3 Ways to Calculate Valuation for a Hotel Appraisal

By cayuga

Jan 25, 2022

When buying or selling a hotel, there are many steps to conducting a hotel appraisal.  Previously, we highlighted the needed market research including environment, supply/demand, location and highest and best use in our guide to practical hotel appraisals.

Once this analysis has been completed and projected income and expense calculations have been made, a licensed hotel appraiser can then begin the process of quantifying the value of a given asset.

3 Methods: How to Value a Hotel

There are three typical and most widely recognized approaches to determine the value of real estate.  These are:

  • Cost
  • Income Capitalization
  • Sales Comparison

The Uniform Standards of Professional Appraisal Practices (USPAP) requires that the hotel appraiser address any, and all, of the approaches necessary to produce a credible result.

1: COST – Hotel Valuation Method

This approach analyzes and computes the cost of constructing a new building or replacing an existing asset. The initial step in the analysis involves developing an estimate of the existing or future asset’s land value. This is based on similar types of recent sales or offerings of land that would be reasonably comparable.

For the to-be-built improvements, an estimate of the development cost can be projected utilizing readily available sources such as an index like the nationally recognized Marshall Valuation Services. For existing buildings, the process is very similar but with a calculation replacement Cost-New. From this a depreciation factor is subtracted.

The Cost Approach is considered the most reliable form of hotel valuation when a relatively new or proposed structure is being valued. Due primarily to the numerous depreciation items present, the cost approach is much less reliable for older existing assets.

2: INCOME CAPITALIZATION – Hotel Valuation Method

The income capitalization approach is considered the most important or reliable of the three approaches as it focuses on value derived from an income and return perspective.  It is an integral part of the underwriting of most financing.

In this approach, the potential revenue of the subject for a specific period of time is projected.  The estimated expenses of the subject are then deducted and this calculation results in a projected Net Operating Income (NOI). These expenses usually include taxes, insurance and reserve for replacement but not debt service.

The NOI is then converted to value via the capitalization process. The capitalization process applies market derived information in the form of a Capitalization or Discount rate to come up with a value for the property which can be considered to be reflective of existing market conditions. This information and capitalization/yield rates can be found in sources such as PriceWaterhouseCoopers (historical) and Integra Realty Resources (geographical). They are also usually broken down by hotel service level, ie Full, Select or Limited.

The capitalization process typically employs one of two methods, Direct and Yield capitalization. The Direct method converts a single years NOI potential into value via the application of a Capitalization Rate. Most simply put, the NOI is divided by the capitalization rate. The rate selected generally is deemed to reflect the relationship between the NOI and existing market value derived from the Sales Comparison approach.

The Yield capitalization process is used to convert potential future income over an extended period of time to present value. This is primarily beneficial in circumstances such as new construction or an unstable market. As with the direct method, a market derived Discount Rate is applied to the projected total NOI of the time period to arrive at a value. A Discounted Cash Flow (DCF) analysis is the tool most often used to accomplish this.

3: SALES COMPARISON – Hotel Valuation Method

This approach uses data from the sales of comparable properties within the subject’s market to project a range of value. Similar to residential properties, sale transactional adjustments are made on the basis of features such as location, age and condition.

Additionally, non-real estate characteristics (ie franchise) and the economic issues such as RevPar, Gross Room Revenue Multiplier (GRRM), capitalization rate and NOI per room are considered.  Often these adjustments are made from a qualitative basis vs. quantitative. For instance, is the subject’s location the same, inferior or superior. Due to all of these considerations, the Sales Comparison approach is generally considered to be the least reliable.

Stephen Dietrich is a former member of Cayuga Hospitality Consultants

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