Hubbart Formula

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  • Topic: Square foot, Area, Hotel
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The Hubbart Formula

Where would a hotel manager start in determining the fair price for a guest

room? What is a fair value? This question has daunted innkeepers from the

beginning. Charge rates too high, and no one will stay with you. Setting rates

too low, and the owner makes less money. For many years in the beginning

of the modern hotel era, hotel managers simply guessed. As unscientific as this

approach sounds, it did work to an extent. After a hotel has been in business

for a while, managers would know by instinct and past experiences what rates

to set. In some ways, this instinctual approach had merit. It allowed for flexibility

and swift market response.

That approach stopped being effective when new lodging management

associations emerged. As owner-operated and owner-managed hotels looked

to expand and evolve into chains and franchise operations, they needed to

borrow capital. It is the banking industry that forced a change in the way

hotels set their rates. The guessing approach didn’t translate well into the language

of income statements. In order for financing to become available, a

standardized rate formula was developed.

In the 1940s the American Hotel Association (the precursor to today’s

American Hotel and Lodging Association) asked a gentleman by the name of

Roy Hubbart to develop a way to compute room rates.1 Mr. Hubbart came up

with a method to calculate a hotel room rate based on the costs incurred in

operating the hotel and a reasonable return on investment for the investors.

Going beyond simple room cost, the Hubbart formula allowed the hotel to scientifically

illustrate to a banker what the return on investment would be.

This quantifiable approach was well received. Financing for any business

enterprise has always been contingent on return on investment and forecasts.

Though this rate formula has its detractors today, it was a valuable milestone

in the evolution of the industry. Here is how the Hubbart formula works.

The Hubbart formula incorporates three different sections, or schedules,

into its calculations: Schedule I looks at specific financial calculations; Schedule

II looks at the rates per occupied room; Schedule III incorporates square

footage into the analysis.

Schedule I attempts to determine the costs incurred with the hotel operation

and incorporate a reasonable return on investment (or ROI). Operating

expenses, taxes/insurance, and depreciation are understood to include all the

same criteria used to determine room cost (Figure 7-1). What the Hubbart formula

does differently from strict room cost analysis is to incorporate a fair

market ROI for the investor. This ROI level can vary widely, but it is understood

to be a fair market value based on equity and interest expense on debt.

The numbers used in the Hubbart formula examples presented here (Figure

7-1, Figure 7-2, and Figure 7-3) are for illustrative purposes only.

Schedule II of the Hubbart formula (Figure 7-2) uses the figure reached

at the end of Schedule I to determine the average daily rate the hotel would

need to charge to meet its obligations—those obligations being operating costs

and owner ROI. Schedule II is similar to the opportunity cost calculation in

that it considers the total number of room nights available for sale in a year

(365 days times the number of rooms available per night). It goes further in

that it takes into consideration an estimated occupancy percentage. Determining

this occupancy percentage is where the Hubbart formula gains detractors.

What would be a fair occupancy percentage? Some hotel markets consistently

run very high occupancy levels. Other areas are susceptible to market fluctuations.

Hotel room supply in an area can vary, as does the demand. Occupancy

expectations must be based on detailed analysis of competition, market supply,

local...
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