While IRR projections are standard, they often ignore:
• Timing-based liquidity drag
• Sponsor execution bandwidth
• Macro volatility in emerging markets
At Bay Street Hospitality, we’ve replaced static underwriting models with a dynamic, risk-adjusted return engine—one that integrates real-time inputs across capital markets, brand operating risk, and public/private benchmarks.
This whitepaper outlines our framework for calculating realistic, defendable return projections using synthetic volatility, scenario-adjusted AHA (Adjusted Hospitality Alpha), and dispersion-informed Bay Score metrics.
Framework Overview: Dynamic Return Modeling Components
Our risk-adjusted return engine incorporates 6 core modules:
• AHA (Adjusted Hospitality Alpha): Measures IRR net of benchmark and illiquidity premium
• BAS (Bay Adjusted Sharpe): Return per unit of volatility + exit dispersion
• BMRI (Bay Macro Risk Index): Downward IRR adjustment in fragile markets
• LSD (Liquidity Stress Delta): Exit risk penalty (modeled as % IRR drag)
• DISP Score: Market dispersion multiplier on volatility
• Synthetic Volatility Engine: Volatility estimate based on public REIT proxies
Together, these metrics refine how Bay Street prices risk, structures deals, and allocates capital.
Return Recalibration in Action
Let’s assume the following underwriting baseline:
• Projected IRR: 18%
• Target geography: Mexico
• Deal type: Brand conversion
• Sponsor: Mid-cap, low co-investment
Using our engine:
• BMRI (Macro Risk Score): 67 → −1.5% IRR
• LSD (Exit Delay Stress): 3.2% → −1.2% IRR
• Sponsor Discount (Low Coinvest): N/A → −0.8% IRR
• Volatility Estimate (Dispersion-adjusted): 22% → Used for BAS calculation
Final Adjusted IRR = 14.5%
AHA = 6.2% (vs BSHI of 8.3%)
BAS = 0.66 (acceptable threshold >0.55)
Bay Score = 83 (Q2, Institutional Grade)
Scenario Modeling: How Volatility and BMRI Impact Decisions
Sample scenarios comparing investment decisions:
• Portugal brand-led JV | IRR: 16% | BMRI: 41 | LSD: 2.5 | BAS: 0.78 | Bay Score: 92 → Prioritize
• India operator equity stake | IRR: 18% | BMRI: 58 | LSD: 3.6 | BAS: 0.62 | Bay Score: 76 → Accept with pref equity
• Philippines leasehold | IRR: 14% | BMRI: 73 | LSD: 5.1 | BAS: 0.47 | Bay Score: 61 → Restructure or pass
The engine flags low BAS and IRR drag when dispersion, volatility, or macro instability compounds.
Technical Design: How the Engine Works
AHA Formula:
AHA = IRR_deal − Benchmark_BSHI − Illiquidity Premium
Where the illiquidity premium is modeled as a function of LSD, FX risk, and capital lockup duration.
BAS Formula:
BAS = AHA / σ_synthetic
Where σ = Synthetic volatility estimate based on public REIT comps, adjusted by regional dispersion and leverage.
BMRI reduces IRR based on macro fragility using a four-factor weighted model:
• Sovereign spread vs U.S. Treasuries
• FX volatility (90-day trailing)
• Tourism deviation vs 5-year average
• Government risk (OECD/WEF composite)
Applications to Portfolio Design
• High BMRI + low BAS → Position as opportunistic; increase pref equity, reduce weight
• Low BMRI + high AHA → Prioritize for growth sleeve or early liquidity harvesting
• Low Sponsor Co-invest + high LSD → Reduce expected IRR via conservative exit assumptions
By simulating thousands of combinations, Bay Street optimizes both expected return and downside resilience.
LP Implications: Why It Matters
Institutional allocators benefit directly:
• Transparent return expectation: No more inflated IRRs untied to market reality
• Defensible downside: Understand how exit drag and market stress impact outcomes
• Scenario-based structuring: Negotiate waterfall terms tied to score outputs
Whether allocating $10M to India or $100M across 5 markets, LPs can trust Bay Street’s numbers reflect probabilistic outcomes, not static base cases.
Conclusion: Risk Isn’t a Black Box
Hospitality investing carries nuanced risks—brand cyclicality, policy shocks, operating leverage.
Rather than oversimplify, Bay Street models these risks directly into return expectations. With a dynamic engine grounded in volatility, dispersion, sponsor quality, and macro risk, we offer investors not just a projection—but a precision-calibrated return expectation.
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