Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Chapter 11 Introduction This chapter will describe the process of hotel valuation. Furthermore, this chapter will discuss:  Users and preparers of market studies and appraisals  Agency relationships  Cost approach to value  Sales approach to value  Income capitalization approach

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ What is an Appraisal and Why are They Done? An appraisal is an opinion of value at a certain point in time. Reasons for an appraisal to be completed  Interest in potential selling price by the owners  For the lender—purchase or refinancing  Tax assessment purposes  Liquidation value

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Parties Involved in the Appraisal Process Lenders  Banks, insurance companies, pension funds Buyer or developer  Usually pays for the appraisal Seller

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Agency Problems in the Appraisal Process 1980’s – appraisals commissioned by buyer/developer  Many appraisals were biased.  Barbers were state licensed; appraisers were not.  Significant savings and loans problems attributed to faulty appraisals. This led to FIRREA in  Changed how appraisals were commissioned and completed; led to state regulation of appraisers

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Appraiser Education Although not the only designation, most commercial real estate appraisers are “MAI”  Member, Appraisal Institute Required coursework, hours of practical experience, a full commercial appraisal and a comprehensive examination More info available at:

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Hotel Appraisal Process Purpose of the appraisal  Why is this appraisal being completed?  Who is it for?  What is the appraisal problem? Value being appraised  Most appraisals are completed using market value, but not all.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Real Estate and Real Estate Interests Real estate is the land, building, and everything permanently attached to it.  Equipment is personal property and valued separately. Real property includes real estate plus ownership benefits. Fee simple interest—ownership interest with the most rights  Most hotel appraisals involve a fee simple interest Other interests  Landlord—leased fee  Tenant—leasehold

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Data Collection Extremely important part of the process The quality of the appraisal is directly related to the quality of data obtained.  Most of it is secondary data  Easier to obtain now  Be careful with sources of data—you are ultimately responsible! What data are relevant? Anything that impacts size, timing or risk of cash flows.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Market Area Information In general, start wide and narrow the focus.  Regional  Metro area or city Look for information directly related to hotel room demand.  Employment  Office space/industrial space  Convention activity  Universities/College  Tourism stats

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Submarket Analysis One of the most important features of a good hotel appraisal  Hotels are more competitive than other types of real estate  Must hunt for demand every night A proper assessment of the competition is absolutely essential  Establishes market demand  Establishes market “price” or ADR $

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Submarket Analysis What makes a hotel competitive to your property?  Location  Demand base accommodated  Rate  Amenities Competitive hotels must be interviewed  Occupancy and rate information is sensitive but is the most important information to obtain

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Market Demand It is important to know which demand segments are in the market  Example: corporate individual  Different demand segments pay different rates and stay at different times of the week and year Most common segments are corporate individual, corporate/association group, tourist, and government/military Ideally, appraiser presents a historical analysis of changes in demand by segment (along with changes in historical hotel room supply as well)

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Historical Market Analysis Five years is preferred; three years is acceptable Which segments increased or decreased? Has there been historical growth in total demand, occupancy and Revpar? The appraiser should not only know if demand has changed, but why it changed

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Market Penetration and the “Fair Share” Concept If a hotel represents 10% of the hotel supply in the market, then all else being equal, it should get 10% of the demand; this is its “fair share.”  If it is accommodating more than this amount, it is “outpenetrating the market” and is at a competitive advantage. The historical analysis should include a market penetration analysis to show the hotels that are doing the best.  The property interviews will help the appraiser understand why certain hotels are doing better than others.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Neighborhood Analysis A neighborhood can be defined as an area with complementary land uses that influence the hotel. Neighborhoods have a life cycle.  Growth  Stability  Decline  Revitalization

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Neighborhood Analysis, cont’d Is there development activity around the subject hotel? What type of amenities are available for hotel guests? Have there been any hotel sales in the subject neighborhood?  This gives the appraiser an idea about trends in hotel values.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Site Analysis Site analysis is critical for hotels because much of the demand is “drive-by.” Legal address/description is not a mailing address. What is the zoning of the subject? Tax assessment Flood plain/flood zone

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Site Analysis Is the site desirable from a guest standpoint?  Visibility  Accessibility  Parking  Close to major roads  Close to demand generators These factors affect desirability of hotel to investors as well.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Description of the Improvements Description comes from a variety of sources such as a physical inspection, the property engineer, and building plans Description of the major systems  Electrical  Heating  Air conditioning  Plumbing  Fire safety Description of room interior and public space Note any deferred maintenance.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Highest and Best Use What type of development makes the most sense?  Physically possible  Legally permissible  Economically feasible  Maximally productive This is done as if the land were vacant and as improved.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Approaches to Value Cost approach Sales comparison approach Income capitalization approach Which one is best for an income-producing property? The appraiser must value the property in a manner similar to market investors.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Cost Approach We must first calculate value of land. Cost of improvements new  Replacement cost vs. reproduction cost Value of furniture, fixtures, and equipment Subtract three types of depreciation.  Physical, functional, and economic Better used with new properties and non- income producing properties

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Sales Comparison Approach The underlying idea with this approach is that properties providing the same utility should sell for the same price. Find similar hotels that have sold and make adjustments. Superior properties are adjusted downward; inferior properties are adjusted upward. Difficult to make accurate adjustments

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Income Capitalization Approach The market value of an income-producing property is the present value of its benefits. We utilize the historical market analysis to make market projections for supply and demand.  Forecast demand by segment  Forecast future competitive room supply A critical point is the future occupancy for the entire competitive market.  This will lead to projecting the occupancy for the subject.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Market Penetration Analysis We examine each segment of demand for the subject hotel and try to estimate penetration rates by segment.  A rate of 100 percent is the standard; more than this and the hotel has an advantage.  It is not uncommon for convention hotels to have a penetration rate of well above 100 percent in the group demand segment. The captured demand from each segment is added together to find total accommodated demand for the hotel.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Average Daily Rate (ADR) The ADR should be market-based (in other words, the existing ADR may not be the ADR the hotel should be achieving). Historical growth should be examined. Rack rates/discounting at competitive hotels to see the achieved average rate. Projections of future growth in terms of discounting/premiums and inflation

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Preparation of Financial Estimates Analysis of historical operating statements  % of revenues  Amount per occupied room  Amount per available room Use of financial statements from comparable hotels Revenues and expenses are to be market- oriented; assume the hotel is managed efficiently (not necessarily with current management).

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Other Financial Considerations Need to include reserve for replacement  Historical ranges (3 to 5 percent of revenue) have been too low. Expenses need to be adjusted properly.  Inflation/increase considerations  Fixed portion vs. variable portion Bottom number is referred to as “NOI” — net operating income.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Direct Capitalization Need to use stabilized NOI in current value currency. Stabilized NOI is divided by a capitalization rate. Two main sources for these rates  Extract from comparable sales  Band of investment  A weighted average of return on debt and return on equity

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Direct Capitalization Many investors do not buy hotels based upon one year of income.  Appraisers must use the method used by investors. Be careful when extracting rates from sales.  Did the comparable sale extract a reserve for replacement? Band of investment requires knowledge of current mortgage terms and expected equity returns.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Yield Capitalization Projected NOI for hotels is discounted at the equity yield rate.  5 to 10 years is common for NOI projection.  Equity yield rate is holding period return for the equity investor.  Usually obtained from investor surveys Final year NOI should include proceeds from a sale.  Sales price is next year’s NOI divided by a terminal capitalization rate.  A broker’s fee must also be deducted.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Other Approaches ADR rule of thumb  Take ADR, multiply by $1,000 to obtain value per room. Rooms revenue multipliers  Find comparable sales and divide sales price by rooms revenue.  Combines income capitalization approach and sales comparison approach

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Final Reconciliation Appraiser will examine the values from the approaches completed. Appraiser must make a judgment about which approach is best.  A major consideration is the quality of data obtained. Appraiser can give most consideration to one approach or another.  Final value is not an average of the approaches used.