Hotel Valuation, A Quick and Dirty Guide

We are in the midst of the 30 days of content from TRET and on the heels of our post about the W Hotel, here is a quick guide on how to price hotels. The Arrowfish Consulting blog has a great article on hotel valuation. This article is a great reference for anyone looking to get a basic understanding of how to value hotel properties. This article highlights the following methods:

1. Income Capitalization Method
2. Cost Approach
3. Sales Comparison Approach
4. Room-Rate Multiplier Method
5. Bottle/Can Soda Multiplier Method

Each of these methods is used for different purposes. Let’s take a brief look at each one.

Income Capitalization

The Income Capitalization Method is the method most frequently used for all income-producing commercial real estate. It requires one to determine the Net Operating Income (NOI) of a property, by deriving the property's gross income and subtracting all operating expenses, excluding any costs arising from the financing of the property. The NOI is essentially the income that the property would generate, if it were purchased all-cash. Once the NOI is obtained, it must be divided by a capitalization rate to determine the value of the property. The chosen capitalization rate, or cap rate, can be the area cap rate for hotels, the cap rate of comparable hotels on the market, or the desired return that the purchaser wishes to make on the property. Using the formula below, one can obtain a rough estimate of value for a hotel property.

Hotel Value = NOI/Capitalization Rate

Although the Income Capitalization Method is frequently used, it does not consider financing costs and thus is not a fool-proof method of valuation. Additionally, published cap rates tend to change much more quickly than actual sales prices, therefore, income capitalization can lead to a valuation that is not exactly in line with what the market will bear.

The Cost Approach

The Cost Approach is another way to value hotels. This approach employs the calculations used to obtain an accounting valuation for the hotel. It considers land value, the replacement cost of the real estate, known as the “improvements on the land” and the property’s depreciation. Using the Cost Approach yields the approximate tax value of the property, which is not necessarily the same as its market value. It is for this reason that this method is less relied upon as a market valuation tool. The tax value of the property, however, is important to know when determining the tax effects of a potential purchase. It can also be used to determine if there is price deflation or inflation in the local market.

The Comps

The Sales Comparison Approach is one of the most often used methods in all of real estate. This approach derives the value of a property from the list and sold prices of similar properties in the target hotel’s local market. This tried and true approach is used to value every type of real estate from single family houses to Class A office buildings and should be used to inform the value calculations of any potential hotel purchaser. Given the possible idiosyncratic nature of each hotel business and the different ways that hotels can earn income, this sales comparison approach should not be the only method used to value a hotel, but it can certainly shed some light on valuation calculations.

The More Informal Methods

The Room-Rate Multiplier Method or the ADR Method is more informal method of calculating hotel value that has a few steps to it. The first is to calculate the Average Daily Rate of the hotel, also known as its ADR. This can be done by dividing the total revenue generated by its rooms by the number of rooms sold, or as Siteminder.com generous illustrates it for us:

Once the ADR is obtained, it is multiplied the standard multiplier of 1000 and then multiplied by the total number of rooms in the hotel. As Hotel Nuggets illustrates for us:

Value = ADR x 1,000 x Number of Rooms

Although this method is a great way to informally get an idea of a hotel’s value, it does not consider the income generated from any hotel business beyond the sale of rooms. Hotels, however, produce income from restaurants, concierge services, spas, advertising space and licensing agreements, all of which are excluded from this formula. This method seems to best serve the valuation of motels and smaller hotels, but can also be used to get a ballpark estimate of larger hotels as well.

One of the most informal ways to calculate the value of a hotel is through the Bottle/Can of Soda Multiplier Method. This method takes the cost of a can of soda in the hotel lobby or restaurant and multiplies it by 100,000 and then by the number of rooms in hotel.

Value = Bottle/Can Price x 100,000 x Number of Rooms

The most informal of all the previously discussed methods, the Bottle/Can of Soda Multiplier can be yet another way to obtain a very rough estimate of value of the hotel. The method obviously omits some of the more nuanced considerations of valuing a hotel, like business expenses, tax implications and financing costs, but can serve to determine if a hotel’s asking price is reasonable.

Hotels are Real Estate and a Business

Although all of the aforementioned valuation methods can be helpful, there is no denying the fact that purchasing a hotel is a hybrid transaction that is part real estate purchase and part business purchase. It is therefore prudent that not only the real estate be valued, but also hotel business or businesses, as the case may be, are also valued as a business. That is why an informed real estate valuation, using replacement costs, income capitalization and comparables should be employed, along with an evaluation of the hotel’s accounting statements, its assets and liabilities and a determination of its earnings before interest, taxes, depreciation, and amortization or EBITDA. Evaluating a hotel’s EBITDA multipliers will allow it to be compared to other hotels and other business on the market.

Purchasing a hotel is far from a simple matter and valuing a hotel can sometimes be a complex process, but properly purchasing a hospitality property can yield lucrative returns.