The market value of a hotel is not a straightforward nor easy-to-assess process. While the same argument can be made for any piece of real estate, a hotel is a unique asset class due to its fluctuation in potential income generation as well as the volatility of the hospitality market. But it is important to have some periodic knowledge about your asset’s value in order to make the best decisions about its future.
Why Assess Market Value
While there is no set schedule as to when you should assess your hotel’s worth, a formal appraisal would typically be required when you are buying, selling, or financing the property. You may also want to figure out market value to negotiate a more favorable property tax assessment level.
“Almost all hotels are bought with a loan, so lenders are going to want to know how much the hotel is worth as collateral for the loan on the hotel,” said Mike Cahill, CEO of HREC Investment Advisors. “Most hotels also have equity investors, and the investors are going to want to know the value at periodic points in time to figure out if they are getting a return on investment.”
Mark Van Stekelenburg, executive vice president at CHMWarnick, agreed that financing is a driver of getting your market value established. “From an ownership perspective, the savvier owners focus on that on a regular basis. Knowing what the value of your property is allows you to establish your equity value, and if it improves from a financing standpoint, you may have a more attractive debt coverage ratio that could lead to more favorable financing terms if you’re doing a refinance or extension. A lot of hotels have more complex ownership structures, and different stakeholders want to know the value of their ownership interest.”
Depending on the ownership structure of the hotel, it may make sense to periodically get your hotel appraised. Cahill said that an owner should reach out to their appraiser or hotel broker every six months or so to assess how the hotel is fluctuating in value.
Who Should Appraise Your Hotel
Appraisals are very intricate, thorough, and are completed by unbiased, third-party, licensed professionals.
Another way to value a hotel is by obtaining a broker’s opinion of value. “Given the rules and requirements surrounding appraisals, lenders require appraisals; however, owners often lean on brokers to generally understand values,” said Katy Black, MAI, managing director at HVS, a global consulting firm focused exclusively on the hospitality industry.
The vast majority of appraisals are requested and ordered by lenders, but if you’re thinking of selling, and an appraisal isn’t required, a broker’s opinion of value may be the way to go. An owner looking to generally understand value usually does not need the full-blown appraisal report.
Factors Affecting Market Value of Hotel
The market value of a hotel is a dynamic number and can fluctuate based on a number of factors, from market trends to a hotel’s reputation and performance.
Broad categories that affect valuation include the hotel’s physical condition, the cash flow it is expected to generate, and the hotel’s brand or quality level.
The primary factor impacting value is the future income potential of the property, which is ultimately capitalized or discounted to determine value in an appraisal report. In fact, said Black, “The number one most important thing in assessing an existing hotel is income generation: how much is this hotel generating in income and how much does it expect to generate in income going forward?” A property that has income from other sources, like a restaurant, an event space, or if resort fees are charged, will have an increased income potential versus one that is a limited-service hotel.
There are also some intangible factors that affect value, such as reputation. If your social media has taken a hit, or your asset has been the subject of a spate of poor reviews, that can negatively affect the value at the time of the appraisal.
Another big factor, and one that provides a challenge in assessing value, is the cost of property improvement plans, a scenario that is applicable when a hotel is up for sale or coming up on a renovation cycle. “Brand-mandated property improvement plans can highly influence value. If an owner or buyer wants to maintain an affiliation, significant funds may be required to be invested in order to do so. New owners of branded hotels often have to obtain a new agreement and would be subject to a change-of-ownership property improvement plan, a PIP. The cost of that can be expensive, and that can absolutely influence value,” said Black.
Other key elements that tie back to income potential include the hotel’s age, location, condition, including any recent renovations, food and beverage outlets. “Is the hotel well built? How old is it? What is its physical condition?” said Cahill. Other ‘macro’ elements that are assessed that affect cash flow, such as the economy of the city around where the hotel is located and whether people are booking rooms at the hotel and in the city in general.
Cahill added that the brand is another element that is important in assessing value. “There are certain buyers that like certain brands. It really affects, from a broker’s perspective, how big your pool of buyers is."
“There is significant strength now behind brands,” agreed Van Stekelenburg. “Where you’re entering into their franchise network, they are managing the hotel for you. It comes with operating procedures, protocols, guidelines, that help you avoid those potential exposures and so sponsorship can really have a lot of impact on cap rates: the risk rating someone would put on an asset.”
Approaches
While there are several approaches to appraising hotels, one of the primary methods is the income capitalization approach. “The primary way we tackle hotel appraisal at HVS is to complete a 10-year forecast of income and expense. We look at what market-typical income or earnings before interest, taxes, depreciation and amortization would be for the hotel over the next 10 years. After consideration of a reversion, or sale at the end of an assumed 10-year holding period, those cash flows are then discounted to present value to determine value.” said Black.
In a stabilized hotel, a direct capitalization approach or rooms revenue multiplier may be most applicable to determining value. In these approaches, only one year of cash flow is considered, which may have some limitations or require subjective adjustments for cap rates or multipliers in order to determine the most appropriate value.
The second most widely used approach is the sales comparison approach. “This is a very important approach because it is reflecting actual, real-time actions of buyers and sellers. Because hotels are incredibly unique, subjective adjustments are often necessary to be applied in this approach, but when comparable sales are available, especially in the same market, the sales comparison approach is heavily weighted in our analyses. These sales are also ultimately supporting the discount rate and capitalization rates that are applied in the income capitalization approach,” she added.
Black said she almost always applies both the income and sales comparison approaches in her appraisal reports, as a hotel is a unique income-producing asset, and relying on only one approach may not be giving you the most accurate answer.
Challenges
The volatility of the hospitality market at any given time makes assessing market value a challenge, even for the most experienced of appraisers.
“One of the biggest challenges is the interest rates, as they cannot be controlled: they are what they are, and changes of interest rates have an impact on its value,” said Cahill.
An appraisal is a snapshot in time, as the hospitality industry is a fickle business. “When times are good, hotel values go up rapidly. When times are bad, the value falls quickly,” he added, noting that three months into the pandemic, the average hotel in America lost 60 percent of its value.