A hotel's NOI falls two to two and a half times faster than its RevPAR, and faster still when the fall comes through rate.
Less than most lenders' instincts suggest, and less again when the fall comes through room rates rather than occupancy. On an illustrative 220-room hotel with a 1.68x DSCR, RevPAR can fall 11.3 per cent through occupancy but only 8.9 per cent through average daily rate before the 1.30x covenant breaks, because a hotel's net operating income falls about two to two and a half times faster than its RevPAR.
Worked in full in The Real Estate Debt Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
On a let office or warehouse, a 10 per cent fall in rent is roughly a 10 per cent fall in net operating income. A hotel is an operating business: wages, utilities, insurance and maintenance do not shrink when fewer rooms sell, and some costs follow revenue while others follow the number of guests. That cost structure decides how much RevPAR headroom a loan really has, and the split between occupancy and rate decides which way the stress hits.
| Input | Value |
|---|---|
| Rooms | 220 |
| Average daily rate (ADR) | 165.00 |
| Occupancy | 74.0% |
| Other revenue (food, drink, parking), share of rooms revenue at base | 8% |
| Cost of other revenue | 70% |
| Rooms cost per occupied room (cleaning, linen, amenities) | 32.00 |
| Distribution costs and commissions, share of rooms revenue | 9% |
| Management fee / FF&E reserve, share of total revenue | 3% / 4% |
| Fixed operating costs (admin, sales, maintenance, energy, tax, insurance) | 3,300,000 |
| Loan, 25-year amortisation at 7.25% | 22,000,000 |
| DSCR covenant (cash trap) | 1.30x |
RevPAR = ADR × occupancy = 165.00 × 74% = 122.10. Rooms revenue = 220 × 365 × 122.10 = 9,804,630. Occupied rooms 59,422. Other revenue 784,370. Total 10,589,000.
Rooms costs 59,422 × 32.00 + 9% of rooms revenue = 2,783,921. Other revenue costs 549,059. Management fee 317,670, FF&E reserve 423,560, fixed costs 3,300,000.
NOI = 3,214,790, a 30.4 per cent margin.
Debt service = 12 × PMT(7.25%/12, 300, -22000000) = 12 × 159,018 = 1,908,210. DSCR = 3,214,790 ÷ 1,908,210 = 1.68x.
The covenant breaks when NOI = 1.30 × 1,908,210 = 2,480,673, a 22.8 per cent fall in NOI. Solve for the RevPAR that produces it, once by cutting occupancy with ADR fixed, once by cutting ADR with occupancy fixed (Goal Seek on the RevPAR change).
| Test | Route of the fall | RevPAR fall | RevPAR | ADR | Occupancy |
|---|---|---|---|---|---|
| 1.30x covenant | Occupancy | 11.3% | 108.34 | 165.00 | 65.7% |
| 1.30x covenant | Rate | 8.9% | 111.22 | 150.29 | 74.0% |
| 1.00x (cash shortfall) | Occupancy | 20.1% | 97.61 | 165.00 | 59.2% |
| 1.00x (cash shortfall) | Rate | 15.9% | 102.73 | 138.82 | 74.0% |
A 22.8 per cent fall in NOI breaches the covenant, and that takes only a 9 to 11 per cent fall in RevPAR. The hotel can lose 40.6 per cent of its NOI before it stops covering debt service, which takes a RevPAR fall of 15.9 to 20.1 per cent.
Take a 10 per cent RevPAR fall each way. Through occupancy, the hotel loses 1,058,900 of revenue but also stops cleaning 5,942 rooms and selling breakfast to their guests, so NOI falls by 651,479: a flow-through of 61.5 per cent, NOI down 20.3 per cent and DSCR at 1.34x. Through rate, it loses less revenue, 980,463, but sells the same number of rooms at the same cost, so NOI falls by 823,589: 84.0 per cent flow-through, NOI down 25.6 per cent and DSCR at 1.25x, already in breach. Discounting to defend occupancy is the operator's instinct in a downturn; for the lender, it is the more expensive way to lose RevPAR.
The multiplier to remember. Here NOI falls 2.03 times as fast as RevPAR when occupancy drops and 2.56 times when rate drops. A lender used to net-leased property, where the multiplier is close to one, will credit a hotel loan with about twice the headroom it really has: a 22.8 per cent fall instead of 8.9 to 11.3.
| Occupancy fall | ADR flat | ADR −5% | ADR −10% | ADR −15% |
|---|---|---|---|---|
| 0% | 1.68 | 1.47 | 1.25 | 1.04 |
| 5% | 1.51 | 1.31 | 1.10 | 0.90 |
| 10% | 1.34 | 1.15 | 0.95 | 0.76 |
| 15% | 1.17 | 0.99 | 0.81 | 0.62 |
A downturn that takes 5 per cent off both occupancy and rate, a RevPAR fall of 9.75 per cent, leaves the loan at 1.31x, on the covenant. A 10 per cent fall in each takes cover to 0.95x and leaves the sponsor funding debt service.
Underwrite a hotel loan on the cost structure, not on RevPAR alone. On this case a 1.68x opening DSCR buys about 11 per cent of occupancy-led decline, or 9 per cent of rate-led decline, before the cash trap springs. For how covenant DSCR is defined in the documents, see how to calculate DSCR under a loan agreement; the occupancy logic for let property is in break-even occupancy on a commercial loan, and the lender's return workbook is on the free companion page for this book.
Higher than on let property, because hotel income is earned night by night and NOI is geared to revenue. The illustrative loan opens at 1.68x with a 1.30x cash trap; even that gap is consumed by an 8.9 to 11.3 per cent RevPAR fall, depending on whether rate or occupancy drops.
The share of a revenue change that reaches NOI. In the example a 10 per cent RevPAR fall through occupancy loses 1,058,900 of revenue and 651,479 of NOI, 61.5 per cent flow-through, because cleaning and guest costs fall too. Through rate, 84.0 per cent flows through, since the hotel serves the same guests for less money.
Rebuild NOI from the cost structure: costs per occupied room, revenue-linked costs such as commissions, management fees and the FF&E reserve, and fixed costs. Then cut occupancy and ADR separately and together. On the illustrative case a 5 per cent fall in both leaves 1.31x, and a 10 per cent fall in both leaves 0.95x.
This article is one calculation from The Real Estate Debt Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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