by Peter Scherman of The B&B Team
In life we all look for advice. We turn to doctors, lawyers, accountants and mechanics without a second thought. But surprisingly, too many people fail to seek out advice when it comes to the largest transactions of their lives. Did you ever hear about the couple that spent their life savings, about $1,000,000, on a bed & breakfast renovation and start-up, only to learn that it was worth barely half that amount when health forced them to sell? How about the pair who were contemplating an even larger investment and who sought council, deciding after only a few thousand dollars in consulting fees that they were on the verge of a multi-million dollar mistake? And then there’s the couple who had a plan, got guidance on the plan, and are now running a very successful business. Which one of these might you be?
I’ve always learned a lot from case studies, so let’s take a look at a real life lesson. John and Susan had their eyes on a property that just begged to become a B&B. It was a classic structure in what they believed to be a good location, but the house needed a lot of work. Classically styled, it hadn’t been touched in decades and was eligible for historic status, rehabilitation tax credits, and was priced accordingly. With their budget, they were confident of being able to acquire the house and had done extensive research about the zoning, the hospitality environment and competition, and how they could create the permitted number of guest rooms plus a spacious owner’s apartment. They’d even planned the landscaping on the overgrown lot. Rarely had I seen more thorough due diligence. As thoughtful people who believed in doing their homework, they decided that, before submitting a purchase offer, they’d hire The B&B Team® to perform a feasibility study for them.
Our challenge was to look at the basic plan for remodeling to assess the rooms and amenities for maximum income generation; to consider the potential costs of renovation; to construct a financial model of future operations based on what the market and competition would reasonably allow, and to assess what the future value of the project might be, if all assumptions held true.
John and Susan hired me to meet with them, the local listing agent, and two rehabilitation contractors. At the end of a fascinating tour of this marvelous old home the number that was estimated for the renovation was “at least” $500,000. The property could possibly have been purchased for $300,000 – $350,000, and there was another $50,000 in landscape work. Add $50,000 in furnishings, and they were looking at a price tag of at least $900,000 – $950,000 before opening their doors.
In and of itself, $950,000 is not an altogether unreasonable price to pay for a six guest room B&B in a potentially strong business locale. So far so good. Enter the analysis. There were few B&Bs in the market, and therefore almost nothing to compare to competitively. Nevertheless, it wasn’t hard to establish a baseline room rate based on the nearest and most likely competition. Occupancy was similarly vague, but looking at the progression of the local economy and historical numbers for the industry, we could see the potential for a respectable rate by the end of the third year, reaching full potential at the end of five. Building a working pro-forma, this B&B could be more profitable than most similar sized properties in many markets.
The problem was, it was impossible to calculate at what point it would become profitable after debt service because of the huge unknown of the cost of rehab. And, if the initial estimate of costs was reliable (and they were likely to be low) the best estimate of future value was comparable to what it was going to cost to create. Not a lot of return on investment, and a highly risky proposition to begin with. This just didn’t seem like a wise move. After all, I suggested, high risk projects should be embarked upon only by people who could afford to lose a fair amount of money. John and Susan agreed and were happy they’d hired a consultant to bring them down to earth. They weren’t discouraged and continued looking for a different bed & breakfast that had a more predictable future.
In this business we’ve all seen and heard of people who lost a lot of money, and others who were successful. Some people don’t need outside advice, but many do. And others think they don’t, but should get it anyway to obtain an objective opinion to test their plans and business models. From remodeling to expansion to the best price to ask or pay for an inn, it always pays to get professional advice.