Hotel owners routinely invest capital into the front of the house to drive revenue growth, as well as comply with brand standards and product improvement plans. However, investments into the back of the house are typically only made after building equipment is approaching (or past) the point of imminent failure. Owners and operators who wait to invest in their back of the house are missing out on a clear opportunity to reduce utility costs, and in many cases are creating an equipment liability that can result in significant displacement of revenue when key building components fail.
Let’s compare a typical investment in the front and the back of the house. A front of the house upgrade (whether a PIP or voluntary cosmetic improvement) will have a 7 – 10 year service life and is a required capital expense. If you don’t make the investment, you know that you will gradually lose market share to your competitors with newer hard product. However, the exact returns from this type of investment can be difficult to underwrite and quantify.
On the other hand, it is a fairly straightforward and routine process to quantify the returns from investing in more efficient building equipment in the back of the house. Unlike trying to drive occupancy, the returns from investing in cost reduction measures accrue entirely to the bottom line, rather than at the operating margin of the hotel. Additionally, owners who invest time and resources in learning more about the condition of their key building equipment can identify and budget for equipment liabilities – ahead of failure.
Based on HVS’ experience in retrofitting of a wide range of building equipment, we’ve identified six proven strategies to help hotel owners and operators invest wisely in your back of the house.
Strategy #1: Understand your goals
The first step in contemplating investment into your property is to align the investment with your ownership goals. Is the asset a potential flip or a short-term, mid-term, or long-term hold? The answer to this question will in turn dictate the owner’s investment criteria (which could consist of a simple payback period requirement, a finite level of capital per annum or over the hold period, or other more detailed financial metrics). Furthermore, are renovations or repositioning contemplated in the foreseeable future? If so, there are nearly always economies of scale in addressing back of the house issues concurrent with other investment or planned capital projects, to minimize disruption of revenue and consolidate both project soft costs (e.g. design, project management) and hard costs (e.g. procurement of equipment and mobilization of construction manpower).
At the same time, specific goals relating to existing equipment issues should be identified – are there some areas of the property that never cool adequately during warm summer months? Is the noisy air handling unit in your ballroom disruptive to meetings and special events? Does it take five minutes for hot water to arrive to the tenth floor during peak showering times? Again, to realize economies of scale, the due diligence to address these issues can be combined with other key investment milestones such as PIP improvements or ROI initiatives.
The good news about establishing your goals early in the process is that this should be relatively easy to accomplish and requires minimal time and effort. The bad news is that this step is oftentimes overlooked, which can lead to overspending on preliminary work such as due diligence and project design.
Strategy #2: Identify in-house versus out-of-house expertise
After establishing your goals, it’s time to determine who is going to perform the work. HVS contends that the vast majority of back of the house projects require significant engineering experience to execute correctly, coupled with strong project management throughout so that the owner’s interests are represented during all phases of the investment process. Does your operations team have the in-house capability to identify, underwrite, design, bid, administer construction, and oversee commissioning of complex mechanical projects? If not, then it’s time to consider engaging a consultant.
If you are required to go out-of-house, it is vital to retain a firm(s) with strong technical capability, coupled with the ability to translate complex engineering information into simple financial terms to support business decision making. When interviewing prospective business partners, you should check both general references and hospitality references – projects can easily fail if your design team or building contractor do not understand the specialized constraints of working in an operating hospitality context. Going beyond this, you should review the resumes of specific personnel who will be assigned to your project. Are they senior-level personnel with significant experience in the design and construction of similar projects? Will a principal-level employee remain engaged, or is the baton passed to junior-level staff without adequate experience to make the critical recommendations required to drive a project to successful conclusion?
Finally, HVS encourages you to ask your prospective business partners for their philosophy on investment into building equipment. If they don’t understand the value proposition in reducing first cost, optimizing operating efficiency over the hold of an asset, and mitigating risk during the project execution process – then it’s time to look for a new consulting team. It should also go without saying that your engineering firm, project manager, and owner’s representative should be vendor-neutral and not have a referral program in place with any particular equipment manufacturer or service provider, which can bias their recommendations or product selections.
Strategy #3: Require stringent underwriting
HVS strongly endorses the completion of Life Cycle Cost Assessment (LCCA) for all major investment into key building equipment such as chillers, boilers, guest room HVAC systems, ventilation equipment, building controls, and other large capital expenditures. The LCCA process involves the review of the first cost of a project against future reductions in utility cost, other O&M expenses, depreciation, and other factors. In essence, LCCA is an IRR analysis for your building’s critical equipment over your hold period for the asset. LCCA can be completed using desktop based analyses or more complex energy modeling, depending on the type of system to be evaluated.
We further recommend that you (or your consulting team) should be somewhat wary of any utility cost savings projections provided by vendors of building equipment or contractors. HVS routinely reviews these projections in an underwriting capacity, and we have found that an alarming number of vendors are inflating their savings estimates by 25% or greater. With that said, we note that there are still good, honest vendors out there in the building equipment and energy space – we work with these firms on a daily basis. Unfortunately, however, there are many more unscrupulous vendors and contractors who prey on owner and operator ignorance in this area. Based on our extensive project underwriting experience, HVS believes that the cost of investment-grade underwriting is nominal in comparison with the potential operational and financial liability of a poorly conceived project.
Strategy #4: Own the design process
For a typical front of the house renovation, the project administration process is a fairly straightforward chronological sequence, including: 1) retain a design firm; 2) prepare construction documents, 3) ensure the construction documents achieve project budgetary requirements; 4) conduct an open bid process; and 5) award the job to the competitive bidder with the correct credentials to complete the job successfully.
Unfortunately, the same regimented project administration process is rarely followed in the back of the house. HVS strongly recommends that mechanical, electrical, plumbing, HVAC, and other similar projects should be administered in exactly the same manner as front of the house projects. By controlling the design, an owner can ensure that appropriate equipment is selected considering both financial and technical factors. Additionally, preparation of construction documents or detailed project specifications is essential to support receipt of “apples to apples” bids from multiple contractors, as well as serve as an indisputable written record of the exact equipment and configuration that was supposed to have been installed at the property.
In some situations (such as a simple one-for-one equipment retrofit or a pending equipment failure where timing is critical), HVS has had success using a design/build approach where the contractor also serves as the engineer of record. However, if the project is complex and/or requires a large level of capital, we also support a design/build with engineer assist model, where an engineering firm retained directly by the owner can provide checks and balances to the contractor’s proposed approach and budget.
When owners attempt to minimize soft costs and correspondingly lose control over the design phase of a project, they oftentimes pay these avoided costs back tenfold in terms of botched installations, unwarranted change orders, and lack of system performance over time.
Strategy #5: Apply rigorous construction management
The best of plans sometimes don’t materialize, and the same can be said for building equipment construction in the back of the house. Unless the owner and operator have someone in place who understands the details of engineering and construction, it is very difficult to gauge whether the actual installation provided by the contractor matches what appears on the construction documents.
When HVS manages complex mechanical retrofits, we engage a qualified Mechanical, Electrical and Plumbing (MEP) engineering firm to provide both day-to-day project management and construction administration services. We find that this approach results in significantly less corners being cut – and in many cases the soft costs of engaging a project administrator are less than the liability created by not having one in place (via change orders, delays, guest impacts, etc.).
If your hotel is going to be fully or partially open for business during back of the house renovations, it is imperative to discuss project sequencing and downtime with the design and construction teams ahead of work commencing. A carefully prepared project work plan, coupled with basic contingency planning, can go a long way toward managing guest expectations during construction.
Strategy #6: Maintain and monitor your investment
Just because the project is over and the punch list is complete does not mean that it’s time to forget about the back of the house. As you would with any financial investment, it is important to monitor performance over time. This can be done in-house via review of utility consumption over time – if the underwritten project is anticipated to result in 20% lower utility costs in the first couple of years, can you see a demonstrable downswing in your energy consumption and costs? If not, there may be commissioning issue with the equipment. This is unfortunately common, but it is easy to diagnose if you track performance closely over time.
At the same time, it is also important to service and maintain your equipment. This can either be done in-house (if your engineering department has appropriate expertise and bandwidth) or using an out of house company. If you do go out of house, undertake the same due diligence that you would for engaging any other service contractor – check references, review their boilerplate agreement, discuss the specific terms and conditions for your property, and evaluate the cost of a service plan versus the potential liability of not maintaining your brand new building equipment.
Conclusion
When you look across the hospitality sector, there is a myriad of daily news announcements about hotel renovations and repositioning. There are also many qualified consultants, design firms, project managers, and vendors to support owners and operators throughout the renovation process. HVS contends that this same level of support should be available for back of the house retrofits, since functional and effective MEP and HVAC equipment is absolutely critical to the hotel being open for business and driving guest satisfaction.
About the author
Kevin A. Goldstein is the President of HVS Energy & Sustainability, a division of HVS that helps hotel owners and operators reduce operating expenses through diligent facility management and informed, strategic investment into building equipment. HVS’ approach in this area is specific to the hospitality industry and is based upon our thirty-years of experience in hotel valuations, operations, management, and transactions. Prior to joining HVS, Kevin led development efforts for hospitality, mixed use, and infrastructure development projects for a waterfront destination development firm. Kevin earned his bachelor’s and master’s degrees from the University of Delaware
