Our network of private lenders, bank, and funding sources can offer you competitive acquisition and construction loans on affordable terms. Please contact us today for a confidential, no-obligation consultation. We are confident that our experience and expertise will convince you. Call us today at 206-622-3000 or simply fill out the form below and we’ll respond promptly!
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PIP vs Flipping Hotel Properties
It’s always attractive to flip a hotel for a fat profit. However, you and your investors may be more interested in long-term income rather than a quick capital gain. How does a PIP factor into deciding whether to PIP or flip?
Well, an expensive PIP that will reach deep into the owner’s pockets may motivate a fast flip instead. Alternatively, an owner can decide to de-flag a property to save money on a PIP.
According to Lodging Magazine, hoteliers cough up about 8% of revenues on PIP costs. Accordingly, an owner must decide whether the hotel under its current flag is worth that much money.
For instance, are the PIP standards reasonable for the hotel’s market? Or are they the overblown manifestations of an out-of-touch corporate board? You didn’t purchase an economy hotel to reinvent it as a luxury hotel, despite the pretensions of an inflated PIP.
Questions to Ask
To get your bearings, you should look at your customer reviews and feedback. Ask yourself the following questions:
- Does the PIP address real problems?
- Will you end up spending large sums on a PIP to fix non-existent problems?
- Is your local market so saturated with competitors that the PIP will do little to improve your market share?
- Will hotel cash flows pay for the PIP?
- Will you have to deal with sleazy politicians and corrupt unions in order to renovate your property?
- Do you have the right people available to execute an ambitious PIP? If not, can you get them?
- Is your neighborhood on the upswing or is it in free fall? Is the population stable or dynamic?
- Will a new highway or airport change the value of your property?
As you can see, you have much to consider before committing to a PIP. Perhaps it would be better to flip the property and buy another hotel in a different location.
How to Negotiate a Perfect Hotel PIP
Your franchisor wants you to spend heavily on your PIP. This is expectable. After all, it helps them burnish their brand image using your money. We suggest you negotiate the following five steps.
1. Professional Review
Perform a complete review with the help of professionals who can quantify the costs of a PIP. Of course, you want to know the cost of the worst-case scenario.
For example, suppose the PIP requires you to replace room packaged terminal air conditioners (PTACs) older than five years. You should survey your property to see how many PTACs are over five years old and determine their current condition.
If they are slightly older than five years, but in good condition, you can argue that they don’t need replacing, at least not for a while. Your professional assistant can make the case that this is a question of judgment. You can apply this same tactic to all relevant items in the PIP.
2. Identify Subjective Items
The PIP may have many subjective items, such as surface materials and finishes. However, you may have units with excellent quality surfaces that happen to be at variance with the PIP specifications.
Price these subjective items and advocate for their retention on the basis of value engineering. Argue that guests will not care or notice the difference between the current and proposed items. You can save thousands of dollars by negotiating these items.
3. Remove Long-Term Maintenance Items
The PIP should not contain long-term maintenance items like the roof or hot-water heaters. Obviously, you’ll eventually need to replace these items, but the need may not be urgent or even immediate. Therefore, argue that you’ll finance these items from future capital budgets and they should not appear in the PIP.
4. Schedule Work Intelligently
The PIP will cover multiple years of work. The problem is that you don’t want to inconvenience guests more than once. For example, you might replace the guestroom soft goods in Year One and the furniture in Year Two. This stretches out the disruption that guests will experience, which may hurt your occupancy rates.
Instead, explore finishing all the guestroom renovations in Year One and schedule the other work over later years. You may be able to isolate these renovations from your guests and minimize disruption. For more information, visit our FF&E Loans Guide.
5. Choose Your Construction Team
Don’t necessarily agree to the PIP’s recommendations regarding the construction company to use. The PIP might recommend a low-ball contractor to placate franchisees, but this can cost more in the long-run. The cheapest contractor might not be the least expensive when you figure in the costs of mistakes and rework. Don’t fall for low-ball pricing that turns out to be a bad deal.
Executing a PIP Perfectly
Okay, you’ve earned props for negotiating a perfect PIP. Even if the PIP is not perfect, it might be perfect for you. In any event, a property improvement plan is only as good as its execution. Consider these steps to prepare for the implementation of a PIP:
1. Fools Rush In
Give yourself a year between negotiating and implementing a PIP. As a new owner, you need some seasoning before committing huge sums to renovation plans. The PIP might contain assumptions that do not reflect the unique realities facing your hotel.
2. Collect the Right Team
Don’t use so-called “experts” without the necessary experience. You want a team that will carry out your vision for the hotel, not fight you every step of the way. Remember, a PIP is not a straitjacket — you can make important design and implementation decisions. Use your preparation year to recruit the right team for the job.
3. Use Third Parties
Consider supplementing your team with third-party help. It’s much cheaper to bring in an expert for a short time than to hire a permanent employee. By contracting with third parties, you can hold them accountable if they fail to live up to their contracts. You may also be able to renegotiate payments if you are not completely happy with the results.
4. Establish Your Timeline
Once you’ve worked out the plan details, set up your timeline for execution. Include penalty clauses for contractors who do not finish on time. However, avoid rewarding contractors for coming in early, as this will encourage shoddy, rushed work. Your contract should be aggressive so that your contractors–not you–pay for delays.
5. Renovate During the Off-Season
Assuming your hotel experiences seasonal effects, plan for your annual renovations to coincide with the low season. This will have the smallest impact on your annual revenues.
PIPs as a Corporate Weapon
Certain hotel corporations (we will not name them) inflict punitive PIPs on franchisees. Why? To force them out of business and make room for corporate expansion.
The strategy starts at the hotel corporate board. Directors draw up expensive refresh and rebrand PIPs that can change the target markets for their brands. By expensive, we mean up to 15% of annual revenues.
All franchisees must implement the new PIPs or face termination from the brand. The corporation can then ruthlessly enforce the PIPs and exact penalties or expulsion for even minor failures to comply.
This strategy hits older properties (over 10 years old) the hardest, since they will have the highest PIP costs. Naturally, the result is that older franchised properties may elect to deflag or reflag. Clearly, this is an opening for the corporation to build a new property in the location.
Obviously, the franchise agreement’s area of protection would prohibit these new properties if the old property remained. The bottom line is that punitive PIPs allow a franchisor to re-franchise an area. Shall we call it “franchise cleansing”?
Property Improvement Plan Financing
When procuring financing for your PIP, you need to evaluate the bids of competing lenders, including the franchisor. Some franchisors might not offer financing, or they might not offer the best deal. You should evaluate financing options along the following parameters:
- Maximum loan amount
- Fixed interest rate or maximum floating interest rate
- Loan-to-value ratio
- Required down payment
- Loan term
- Amortizing vs balloon payments
- Prepayment penalties
The packaging of the financing can vary from one lender to another. You might need an acquisition loan and a construction loan. How will these coordinate? Will you use interest-only construction loans that you’ll replace with long-term financing? How will the lender structure construction loan installments? The most important point is to choose a lender who will provide you with the most advantageous deal.
Hotel PIP FAQs
What does a “Hotel Design PIP” mean?
This is the portion of the hotel PIP dealing with the design features of the hotel. Explicitly, these are the visible aspects on interior and exterior design that affect guest perceptions. Other portions of the PIP deal with technical and engineering aspects that do not affect the hotel’s look.
How much does PIP cost a hotel over 10 years?
A hotel PIP might not extend beyond 10 years. But whatever the duration, a reasonable cost is 7.5% to 8% of revenues. The cost allocations may be front-loaded, so you should average these costs over a 10-year period.
What does a “PIP list” mean for hotels?
The list contains the PIP items you will have to address. You negotiate the final list so that you can meet the requirements at the minimum cost. You should use professional assistance to help you arrive at the final list.