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Pricing a Bed and Breakfast Inn

September 28, 2008

by Kit Cassingham

You may want to buy a bed and breakfast today, but you'll want to sell it another time. Evaluate any bed and breakfast for sale with solid valuation skills, grow the business, and use the same valuation skills to price your bed and breakfast for sale when it's time.

Think about how you will sell your inn as you buy or build. As you want to make a wise business decision when you buy, you can be assured when you are ready to sell your buyer will also strive to make a wise business decision. Approaching your purchase this way will have you contemplating how you will conduct your renovations (total cost and specific item costs), what price you pay, options you build in to your situation, and how you plan to build your business.

There are some gross rules-of-thumb to keep in mind as you examine prices of B&B properties you examine for your possible purchase; remember "gross" rule-of-thumb give "gross" results that you can use as guide posts for a reasonable purchase price. Also, these rule-of-thumb values change regularly -- these are guidelines based on information shared at the PAII (Professional Association of Innkeepers International) 2002 conference.

GRM (Gross Room Multiplier)

GRM is calculated by multiplying the annual gross room income (GRI) by a factor. This approach looks at a B&B at its most basic level -- income. There is no question of how the money is spent, or therefore how the business is run. This approach allows properties to be compared on the same plane, regardless of location, amenities, or size -- the income reflects the business as it is. Other income sources, such as gift shops, special events, and rentals (bikes, boats, and skates being examples), are typically considered separately. The B&B, including the real estate and FF&E (furniture, fixtures and equipment), is the primary business you sell. There may be other businesses, like gift shop and restaurant, and they're valued separately.

The national factor range is 3­-7. The variables in this range include level of amenities (private baths, jetted tubs, room phones, fireplaces), maintenance and condition of the property, and location. The national factor average is 5.

GRI x Factor = Price
ex: $140,000 x 5 = $700,000

NOI (Net Operating Income)

NOI is calculated by taking the normal operating expenses (NOE) and subtracting them from the gross room income (GRI); the result is then divided by a factor, or capitalization rate. NOI includes only normal daily operating expenses -- no debt service, personal items, extraordinary expenses, or management costs are included. This approach shows the whole picture of income and expenses. Most commercial real estate investments use industry standards in making assumptions for the income and expenses to calculate the sale price. Therefore, that is the primary approach used in pricing commercial and investment properties. However, B&Bs don't yet have universally accepted industry standards for income and expenses, so one can't as easily gauge the soundness and fairness of a B&B's income and expenses (e.g., is the shown income all there is, and how much of the expenses are really personal) to therefore calculate a sale price. The national factor range is 9-­13% (with the same reasons for variability as found in the GRM discussion). The national factor average is 11%.

ex: $180,000 - $108,000 = $72,000

NOI / Factor = Price
ex: $72,000/ .11 = $654,545

NOTE: There are some consultants, innkeepers and speakers who think this formula is to multiply the NOI by the factor as a non-percentage. That works beautifully if the value is 10, but as soon as the value changes the results are skewed and incorrect. The factor is a percentage, and it is divided into the NOI.

Price per Furnished Guest Room

The Price per Furnished Guest Room formula is useful only if the inn has a 65 percent occupancy rate. I personally don't value this approach because I feel it ignores the condition and amenities of the rooms, the building, and the strength of the business, though the 65 percent does acknowledge some of the business value. I believe that the business strength is important since that is what you are selling and is a reflection of the building condition and hospitality. Others use this approach so I feel compelled to show how to use this -- in case an Inn you are examining has a 65 percent occupancy rate. The price range runs from $80,000­$155,000. There is no national average because that number is so specific to a property, based on its quality and extent of amenity.

#Guest rooms x Factor = Price
ex: 7 x $125,000 = $875,000

Price per Square Foot

The Price per Square Foot formula is useful only when the inn has a 65 percent or higher occupancy rate. I don't like this approach for any real estate, unless you are comparing identical properties, because it has the same limitations as Price per Furnished Guest Room, only to an even greater extent. The price range is $100­$150 per square foot, but that higher price could be much higher if the finish was exceptional and amenities abundant.

$/SF x Total SF = Price
ex: $125 x 6,000 = $750,000

At this point, according to these rule-of-thumb formulas that the examples shown were all applied to the same sample property, the suggested sale prices results in values of $700,000, $654,545, $875,000, and $750,000 (nearly a $200,000 span!). Applying your knowledge of the area, competition, condition of the building and marketing plan helps you narrow in on the most reasonable sale (or purchase) price for "today". "Today's" price is the most reasonable to consider since that’s where you are at the time of purchase. Many sellers tend to price their B&B inns based on what they hope to sell for by the end of the typical sale period, which is three years -- "tomorrow". The challenge is getting to a price which satisfies the "today"-thinking buyer and the "tomorrow"-thinking seller.

The factors used in these rules-of-thumb will vary up or down depending on the condition of the property, the degree of luxury, the location's desirability, the degree of amenity (private bath vs. shared bath, gardens, jetted tubs, fireplaces), and maintenance quality. My favorite rule-of -thumb is the GRM, because I feel it most accurately reflects the business. If you can get a clear, accurate picture of what the net operating income is, then NOI is an even stronger indicator of what you can expect of your bottom line if you plan on operating the same way as the present owners. The challenge with any pricing strategy is the subjective aspect of selecting the factor.

Using an experienced inn broker will help you tremendously because their industry knowledge will help them in their pricing approach. I've seen too many buyers and sellers caught up in the inn to the fault of over valuing it for what it is to them. Either the inn doesn't sell or the buyer pays too much and struggles with keeping the inn financially viable, and occasionally losing it to foreclosure. These rules-of-thumb give you sound guidance for the general "size and shape" of the price target. Don't thumb your nose at this approach.

Once you determine a price range using these formulas, test the price from the lender's perspective. With a 30 percent down payment (30 percent is the minimum you should put down on the purchase), is the annualized debt service less than or equal to 40 percent of the income? If it is, then you as the buyer can operate the business successfully and the price is "reasonable" for the income. If not, you need to evaluate whether this purchase is a good idea. There can be extenuating circumstances that make some "bad purchases" become "good purchases" in Putting The Puzzle Pieces Together chapter. Look at those circumstances carefully, evaluate them with your situation in mind, and make a decision. Be careful to not fool yourself -- try to not let your heart rule your mind. Both heart and mind need to be involved in making these critical decisions.

When in doubt, don't.

What can you afford to buy? My quick rule of is to multiply your available cash that you plan to use for this B&B purchase (home equity, savings, gift money, stocks/bonds) by three to see which price ballpark you can reasonably look in. If you have $200,000 in available cash, a $600,000 purchase isn't unreasonable for you. You may be able to afford a slightly higher price than that, but you still have an idea of your price target. If you have additional outside income to help support you and the inn, you can buy more inn than this formula indicates. But if you are buying an inn to be self-supporting, then pay close attention to this advice.

This bears repeating -- don't buy more than you can afford; this is one real estate purchase that you don’t want to leverage. Many buyers with $100,000 think they can buy a viable B&B, make lots of money, and have a healthy cushion. My experience is contrary to that. I have seen innkeepers file bankruptcy and lose not only the inn but their cash and time investment too. I've seen them lose money in their operations and sell the inn at a loss. I've seen the stress of insufficient funds break up relationships. Make sure you buy within your means.

There are loans out there for buyers with a down payment of less than 30 percent, but they are hard to get (80 percent loans are rare, and as of this writing I don't know any innkeeper who has gotten a 90 percent loan). Even if you could get a higher loan-to-value (LTV), it doesn't make sense to leverage your money this much when buying a B&B. Inns operate with a low profit margin. The mortgage is the biggest item in the budget. Keeping the mortgage less than or equal to 40 percent of your gross annual room income allows you to better survive down times such as off-season lulls, natural disasters (hurricanes, tornadoes, earthquakes, and forest fires are some that immediately come to mind that I know have impacted innkeepers' businesses), recessions, and even terrorist attacks. You can trim the budget in slow times in many categories, but once you have your mortgage, that's one expense you can't as easily trim, especially if your cash flow is tight and your money reserve low. Focus on keeping your debt service as low as possible so you don't become a casualty of "slow times".

You'll also want and need cash for closing costs, moving costs, operating reserves, and "ramp up" costs. Ramp up costs are the funds you need to announce to your guest list you are the new owner, modify the inn's web site and brochure, freshen linens/paint/etc, or even to decorate/renovate to make the inn more your style. Caveat: don't go overboard initially making changes because you will want to "know" the inn and your business before making big changes. Also, you want the inn's cash flow to finance those changes to keep your early cash outlay as low as possible. "Life happens" and you don't want to find yourself in the position of owing more money on the inn acquisition and renovation than you can get out if you have to sell early in your ownership.

I firmly believe where there's a will there's a way. My approach to innkeeping is that you can do anything you want as long as it's true to your dream -- and you convey your dream to your guests. (For guidance on developing your dream, my eBook Building a Good Foundation is invaluable.) There are few rights or wrongs in this business. That's part of the beauty -- and the curse -- of this industry. There are those who "know" you must have more than 8, 10, or 22 rooms to be a viable B&B. Others are of the school you must have a restaurant with your inn to be viable. That's true for them but doesn't have to be true for you. Follow your dream. Do your homework, consult with experts, and determine how you can make your dream viable. Make adjustments to the dream, guided by your homework results. Then act on your dream to create your reality.

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