Perception is not always Reality

Perception is not always Reality

• Posted By Andrew Morgan

Anyone involved in some way in the accommodation industry enjoys hearing stories of high occupancy rates being achieved.  So, it stands to reason that when considering a motel investment, occupancy rate seems like a logical question to ask about.  The perception is that it reflects how well the business is performing.  But how important is the occupancy rate for this assessment?  Does it paint the real picture, or can it lead to an inaccurate determination of the motel’s actual performance?

In a recent article of mine, occupancy rates were outlined as one out of a few useful tools to make a quick early assessment of the reliability of a motel’s revenue, whilst accompanied with other pieces of information required for the calculation.  That was for a quick assessment though, not a complete determination.  It does form a part of the puzzle, but can also lead to inaccuracy if not considered in its entirety with the other parts of that puzzle.  As a result, many people do not ask early on about occupancy rates as it is not high on their agenda as far as making a complete assessment of the overall business.  Why would this be?

I have heard commentary very recently, but it also dates back to as early as 1995 when I first started in the industry, where I was hearing the comment, “it’s the best motel in town, the carpark is always full” because it ran at an occupancy rate in excess of 90%.  My inexperience at the time caused me to believe a lot of things I was told that I absolutely would not believe today.  I wondered how this could be the “best”, as its presentation was less than good, to be polite.  In discussions with the owners about offering that business to the market, I perused the financial statements.  It did not take long to work out that the motel ran at a very high occupancy of over 90%, confirming the rumours.  Thereafter, it became evident that the average tariff the motel was achieving was approximately 30% below other similar motels in the area.  Others were averaging occupancy rates of 65% with a room rate 30% higher.  It was clear that by underselling the product, they were able to sell more rooms.  Therefore, the badge of honour of “being the best motel in town” was a façade.  Just because the carpark was full every night, it was not the result of “good business practices”.

The below is a very simplified table showing the effect of a higher occupancy rate with a reduced average nightly tariff.

Note the above numbers will vary with individual motel businesses and required assumptions.  All amounts exclude GST.  Cost to rent a unit does not account for rent or loan repayments.  Fixed costs are not a reflection of any particular motel or location and will vary depending on each.

The cost to operate Motel A at 90% occupancy compared to Motel B at 65% and Motel C at 40% is high.  The two types of expenses being fixed costs and variable costs can help to explain this.  Some of the fixed costs of renting a room may include property rates, insurance, accounting fees, and rent (in the case of a lease).  These fixed costs will always remain and will not vary whether a room is rented or not.  However, the variable costs will increase the more times a room is rented.  This is where Motel A does not look all that good, by discounting room rates.  Some of the variable costs of renting a room may include – electricity, linen, repair and maintenance (which will be very high at 90%), and wages.  There is a compounding effect with the increased number of rooms rented multiplied by the variable cost to rent those rooms, all at a lower than market room rates.  This table has not allowed for a possibly higher variable cost than the other motels, particularly regarding repair and maintenance costs growing as a result.

The table shows that Motels B and C are far more profitable and therefore more successful accommodation operations with superior profit margins.  A higher tariff and lower occupancy (within reason) is preferred in sustaining a strong underlying business as opposed to relying on a budget driven clientele that will move to the next motel if they were to discount their rates as well.  Under selling the product to this market does not create a loyal, returning client base.

The situation for Motel C’s occupancy rate at the nightly tariff was only 40%, indicating that their nightly room rate was probably too high, and not meeting the market at the opposite end of the scale.  This is on the proviso that the motel’s competitors are trading at higher occupancy rates.  Although looking at the profit it would seem the result is still very good.

Motel A may be turning each room over almost every night at 90% occupancy and appearing on the outside to be the more successful, however the number of cars in the car park does not tell the full story and has little bearing on whether the motel is a strong and sustainable business.