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Don’t judge a lodging asset by its price in relation to replacement cost

Well the deal has finally closed. After a contentious, drawn-out effort to find a buyer, Revel Hotel and Casino, the bankrupt Atlantic City boardwalk property that originally cost US$2.4 billion to build, has now officially traded for US$82 million, or 4 cents on the dollar. There is little question that Revel was an ill-conceived development and a financial failure with billions of dollars lost by several very sophisticated investors.

The US$4.3 billion Cosmopolitan Hotel of Las Vegas is another example of a poorly planned hotel casino development where smart money took a bath. Last year, Blackstone purchased the 3-year-old asset from Deutsche Bank for US$1.73 billion, or 40% of replacement cost.

Generally speaking, acquiring a lodging asset at a price that is below replacement cost allows investors to charge lower room rates while achieving returns similar to new-construction projects, as a result of their investment basis being less than the cost of development. The fact that Revel and the Cosmopolitan, which during each of their short operational existences never turned a profit and ultimately traded at dramatic discounts to replacement cost, indicates that both developments were misjudged and never financially feasible.  

The moral of the story is that just because a hotel asset can be acquired below or, as in these instances, significantly below replacement cost does not automatically mean that an investor has an opportunity to snag a good deal. With this said, many savvy investors have and continue to achieve solid returns purchasing hotel assets below replacement cost and successfully executing business plans that encompass property repositionings through implementation of value-enhancement initiatives.

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