Real Estate, Commercial

How to Underwrite a Hotel

Underwrite a hotel as an operating business: analyze RevPAR, ADR and occupancy against a competitive set, then build departmental profit down to NOI after management fees and an FF&E reserve. The key metrics are RevPAR index, GOP margin, DSCR and debt yield, plus any franchise property improvement plan (PIP) cost.

What makes hotel underwriting different

Hotels re-lease every room every night, so income behaves more like an operating business than real estate. Revenue depends on occupancy and average daily rate, driven by demand generators, seasonality, brand affiliation and the competitive set. Expenses include labor, franchise fees, management fees, distribution costs and utilities, which makes margins sensitive to both revenue swings and wage inflation. Hotels also require constant capital: FF&E replacement, brand-mandated property improvement plans and periodic renovation. Motels, resorts and short-term rental portfolios share these dynamics with different cost structures, guest mix and regulatory exposure.

Lenders treat hotels as higher risk than leased real estate and typically underwrite to trailing cash flow, often looking at both the most recent year and a normalized average, with lower leverage and higher debt yield requirements. They care about brand, flag term, manager quality and PIP funding. Equity investors focus on repositioning, rebranding, revenue management improvements and operating margin expansion, and they underwrite RevPAR growth versus the comp set. The gap between lender and equity views is often widest here, because equity is buying an operating turnaround that lenders will not size until it shows up in trailing results.

Key metrics

RevPAR

Revenue per available room combines occupancy and rate, the main top-line driver.

RevPAR Index

Compares the hotel's RevPAR to its competitive set, showing whether it is gaining or losing share.

An index above 100 indicates the hotel is outperforming its comp set.

GOP Margin

Gross operating profit margin shows operating efficiency before fixed charges and management fees.

Debt Yield

Hotel NOI is volatile, so lenders lean heavily on debt yield for sizing.

Lenders commonly require higher debt yields for hotels than for apartments or industrial, often in the low to mid teens.

DSCR

Tests coverage after management fees and FF&E reserve.

Lenders often look for 1.40x or higher on hotels.

FF&E Reserve

Hotels must continually replace furniture, fixtures and equipment. Underfunding hides real costs.

A reserve of about 4% of total revenue is a common underwriting assumption.

How to underwrite it, step by step

Collect monthly P&Ls and STR or comparable competitive set reports for at least three years.
Analyze occupancy, ADR and RevPAR trends, seasonality and segmentation (transient, group, contract).
Rebuild departmental revenue and expenses and normalize labor, utilities and insurance.
Deduct base and incentive management fees and an FF&E reserve to reach underwritten NOI.
Review the franchise agreement, remaining term and any required PIP and its cost.
Assess demand generators, new supply and the competitive set.
Size the loan on trailing NOI using debt yield and DSCR, and stress RevPAR declines.
Structure PIP reserves, seasonality reserves and cash management.

Due diligence checklist

Monthly P&Ls for three years plus year to date
STR or competitive set reports
Franchise agreement and PIP
Management agreement
Budget and forecast
Capital expenditure history
Property condition report
Occupancy tax filings
Group booking pace report
Insurance and loss runs
Liquor license and permits
Phase I environmental site assessment

Key risks and mitigants

RevPAR declines in a downturn or due to new supply.

Underwrite to trailing results, stress RevPAR, and size to a higher debt yield.

Brand requires a costly PIP at sale or renewal.

Obtain the PIP before closing and fund it through an upfront reserve or in the capital budget.

Labor cost inflation compresses margins.

Benchmark staffing and wages and stress labor costs.

Management or franchise agreement is not terminable on sale or foreclosure.

Review termination provisions and obtain a comfort letter from the franchisor.

Short-term rental regulation restricts operations.

Review local ordinances and permits and underwrite a long-term rental fallback.

Typical financing and deal structure

Hotels are financed with bank loans, CMBS, debt funds and, for owner-operators of smaller properties, SBA 7(a) and 504 loans, since hotels qualify as operating businesses. Leverage is usually lower than for leased real estate, and lenders often require a franchisor comfort letter, PIP reserve, FF&E reserve and seasonality reserve. CMBS hotel loans commonly include cash management triggers tied to debt yield. Bridge loans fund renovations or rebranding with future funding. Equity structures often include a sponsor with hotel operating expertise or a third-party manager, and preferred equity or mezzanine debt is common in larger transactions. Seller financing occurs in smaller deals.

Red flags

RevPAR index declining against the competitive set for several quarters.
Unfunded PIP or franchise agreement expiring near term.
Management agreement that cannot be terminated by a lender or buyer.
Reported income relies heavily on a single contract or group customer.
Deferred capital spending evident in guest reviews and physical condition.

Frequently asked questions

What DSCR do lenders require for hotel loans?

Hotel lenders typically require higher coverage than for other property types because hotel income is volatile. Minimums around 1.40x or higher are common, with sizing also constrained by debt yield. Lenders usually calculate NOI after management fees and an FF&E reserve, and they may average several years of results to smooth volatility.

What is a PIP in hotel underwriting?

A property improvement plan is a list of renovations a brand requires, usually at a change of ownership or franchise renewal. PIPs can be expensive, covering guest rooms, lobbies and systems. Underwriters obtain the PIP before closing, include its cost in the budget, and lenders typically require it to be funded through an upfront reserve.

How do you underwrite a short-term rental?

Underwrite a short-term rental using actual booking history and market comparables for occupancy and nightly rates, then deduct cleaning, platform fees, management, utilities, supplies and an FF&E reserve. Review local regulations closely, since permits and caps can change. Many lenders also underwrite a long-term rental fallback scenario to test downside coverage.

Can you use an SBA loan to buy a hotel?

Yes. Hotels qualify as operating businesses, so owner-operators often use SBA 7(a) or 504 loans. Underwriting then focuses on the operating cash flow, borrower experience and franchise relationship. SBA loans can offer higher leverage and longer amortization than conventional hotel loans, but require personal guarantees and active owner involvement.

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Educational content, not investment, credit, legal or tax advice. Benchmarks are common practitioner rules of thumb and vary by lender, market and cycle.