Value Drivers and Considerations for Hotel Valuation
Much has changed in the appraisal industry in the past 30 years, and hotels are no longer considered just pieces of real estate. While hotels are a business and as such may be appraised as any other business would be, there are some distinguishing factors that valuation experts need to seriously consider.
In a chapter from BVR’s Special Report: "What It's Worth: Hotel Business Value", which we’ve excerpted here, Mark Dayman, founder and vice president of FranIntel Inc., a franchise consulting company, outlines value drivers and considerations of hotel businesses that involve both tangible assets such as land and the building and intangible assets such as workforce, technology, and customer lists.
Common Tangibles Associated with a Hotel’s Value
⎆ Current assets, current liabilities
⎆ Tangible noncurrent assets and liabilities
⎆ Land, buildings, and FF&E
Common Intangibles Associated with a Hotel’s Value:
A hotel’s intangible assets can be substantial and contribute significantly to the overall value of the business. The following lists the most significant common intangibles associated with a hotel’s value.
⎆ Flag (franchise, but also possibly for independents)
⎆ Reservation System
⎆ Non-compete agreements
⎆ Customer lists
Flag Value: Many hotel properties have a “flag”, meaning they are franchised under a brand name hotel. The flag is intellectual property, and it has value, which could be viewed as the present value of all the royalty payments that will be paid. Some independent hotels and resorts may have a flag, so that is something to consider in a valuation.
Reservation System: The reservation system can be a very important intangible for a hotel. It is often the reason a hotel owner signs on to a particular brand. The reservation system is part of what you are buying when you buy the flag. Along with the reservation system come standards, system support, and an entire group of assets provided to the buyer when the flag is purchased.
Workforce: A hotel’s workforce and management are other key intangibles. In independent hotels, management is often more valuable because, in a flagged hotel, the owner relies on the capacity of the franchisor to help manage the property. When an owner operates as an independent hotel, the staff has to have the skill to operate under all circumstances. The bottom line is that the questions stop at the hotel CEO’s desk.
Technology: Technology, such as telecommunications and internet access, is an important consideration to value. Any hotel can have unique technology, and, certainly, if it is an independent business, it will have a technology platform that needs to be valued.
Noncompete Agreements: Noncompete agreements may be in place for the hotel, and they likely have a value, so they need to be examined.
Customer Lists: Customer lists will exist for the independent hotel, but a flagged hotel may not have a separate customer list. It may be an integral part of the reservation system embodied with the flag.
Goodwill: As with any business being valued, each case will be different, and there may be other intangible assets to consider for your subject hotel. “But at the end of the day, we have goodwill if we don’t have anything else” says Mark Dayman.
Unique Aspects of Hotel Value
The basic underlying theory of value for a hotel is no different from that of any other business. The value is driven by the present value of future economic benefits using a reasonable cost of capital. How an appraiser determines the future economic benefits and the cost of capital requires some unusual considerations, but the basic concepts are no different and will include consideration of comparative sales.
In most business valuation work, appraisers consider a subject’s position in the market and the competitive advantages, which can be subjective. The distinctive feature for hotels and most hospitality businesses is that there is a pure supply and demand feature. An appraiser can actually study why a hotel is performing the way it is and how it is competing against the others in the competitive market where it stands.
Being able to identify why a hotel is performing the way it is provides you with incredible insight about what will happen in the future in terms of cash flow. Of course, you have to consider competitive properties that may have been sold (usually on a per-room basis), but, at the end of the day (if your valuation is for buy/sell purposes), this is a cash transaction, and the individuals involved in the transaction want to know the cash returns.
Digging into the details
Business appraisers study a host of criteria for hotel valuation, particularly three basic concepts: the occupancy rate, average daily rate, and the revenue per available room (Exhibit 2). The occupancy rate (rooms sold divided by rooms available) indicates how often the rooms are sold. The average daily rate (ADR) consists of room revenue divided by the rooms sold. The revenue per available room metric is rooms sold divided by the number of rooms available.
Sources for Benchmarks
Tools and data are readily available to help appraisers specify the market position. Benchmark is where competitive strengths and weaknesses come into play. “You have to be able to position your subject property within the competitive marketplace”, Mark Dayman says. In the analysis for the properties you are examining, you not only want to show basic historical financial information, but you also want to show what is happening in the marketplace.
A good source not only for market data but also for financial data on hotels and resorts is Smith Travel Research (STR). STR is probably the most widely relied upon source of market and operating data for hotels. Most hotels receive monthly reports from STR that tell them exactly how they are performing within the marketplace. “Don’t hesitate to ask your client about this,” Dayman advises.
Other sources of benchmark information include Econometrics, PKF Consulting, and the Highland Group, which specializes in limited service hotels. These data reveal the subject hotel’s direct competition and help measure its strength and how well it is managed over the years and who’s actually doing better or worse than your subject.
Site Visit Idea
Paying a visit to the business you are valuing is, of course, standard practice during a valuation engagement. But, why not visit competing firms as well? After all, you are assessing the performance of your subject hotel versus others in the market, so dropping in on rivals can yield some valuable information.
Visiting competitors is necessary when valuing a business in the hotel industry, according to Mark Dayman. “Suddenly the quantitative information you’ve developed begins to come to life,” he says. “You start to understand why your client performs better than the others within that market. You also learn what is missing in the market that may be an opportunity for your subject entity.
Those interviews are really important.” Sometimes the firms that are initially considered competitors are not really competitors at all because of the nature of their operations. One way to weed these businesses out of the list is to visit them.
Analysis of Market Share
The hotel industry is highly segmented, and there may be a dozen different limited service properties out there, which is challenging because it is difficult to distinguish one from another.
This can be accomplished by identifying the market share of your subject property and its penetration into its market. Determining its market share is one of the major aspects of valuing a hotel.
This is a supply and demand business, so you must take the supply into account as well. The more rooms you put into the market, the lower the market occupancy will be.
If you overlook the fact that more supply is coming into the market, you will overestimate the future performance of the property and overvalue it.
Other Revenue and Costs
Don’t forget to consider other forms of revenue that may come along, such as from a food and beverage operation, stores, fitness centers, etc. If your subject company is a resort, a wide range of amenities could generate revenue.
EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization
At the end of the day, value comes down to EBITDA. That is, how much cash flow will this property generate for the owner of the property.
When you are doing a study for value, you need to take into account the assumption that there is a franchise fee, royalties, and marketing fees, and there will be a third-party management company. “Almost every valuation or feasibility study for a hotel assumes that there is third-party management,” says Dayman.
If you are valuing a non-franchise, independent hotel, keep in mind that you will actually see a higher cost of operations than a franchise location, even though the hotel is not incurring the royalties and marketing fees.
A final point to keep in mind is the replacement reserve that needs to be built into the cash flow. This is not a depreciation deduction but rather an amount of money that must be set aside for replacement for furniture, fixtures, repairs, etc...
“For most brand new hotels, the rate is around 1% of revenues per year, but it can go up to 4% to 5% a year after three or four years,” Mark Dayman says. He also notes that, in many debt agreements today, the lenders are becoming very serious about the replacement reserve. “I have even seen money in escrow in order to make sure it is around for future use.”
Before completing your appraisal, you will need to be aware of common valuation mistakes and special considerations when appraising hotels. These are discussed in Chapter 3.
There are different approaches to valuing a hotel, motel, or resort, depending on the need discussed in more detail in Chapter 1. As with any business being valued, each case will be different, and there may be other tangible and intangible assets to consider for your subject hotel.
To learn more about Valuing Hotel Businesses, feel free to check the BVR’s Special Report: "What It's Worth: Hotel Business Value"
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