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Refinancing Your Inn — Food For Thought

by Peter Scherman of The B&B Team

When you’re thinking of refinancing to make capital improvements to your inn, there are many questions to ask. In the analysis of finance and construction costs, anticipated revenues, and future value of the tangible assets, one question that is often overlooked is this: How will improving the physical plant impact the future marketability of your inn when you sell?

The resale market for inns can be broken down into three basic categories. First, there are homes from which someone operates a bed & breakfast for fun, some additional income, and tax breaks. Second, there are somewhat larger homes with stronger businesses that generate a significant amount of lodging income, but which have a potential market as a high end residence. And third, there are large B&B’s and full service inns and spas which are strictly businesses and, essentially, commercial property, valued almost entirely for their ability to generate income.

The third category of properties is ideal for refinancing for capital improvements which can enhance their ability to increase revenues — and, therefore, value — and are not addressed here. The first two, however, are. Consider this: you have a lovely three to five guest room B&B in a nice area, make a respectable, if modest, living from the B&B business, and you are at a crossroads. You’d like to earn more and have decided that you are either going to “improve” the property to grow your business, or sell it and buy something larger. Capital investments are generally considered improvements, but they may not improve your chances of selling. The reason is simple. If, for instance, you turned your five bedrooms into eight or ten, or you added a commercial kitchen and a restaurant, both intended to increase your business (which they may well do), you will have fundamentally changed the nature of what you own and caused you to travel down a new path.

Your new property with ten guest rooms and/or a small restaurant (or other business requiring a physical change to the property) may no longer be attractive as a home in the residential market where people pay a price based on the supply and demand for housing in an area. Market factors may have caused the value to be much higher as a residence than could be supported by any lodging income after improvements. The residential market is very broad and, in recent years, home values have increased dramatically with no reduction in demand for these homes. However, with your new, “improved” property, you now have to generate enough income to support your investment plus add revenue-based value, as you have now converted your residential real estate to commercial, with the commensurate change in valuation approaches. You may or may not be able to grow the revenues sufficiently – even if it is enough to pay back the loan – to increase the value beyond what it may have been previously. You will have certainly narrowed the pool of potential buyers when the day comes to sell. But if you do your homework and know what your goals are, growing your inn may be the best business decision you’ll ever make.

To help with the “go, no-go” decision when contemplating a major capital improvement, consider hiring an experienced inn consultant to help you assess the potential return on investment, both from a cash flow as well as a marketability standpoint.

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