Page 1 of 105 October 24, 2011 FINANCIAL FEASIBILITY STUDY: Boutique Hotel, Address Deleted lf;ljfljflkfljk Address Deleted jfldhfdhf Austin, Texas 78701 This study has been prepared to determine the financial feasibility of building and operating a very high-end independent boutique hotel in downtown Austin, Texas. The property is expected to open as a 25 unit boutique hotel in January of 2013. The site is expected to be completely redeveloped, with the existing multi-story buildings and landscaping completely renovated, with the hotel portion of the project developed alongside a new bar/restaurant which would provide an outdoor seating area beside the hotel pool. The hotel is expected to have approximately 18 mini-suite units of 400 square feet, and 7 unique suites with balconies, of 600 to 1,000 square feet. The hotel will be convenient to downtown Austin, The Capitol, University of Texas, and all area attractions. Project quality must meet the physical and operating standards of other four diamond hotels, as listed in the AAA Texas Tourbook.1 Product specification, revenues, and operating costs are set at the level of similar, high priced independent hotels. KEY FINDING: Developing and opening a four diamond Boutique Hotel at this site should generate an unleveraged, pre-tax return on total invested capital of 20%, with a return on equity of 51%. This return on invested capital also assumes that improvements per unit are completed at the estimated cost of $160,000, plus $2,000,000 for land. This is a good hotel investment. Project details follow: PO Box 120055, San Antonio, TX 78212 ♦210-734-3434♦ Fax 210-735-7970 ♦ www.SourceStrategies.Org 1 Four Diamonds: "Four Diamond lodgings are refined and stylish. Physical attributes are upscale. The fundamental hallmarks at this level include an extensive array of amenities combined with a high degree of hospitality, service, and attention to detail.” AAA Texas Tourbook. Page 2 of 105 Total Investment Est. Land Investment $ 2,000,000 for 2.5 acres Existing Structures $ 1,000,000 Improvements $ 3,000,000 @$120,000 per unit Total Investment $ 6,000,000 Pre-Tax Project Return 19.98%2 Pre-Tax Return on Equity 51.43%3 This study incorporates the current downturn in the Texas hotel market, caused by the broader national recession, which began in late 2008. In our Market section, we highlight the historical hotel performance in Texas, noting the effect of past recessions. While every market has its own unique characteristics, our projections for the local area market consider how the lodging industry reacts in times of economic downturn and in normal times. We anticipate that the current downturn will continue to impact subject markets during 2011, followed by a slow, long-term period of recovery. See the Market section for more details. With a January 2013 opening, cash flow market projections for this Boutique Hotel in Austin, before taxes and after renovation reserves, should be available for debt service, income tax and dividends as follows: Project Summary Occupancy Average $ Total Percent $ Rate REVPAR Revenue CashFlow** Year I 68.6% $270.37* $185.51 $1,777,421 $897,276 Year II 73.7% $273.08 $201.28 $1,928,550 $994,348 Year III 73.8% $275.81 $203.48 $1,949,591 $995,922 Year IV 73.4% $286.83 $210.60 $2,017,827 $1,027,889 Year V 73.4% $296.87 $217.97 $2,088,451 $1,012,561 Year VI 72.5% $305.78 $221.83 $2,125,449 $1,016,163 Year VII 72.5% $311.29 $225.76 $2,163,102 $1,046,053 Year VIII 72.5% $316.90 $229.76 $2,201,423 $1,072,190 Year IX 72.5% $322.56 $233.83 $2,240,422 $1,042,738 Year X 72.2% $394.56 $284.90 $2,729,724 $12,338,368*** *Year I ADR equates to approximately $319 in current market dollars.**Before Income Tax & Financing expense, but reflecting $1,276,433 in reserves for capital expenditures / property renovation ($51,057 per unit). ***assumes valuing property at Year 10 cash flow at an 11% return-to-buyer, less 4% expense of sale, plus year 10 cash flow. 2 After reserve for on-going renovations, and incorporating a management fee. 3 Assuming 30% equity and 70% debt at a 6.5% pre-tax debt cost; calculated weighted average. Page 3 of 105 The above cash flow, assuming a Year 10 sale, has been discounted at the rate of 19.98% to a present value of $5,999,583, approximating the total budgeted investment of $6,000,000. This 19.98% is the project's unleveraged return, provided capital is kept at this level.4 An estimated total capital budget for existing structures, renovation, construction, and FF&E of $160,000 per unit 'turn-key' costs for a hotel of this size and quality is well above average for this level of quality and hotel product, in our experience. If capital outlays vary from budget for this project, returns will vary accordingly. The following table illustrates the linear nature of financial returns as capital requirements escalate or decline and revenue streams remain stable. Effect on Returns if Capital Investment Changes5 Improvements Budget Land Total Discounted Cash Flow Variance Per Unit Total Cost Investment Total Proj On Equity (85%) $136.0 $3,400 $2,000 $5,400 22.16% 58.70% (90%) $144.0 $3,600 $2,000 $5,600 21.39% 56.13% (95%) $152.0 $3,800 $2,000 $5,800 20.67% 53.73% BUDGET $160.0 $4,000 $2,000 $6,000 19.98% 51.43% (105%) $168.0 $4,200 $2,000 $6,200 19.32% 49.23% (110%) $176.0 $4,400 $2,000 $6,400 18.70% 47.17% (115%) $184.0 $4,600 $2,000 $6,600 18.11% 45.20% 4 As an unbranded the hotel, the performance of this investment is greatly dependent on matching the physical and operational characteristics of other existing very high end independent hotels operating in Texas, as well as maintaining a 4 diamond rating in the AAA Tour Book travel guide. 5 Discounted Cash Flow / Internal Rate of Return. Page 4 of 105 A detailed look at Year III shows the following: Year III 2014/2015 Room Revenues $1,856,753 Total Revenues $1,949,591 Income Before Fixed Costs $1,180,323 (60.5%) Net Income Before Tax & Fin. $ 955,745 (49.0%) Cash Flow Before Financing $ 995,922 (73.8%)6 Occupancy % 73.8% Average Daily Rate $275.81 $ REVPAR $203.81 Per Occupied Room Costs $102.35 The critical statistic used in this study is REVPAR. REVPAR means revenue per available room per day, and reflects the average daily room revenue yield of every room in a property or market (not just occupied rooms). REVPAR is generated by multiplying occupancy times rate (i.e. REVPAR = % occupancy times average daily rate), and is the most effective and important tool in the evaluation of the success of any lodging concern. SUMMARY OF CRITICAL ASSUMPTIONS: Critical assumptions are summarized as follows, with the Market History and Projection study (page 11) following the Methodology section (page 7). 1. The local Downtown Austin Area Market reflects a mixture of mainly old properties and some newer competitive hotels. The average hotel room in the local market is 23 years old, more than two-thirds of the way through the life cycle of the typical hotel building, and well past its peak performing years. The typical hotel building becomes stylistically and structurally obsolete after 30 years, though this figure is significantly higher for larger for high-rise/concrete and for historic structures. The local market has 4,622 hotel rooms built before 1990, and 1,044 rooms built since 2005. There is typically a wide and dramatic gap between the performance of new and older properties, with the typical hotel in the area either being relatively new and competitive or older and on its way to closure. We are comfortable with market projections. After weathering the 2009/10 recession better than most of the state of Texas, market occupancy is expected to continue to rise to 6 Before deductions of loan principal and interest, before income tax deductions, and before any equity payout. Page 5 of 105 before falling to an equilibrium level of 63% from the current 72%. The addition of two 1,000+ room hotels downtown will encourage this slide to more typical market occupancy levels. Further, REVPAR in this market is projected to grow by 2.5% annually over the next nine years, compared to the 6.2% rate of the past nine years. Detailed local market history and projections commence on page 17. AUSTIN AREA MARKET7 Year Occupancy % $ REVPAR 2002 57.2% $ 65.10 2004 61.3% $ 67.76 2006 70.4% $ 93.86 2008 70.2% $106.93 2011 72.0% $109.788 Projected 2012 75.4% $126.07 2019 63.1% $129.78 Historical Annual Compound Growth Rates Past 9 Year Average 2.7% 6.2% Past 4 Year Average 0.1% 2.4% Past Year Average 5.8% 14.4% Future Annual Compound Growth Rates Next 9 Years -1.4% 2.5% Next 5 Years -2.6% 1.7% 2. Versus the local market's REVPAR dollar projections, the REVPAR index of the proposed Austin Boutique starts at 143% of the market average REVPAR in Year I, peaking at 174% of the market in Years III-V. Thereafter, the REVPAR Index declines due to the normal aging cycle. Detailed REVPAR derivation and subsequent projections commence on page 33.