On average, it costs $27 million to build a hotel in 2020. While that figure may seem intimidating at the outset, once you have a clearer picture of how the costs should break down, odds are that it will start to make more sense. With that in mind, read on below for an explanation of some of your biggest spending categories and an overview of your financing options.
What goes into the cost of building hotels?
Before we can get into the more specific figures of what you can expect to spend on hotel investments, it's important to get a clearer picture of where your money is going. With that in mind, we took the liberty of breaking down the six biggest spending categories you should have in your budget.
In order to find these figures, we relied on data from a recent study by Cushman & Wakefield, a company that provides consulting and valuation services for both existing and new hotels. Here is what they found in their research:
1. Land costs
Buying land is the first big expense in hotel development. On average, land costs made up a total of about 9.0% of each hotel's total development cost. However, the survey notes that, especially in urban areas, they are seeing an increase in long-term ground leases as opposed to market-based site acquisitions.
2. Hard costs
For a hotel, hard costs will include building permits, contractor and subcontractor bids, engineering costs, landscaping costs, and the construction cost to build any supplemental construction projects like building a parking garage.
Generally, hotel owners should expect these costs to take up the largest percentage of the budget. In the study, hard costs accounted for somewhere between 64% and 72% of the budget, depending on how high-end the hotel. The more high-end the construction project, the smaller the percentage of the overall cost.
3. Soft costs
Meanwhile, in calculating building cost, soft costs account for your architectural fees; consulting fees for professionals, like surveyors and interior designers; financing costs; and carrying costs.
While the study notes that these costs added up to anywhere between 10%-18% of the budget, on average, it's also important to note that the spread of COVID-19 and various shutdown efforts have undoubtedly had an effect on those numbers.
It cites a study by McKinsey & Company that anticipates that measures to prevent the spread of the virus will cause these costs to inflate by as much as 15%-30%.
4. Furniture, fixtures, and equipment (FF&E)
As the name suggests, things like hotel room furniture, bathroom fixtures, public space furniture, and soft goods like carpeting and drapes are all encompassed in FF&E costs. Notably, any technological or telecommunication equipment is also included in this category.
According to the study, these costs accounted for between 8%-10% of the hotel project's total budget, on average.
5. Working capital and pre-opening expenses
This category includes operating reserves, expenses for hiring and training staff, the cost of building up the supply inventory for things like linens and towels, as well as any technical service fees. The study points out that these costs make up a relatively small percentage of the budget for a new hotel, accounting for between 1%-4% of the total cost, on average.
6. Development fee
The last cost category to consider is the development fee. This category includes any costs incurred by the hotel's development team, such as travel costs, administrative fees, and payroll.
Interestingly, this fee is separate from any revenue expected to be generated upon the successful completion of the hotel. It typically ranges from 1%-5% of the total cost to build the hotel, with a luxury hotel project commanding a bigger fee.
What is the average price per hotel room?
Since the cost of building hotels can vary so widely, it's often more useful to look at building costs on a more granular level. By that, we mean projecting potential costs based on price per each hotel room, rather than looking at the cost for the building as a whole. That way you have the ability to work out a projected budget based on your occupancy capabilities.
That said, the Cushman & Wakefield study found the following average price per hotel room for each of level of hotel:
- Midscale hotels: $147,000 per room.
- Upper midscale hotels: $175,000 per room.
- Upscale hotels: $235,000 per room.
- Upper upscale hotels: $409,000 per room.
- Luxury hotels: $1,630,000 per room.
Doing the math: How much does the average hotel cost?
With those figures in mind, it's easy to come up with a figure for how much the average hotel might cost. For the purposes of this exercise, let's assume that the average hotel has 115 rooms, as some data suggests. Keep in mind, though, that generally the higher-end a hotel gets, the larger it is. Unless it is a boutique hotel, in which case it's likely to be smaller.
Based on those numbers, below is the average cost for each level of hotel:
- Midscale hotels: $16,905,000.
- Upper midscale hotels: $20,125,000.
- Upscale hotels: $27,025,000.
- Upper upscale hotels: $47,035,000.
- Luxury hotels: 187,450,000.
Of course, this is just the average figure. The cost per room might be higher if you plan to add in plenty of amenities or if you're planning on opening up a franchise hotel and you have to pay franchising fees. You could also cut down on costs by buying and renovating an existing hotel.
How does hotel financing work?
Now that you have an idea of how much the average hotel costs to build, it's time to get a sense of how you can access enough financing to actually complete your hotel project. Below are four common financing options that are used in the hotel industry:
1. SBA 504/CDC loan program
If you're a qualified business owner, SBA loans should be high up on your list. The Small Business Association (SBA) partially guarantees loans, making them easier for small business owners to access.
In particular, the SBA 504/CDC loan program offers financing for the following purposes:
- Purchasing land.
- Making land improvements.
- Constructing new facilities.
- Purchasing existing buildings.
- Doing renovations.
Like all SBA loans, the loan term on an SBA 504/CDC loan can be 10, 20, or 25 years and borrowers can finance up to $20 million.
2. SBA 7(a) loans
On the other hand, the SBA's 7(a) loan is a working capital loan, which means it can be put towards the more general costs of building a hotel, such as FF&E or your development fee and operational expenses.
In this case, loan amounts go up to $5 million and the loan terms will vary, depending on how the money will be used. The loan term can be up to seven years for operational costs, 10 years for equipment purchases, and 25 years for commercial real estate purchases.
3. Commercial real estate loan
Unfortunately, though SBA loans often come with some of the best loan terms, they aren't always easy to qualify for. With that in mind, if you're unable to get an SBA loan, you can always try for a traditional commercial real estate loan.
Depending on what loan product you get, the loan terms and borrowing requirements can vary widely. You may see loan terms ranging from one year if it's a hard money loan to 25 years if it's a bank loan. In addition, interest rates and loan amounts can be all across the board as well.
4. CMBS loan
If you're able to secure a construction loan to build your hotel -- sometimes called a CapEx loan in the commercial financing industry -- but are unable to secure traditional bank funding for a mortgage because you don't have a proven business history, you may want to consider a CMBS loan. A CMBS loan is essentially a bridge loan that can be used for temporary financing until you've established a proven payment history.
The bottom line
At first glance, the cost to build a hotel may seem astronomical, but once you've had the chance to see a breakdown of where the money goes in your budget and review some of your financing options, odds are that the prospect will seem much more doable. If you're planning on starting a hotel project, use the figures and information above to give you a clearer idea of what you can expect to spend.
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