Measure hotel managers using RevPAR-adjusted budgets

WORLDWIDE Budgets are a good planning tool for hoteliers, but it is not always appropriate to use them as benchmarks to measure a hotel manager’s performance. Miguel Rivera, senior vice president for HVS Asset Management & Advisory, explains why RevPAR-adjusted budgets are a better indicator of how well a hotel manager is doing.

Perhaps the best example of why budgets should not be used as performance benchmarks has occurred over the last three years. In 2009, nearly every hotel in the country performed below its budget. This was not surprising; in 2008, nobody had the foresight to predict the extent of the financial crisis or its impact on the hotel industry. To have judged managers at the end of 2009 based on their failure to meet budget would have been unfair. Their performance should have been judged against the market. Even declining RevPAR should have been praiseworthy, if it meant a smaller decrease than for the rest of the market.

By contrast, in 2010 many budgets reflected very conservative assumptions made in the midst of an unusually uncertain environment. It would have been equally unwise to praise operators based on exceeding budget in 2010. The excess performance that the market produced for them was as much out of their control as the underperformance generated the previous year. Management performance, again, should have been judged against the market.

Management’s effectiveness in generating cash-flow for an owner must be judged on two primary metrics: its ability to generate an appropriate share of revenue within its competitive market and its ability to convert that revenue into cash-flow available to the owner. However, both these factors are influenced to a great extent by the performance of the overall market. There is a need then to separate between results generated by the market and those generated by management skill. A buoyant market produces higher RevPAR and better profit margins for all properties, whether they are managed marginally or superbly.

In order to make meaningful comparisons between actual and budgeted results that focus on management’s—rather than the market’s—performance, I strongly recommend restating budgets as the year progresses in terms of the RevPAR that should have been achieved given an explicit or implied RevPAR penetration target. An implied target most times means assuming the same penetration index as the previous year. An explicit target involves asking your operator to state his or her budget occupancy and ADR projections in terms of penetration indexes. This encourages operators to focus on maintaining or increasing the competitive position of the hotel throughout the year, rather than on meeting an arbitrary budget number.

To restate a budget for actual market performance, follow these steps:

1.         Adjust the budgeted occupancy and ADR (and, therefore, RevPAR) for actual market performance using penetration indexes. Replace the budgeted occupancy with the market occupancy multiplied by the occupancy index target. Do the same with ADR.

2.         Adjust other departmental revenue based on the revised RevPAR assumptions using one of two approaches. To use a POR (per-occupied-room) adjustment, take the budgeted revenue POR for each department other than rooms, and multiply it by the new number of occupied rooms implied by the adjusted occupancy percentage. To use a percentage of revenue adjustment, adjust the revenue for each department to match the percentage of total revenue indicated by the budget. If the mismatch between budgeted and market-adjusted RevPAR is due more to occupancy than to ADR, favor the POR adjustment, and vice versa. Other considerations at play may be significant changes in market segmentation (for instance, a lot of group business with high F&B consumption), but strive for simplicity.

3.         Adjust departmental expenses based on new occupancy and departmental revenue levels. This can be done based on POR amounts or departmental expense percentages. For the rooms department, using the same expense POR as the original budget usually makes the most sense. For other departments, adjusting the dollar amounts to keep the same expense ratios as the original budget is usually best. Departmental expense ratios decrease as related revenue increases. However, the subjectivity involved in making more nuanced adjustments will open the door to arguments. Keep the math simple and the nuances in the back of your mind.

4.         Adjust undistributed operating expenses, and fixed expenses based on adjusted RevPAR. Since these items tend to be mostly fixed, keeping them more in line with the original budget usually makes sense. There are a couple of exceptions. Keep reserve-for-replacement as a percentage of total revenue. Make a minor adjustment to administrative and general to account for credit card commissions. If there are wide margins between the original and adjusted occupancies, adjusting POM and utilities expenses to match the original percentages of total revenue or POR amounts could be warranted.

The resulting NOI—and departmental totals—after making the suggested adjustments will reflect a much fairer basis to compare actual results to budget that is not obfuscated by changes in the broader market. The idea is to make a distinction between results that are the consequence of market performance—and beyond management’s control—and those that are the result of management skill. A more detailed discussion of the adjustments discussed here will be included in a more comprehensive version of this article to be published in the summer issue of Real Estate Finance Journal. It can be found at