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Leveraged Breakdowns

REPE Interview Prep: Hotel Pro Formas and Retail Leases


This series on interview prep exists to help you excel during interviews and crush any real estate investment case study. To make this the best real estate private equity course possible, respond to these questions as if you’re actually being interviewed. That means look away from your computer, don’t read or memorize the answer, and try to respond from a perspective of true understanding. This will require practice, but best to always prepare deliberately rather than passively.

In which major real estate sectors would you expect to receive food and beverage income?

First and foremost, hotels receive a meaningful portion of revenue from food and beverage (F&B) income. Using hotel landlord Host’s (NYSE: HST) 2019 10K as a proxy, F&B accounted for 30% of total revenue in 2019 (see page 44). This dependence on F&B income sets hotels apart as an operations-heavy business model, much more so than self storage facilities which are on the other side of the extreme as operations-light.

Seniors housing is the other industry where F&B could be a massive component of income because of on-site cafeterias and similar outlets for dining. You might see a bit of F&B income at high-end office buildings with catering operations and malls if the food courts are operated in-house, but these income streams are far more ancillary and less critical to the core business. Apartment buildings, self storage facilities, manufactured housing, industrial warehouses, and most other sectors do not incur any F&B income.

What are the key differences between select-service and full-service hotels?

To understand the difference between select-service and full-service hotels, we can play to extremes. On the extreme end of full-service, you could refer to The Plaza Hotel in NYC, the Leela Palaces in India, or the Temple Hotel in Chengdu. These hotels are extremely amenitized with lush restaurants, bars, and desirable conference spaces. Flipping to self-service, think of any old Ramada Inn or Courtyard by Marriott with rudimentary or perhaps zero amenities. They may not have F&B or any conference rooms, really the focus is on providing a bedroom for guests that are more cost-conscious such as business travelers or frugal patrons. Put shortly, the difference between full-service and select-service hotels is their degree of amenitization.

What types of rent might you expect to see in a retail lease?

The first type of rent you would expect on a retail lease is base rent. This type of rent is akin to your basic apartment rent that is due each month. Using a five-year lease as an example (retail leases are predominantly multi-year), you might agree to 3.0% fixed contractual step-ups so that you’d pay $100 per month in the first year, then $103, $106, $109, and finally $112. After base rent, retail landlords often charge overage rent. The concept of overage rent is simple: if a store absolutely crushes it, the landlord doesn’t want to miss out on that action. This second type of rent is called percentage rent or overage rent. Thus, a landlord will often negotiate the right to receive a percentage of total sales revenue or perhaps a percentage only after a fixed dollar hurdle.

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