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Since 1990, real estate appraisers in the US have required to consider the influence of both tangible personal property and intangible assets on the value of a property, especially when the objective of the appraisal assignment if to estimate only the value of the real property. The Uniform Standards of Professional Appraisal Practice have mandated that real estate appraisers estimated the value of non-realty components of properties.

Since 1990, real estate appraisers in the United States1 have been required to consider the influence of both tangible personal property and intangible assets on the value of a property, especially when the objective of the appraisal assignment is to estimate only the value of the real property. The Uniform Standards of Professional Appraisal Practice (USPAP)2 have mandated that real estate appraisers estimate the value of non-realty components of "properties."

The value of either tangible personal property or intangible assets (or both) represents a measurable and separable proportion of total property value. Both must be extracted from going concern value when the revenues and operating expenses of the business(es) occupying the real estate are intertwined with those of the real estate. Such properties are frequently termed "operating properties."3 Examples of operating properties include healthcare facilities (hospitals, nursing homes, continuing care retirement communities), hotels, landfills, recreational facilities (marinas, amusement parks, ski resorts), certain manufacturing plants, and regional shopping centers.

When revenues, operating expenses, and net operating income of these businesses provide the only basis for an income approach valuation, elements of revenue and income attributable to both the tangible personal property (machinery and equipment; fixtures, furniture, and equipment) and the intangible assets of the business are included. The values of these business components are included in the values of, or prices paid for, the operating property. These total "property" values are labeled the "going concern value."4

Separating Real Property Value from Going Concern Value

When an operating property is bought or sold, the entire going concern is transferred.5 Operating properties are rarely leased, so their operating incomes are those of the going concern. Thus, the cost approach is seemingly the only valuation method available to value the real property component of an operating property. The cost approach is inadequate, however, because the lack of market data on similar, competitive real property sales and rentals precludes any supportable calculation of market-based accrued depreciation.

As a result, the primary focus of the literature has been on the income capitalization approach as a method of separating tangible personal property value and intangible asset value from going concern value. The revenues, operating expenses and net operating income identified as allocable to tangible personal property and to intangible assets must be estimated directly and separately. Their capitalized present worth next must be calculated. Then two related but separate estimates of the market value of the real property may be derived.

First, the real property value can be identified as the residual difference between going concern value and the combined total of tangible personal property and intangible asset value. Second, the residual net operating income (NOI) ascribable to the real property can be derived by subtracting the NOI assignable to the tangible personal property, plus the NOI assignable to the intangible assets, from total NOI to the going concern. Then the NOI to the real property is capitalized at a market-derived real property rate to estimate the market value of the real property.

Direct and Individual Valuation of Intangible Assets

When income capitalization is used to value real property, the NOI of the total leased or rented space can be capitalized as a single entity. Similarly, the NOI required to cover the value of tangible personal property (often estimated as replacement cost new less accrued depreciation) typically is identified as a single, lump-sum figure. Not so with intangible assets, however. The varied characteristics of intangible assets, and the diverse data and methods employed to value them, dictate that each category or subset can be analyzed and valued individually and separately. The following operating hotel valuation case study illustrates not only how this can be done, but also why it must be done.

Comparison of Data Sources

In carrying out the appraisal assignment on which the case study that follows is based, we used and compared data obtained from both readily available published sources and the client hotel. Because hotels are location-specific properties, it is usually preferable to rely on local submarket data, or (when available) operating data from the hotel being valued. It is not usual for detailed operating data to be available for public use, however, especially over a period of several years. In such cases, reliance on published market operating ratios, trends, and norms is necessary.

Moreover, one question that often arises is: How representative of the competitive market are any property-specific operating data for the subject hotel? Only through comparative analysis can that question be answered. One objective of this study is to make such comparisons.

If the actual experience of the real property being appraised is similar to and reasonably comparable with market standards and averages, then that actual experience may be used to develop a figure that is labeled "Market value." If there is a perceptible, measurable divergence from the market norms and standards, however, then an explanation for this divergence must be identified. This is particularly necessary when such divergence is based upon the existence and influence of intangible assets (e.g., copyright or trademark names,6 licenses, reservation systems, supra-normal management, and profit centers). In such circumstances, an appropriate allocation of total going concern value to the sources) of that value differential must be made.

Elements of Intangible Assets in Operating Hotels

Ultimately, the question that must be answered by any appraiser or assessor who is estimating market value of hotel real property is:

What would a typical informed, prudent, rational purchaser-investor pay for, or allocate to, the real estate of the total property or going concern being appraised, assuming continuation of the current use of the property, as of the Valuation Date(s)? Moreover, what would the buyer be buying?7

There are numerous measurable elements of non-realty at a hotel property which are separable from the real property/realty. These include (but are not necessarily limited to):

1. Furniture, fixtures, and equipment (FFE). (Tangible personal property)

2. Working capital for the hotel business. (Intangible asset)

3. Assembled trained and skilled work force. (Intangible asset)

4. The name of the individual hotel and its reputation. (Intangible asset)

5. Affiliation with a chain or an association of independent hotels that provides a reservation system, a referral system for members or affiliates, group advertising, both information for travel agents and publications aimed at travel agents, and frequently an identifiable and recognized name/"flag." (Intangible asset)

6. Licenses and permits that are specific to the business operator, as opposed to those "going with the property." (Intangible asset) [Sometimes incorporated with name and reputation.]

7. Profit centers (mostly guest services): Food & beverage, meetings/events, telephone service, valet/laundry service or concession, parking service or concession, health club/fitness center, business center. (Intangible assets)

Income Capitalization: The Traditional Approach Valuing Hotel Properties

There is virtual unanimity among leading practitioners, theorists, and other authorities on hotel property valuation, that income capitalization is the preferred method for valuing an operating hotel property.8 Indeed, many argue that income capitalization is the only appropriate approach to valuation, whether direct capitalization or a discounted cash flow analysis (or both) is utilized.

There also is nearly unanimous agreement among scholars, authors, and practitioners that there is a discernible, separate, and measurable business component in an operating hotel. Its value is often termed the "Business Enterprise value," as distinguished from going concern value. Indeed, the great majority of texts and articles by acknowledged authorities on the subject of hotel valuation do recognize and account for business enterprise value (BEV) in one form or another.9

There is some controversy or disagreement among authors concerning the extent, composition and amount of business value in an operating hotel. There is no substantive or fundamental disagreement, however, over the fact that the process of valuing the net operating income stream of an operating hotel produces an estimate of going concern value. From that figure, the non-realty elements must be deducted in order to derive an estimate of the market value of the hotel real property/realty. The obligation to carry out this type of analysis and to separate realty and non-realty values appears as Standards Rule 1-2(e) in USPAP, as noted previously.

The Case Study: Valuation of an Operating Hotel Property

In this article, we use an ongoing real estate enterprise to illustrate the identification and deduction of the values of tangible personal property (FF&E) and of intangible assets (including profit centers) from going concern value. We have chosen a 566room, downtown luxury hotel property: Hornblower Hotel Towers (HHT) in the small-market, relatively isolated Pacific Coast city of Mar del Sol. HHT is an operating business or "going concern," with five restaurants, a health club, a business center, several retail facilities, a ballroom, meeting rooms, and banquet facilities.

The property is owner-operated. Hornblower Hotel Towers is also a member of a restricted-entry, international group of affiliated hotels and resorts: The A Group (TAG). HHT must therefore meet and maintain the high standards of facility quality and service established by this organization. TAG advertises in selected target publications, maintains a centralized reservation and referral system, and regularly inspects member properties to ensure maintenance of standards adopted for all members of the group.

Guidebooks published for travel agents refer to HHT as the only "luxury" or "4-Star" hotel in its market. Additionally, the property contains the only AAA 4-Diamond restaurant listed for Mar del Sol. HHT is the best-known hotel in its market, with a national (indeed, international) reputation for the provision of high-quality service and amenities to its guests. Therefore, it commands premium prices for its rooms and its food services, in comparison with its local competition.

The building was built in stages: Tower 1 and the major portion of the ground floor, mezzanine and basement in 1968; Tower 2 and the remainder of the ground floor and mezzanine in 1975; and Tower 3 in 1982. HHT ownership-management appealed the real property tax assessments and taxes for the years 1993-1997. The valuation date is January 1 of each year.There has been little market sales activity among the seven major downtown hotels ("the 7 Sisters") in Mar del Sol during the past 10 years. The six competitors with HHT are all newer, and five are somewhat smaller, than HHT. They total 2,154 rooms, which brings the total downtown market to 2,710 full-service hotel rooms (including HHT). The sales comparison approach cannot be used effectively to value HHT because none of the 7 Sisters has sold within the previous decade.

Similarly, the age of the HHT building mitigates against reliable estimation of market value of the real property via the cost approach. As Graaskamp indicates:

...after adjustment for wear and functional obsolescence, [the cost approach] must fall back on the income approach to explain the economic obsolescence or premium that is due for a particular project. [Therefore,] if the market approach and the cost approach are increasingly unreliable, then the income approach might be necessary, which brings the essay face to face with the problem of attributing income to real estate."

In what follows, we address the problem of attribution or allocation of the income to the going concern of HHT and to individual intangible assets in particular.

To value the real property via the income capitalization approach, it is necessary first to estimate the going concern value of the entire hotel business operation. Then the value of the real property/realty must be estimated by subtracting the indicated value of FF&E, as well as the measurable values of the several profit centers and other intangible assets found at HHT.

Operating Revenues and Expenses

The operating revenues and expenses of HHT are presented by profit center category for the operating years 1992-1996 in Table 1. The data were derived directly from the audited annual financial statements of HHT. However, we made two changes on the operating expense side: in the management fee (for both management of the real estate and management of the hotel/business, separately), and expenditures for replacements (in lieu of a reserve for replacements).

Management Fee. A deduction for real property management is standard procedure for any estimate of net operating income (NOV when applying the income capitalization approach. This is the case whether the property owner is a passive investor or an active ownermanager.12 Traditionally, a real estate management fee is expressed as a percentage of effective gross income (revenue collections). As with other components of operating expenses, actual expenditures can and should be used whenever they represent or approximate market levels. The typical market range for a full-service hotel property during 1992-1996 was reported to be 1.0%-2.0% of total revenues."

In addition, the management fee for operating a hotel (independent of real estate/facility management) is typically expressed as a percentage of total operating revenues. The market percentage is usually in the range of 2.50%3.5% of total revenues, although franchise fees are separate and additional.14

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For HHT, it was not clear whether the line item titled "management" included both real estate management and hotel (business) management. As a percentage of total revenues, however, the actual management fees charged by Hornblower Hotel Towers ownership in every year except 1992 exceeded slightly the 5.0% of total revenues represented by the sum of real estate and hotel management fees that is derived from the market (Table 2). For this analysis, we accepted and used 5.0% of total revenues as a charge for all management fees: real property management and hotel business management.

Replacement Allowances. Elements of hotel structures wear out, break, malfunction or become inadequate by the standards of current users (e.g., guests, convention registrants, or event attendees). When any event listed above occurs, the worn out, broken, malfunctioning, or inadequate building component has to be replaced. Such expenditures are necessary to keep the building(s) functioning adequately.15 In the case of the HHT facility, the level of performance and appearance must be consistent with that of a first-class, high-quality service operation, in order to keep the TAG affiliation. Similarly, FF&E must be replaced regularly, but over a shorter life cycle than that applicable to building and structural components.

Traditional wisdom in the hotel industry has been that 3.0%-5.0% of total revenues is sufficient to allow for replacement of both short-lived real estate components and FF&E." In 1995, however, the International Society of Hospitality Consultants (ISHC) published the results of a comprehensive survey of capital expenditures (CapEx) by full-service, limited-service, and resort hotels in the U.S. It covered the period 1983-1993.17

The ISHC found that full-service hotels typically operate on a 25-year life cycle, at the end of which massive renovation and rehabilitation expenditures are necessary to maintain the facility's (and the operating hotel's) competitive status. During that life cycle, there are "spikes" of major replacement and renovation requirements. ISHC concluded that, on average, over a 25-year life cycle, for a new hotel facility, average expenditures on CapEx at a downtown fullservice hotel were 9.4% of total revenues per year. Similar but older hotel facilities, such as HHT, averaged 9.6%. The CapEx figures included both building/structural component replacements and FF&E replacements.

The CapEx for replacements reported by ISHC exclude repairs and maintenance (R&M), which in the ISHC study average 4.5% of total revenues for downtown full-service hotels, and 4.4% for hotels built before 1981. Therefore, the market-derived charges for R&M at HHT should approximate 4.5%.

Table 3 compares the actual expenditures for replacements at HHT with figures equal to 5% and 9% of each year's total revenues. The figures vary widely from year to year. The five-year average was $1,170,000 per year. The ISHC study suggests a figure in excess of 9% of total revenues for replacements. It is clear that the reported actual replacement expenditures at HHT reflect replacement of real property (building and structural) components only. They averaged only 4.8% over the 5 years 1992-1996. Therefore, it was necessary to account for recovery of the capital value of FF&E as well. (See Note to Table 3, Panel B.)

Valuation of Goinq Concern

When income capitalization is used to arrive at the going concern value, each year's net operating income should be capitalized at that year's effective capitalization rate, including the appropriate surcharge for that year's effective property tax rate.

To identify the base capitalization rate for valuation of the going concern value of HHT, information from three readily available and widely recognized published sources was used: The American Council of Life Insurance (ACLI), the quarterly Korpacz RealEstate Investor Survey (Korpacz), and the quarterly RERC Real Estate Report published by Real Estate Research Corporation (RERC) (see Table 4).18

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The Korpacz and RERC figures are all expected or required ("hurdle") rates, derived from surveys of institutional investors and others looking for investment grade or trophy property. These generally represent the lowest rates necessary to attract institutional investment funds (e.g., pension funds, REITs) to hotels.

The ACLI rates, on the other hand, represent a composite of loan commitments by the 20 largest life insurance companies in the USA. Life insurance companies typically lend exclusively on new or proposed construction of major facilities in metropolitan market areas considered to be growth areas. Older properties are rarely, if ever, included in the ACLI study reports. As with the Korpacz and RERC survey results, the ACLI reports generally rank hotels as riskier investments than other property types.

Similar information from PKF Consulting was presented in the August 1997 issue of Real Estate Forum (Table 4). Biennial data from 1986 through 1994, with annual data for 1995 and 1996, confirm those in the Korpacz reports, except that overall capitalization rates are slightly higher. Indeed, the entire pattern of market attitudes, reactions and behavior toward hotel property investments that is reflected from these four widely recognized and accepted published data sources is one of above-average perceived investment risk during the period at issue.

In applying the direct capitalization method to establish the going concern value of HHT, average real property capitalization rates were used with 150 basis points added to reflect the risk premium for the small size and relative isolation of the Mar del Sol market. This premium was confirmed with hotel analysts and appraisers familiar with that market. Using the NOI of the hotel operation (Table 1) and the effective capitalization rates (Table 4), we derive each year's going concern value for HHT (Table 5). The figures range from $41,470,000 on January 1, 1993 to $65,543,000 on January 1, 1997.

Lump-Sum Deductions of Non-Realty Values from Going Concern Value

As noted previously, the indicated values of FF&E, and of measurable, quantifiable elements of intangible asset values (e.g., assembled workforce; working capital; and hotel name, reputation and "flag" or group affiliation) must be deducted from going concern value to derive an estimate of the market value of the real estate/realty of HHT. Those lumpsum deductions must be derived as much as possible from market evidence.

Tangible Personal Property: Furniture, Fixtures, and Equipment

In the HHT property, there is a substantial amount of FF&E: in the guest rooms; in the five restaurants, banquet/reception/meeting facilities and the pub and other bar areas; in the meeting rooms, the health club and the business center; and in the public areas, the front desk area, and the hotel offices. The values that were accepted by the assessor from the property tax reports of HHT ownership have been used to construct Table 3, Panel B. These figures are deducted from going concern value to remove tangible personal property value.

Intangible Assets

Measurable elements of intangible assets include working capital, an assembled trained and skilled work force, and the value of the hotel's name, repuration and franchise or "flag" affiliation. The first two elements are calculated as the investments and/ or expenditures necessary to achieve and maintain the level that is required for efficient and profitable operation of the hotel business. The third is calculated as the present worth of the supra-market room revenues per available room (REVPAR) generated at HHT, which may also reflect other elements of non-realty revenues that are not otherwise treated separately.

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Working Capital. Working capital is required for an operating hotel's continued operation/liquidity and solvency. Although some authorities have argued that working capital is derived from operations,19 a new purchaser would have to fund that amount until the hotel's revenues were at a level sufficient to provide the liquidity and till cash required for the new operation. Alternatively, the purchaser would pay the seller for the working capital on hand, as part of the purchase price for the hotel's going concern. HHT ownership reports that between 10 and 15 days' revenues are necessary to maintain liquidity and sustain continued operations without undue borrowing. We have selected two weeks (14 days), which averages roughly 3.84% of total revenues (Table 6).

Assembled, Trained, and Skilled Workforce. A skilled work force would have to be assembled and trained by a purchaser of the real estate only. Therefore, a portion of any purchase price of an operating hotel is the opportunity cost of assembling and training the required work force. On average, a period of approximately six weeks of training (and hiring) is reportedly appropriate and reasonable for staff to be assembled and prepared to operate a first-class fullservice hotel.

Trends in the Hotel Industry. Trends report that payroll expenses at the top 25% full-service hotels, ranged between 33.8% and 35.3% of total revenues from 1992 through 1996, averaging 34.5%." Based on these numbers, Table 7 contains the calculated payroll figures for HHT from 1992 through 1996. The CFO at HHT agrees that the typical hotel employee can be trained in approximately 6 weeks. Therefore, a reasonable estimate of the value of an assembled, trained and skilled work force would be 11 .5% (6/52) of the annual payroll (Table 7).

Business Enterprise Value: The Value of the Name and Reputation, Plus the Value of Group Affiliation and Related Intangible Business Assets.

As previously noted, HHT is an operating business enterprise utilizing a combination of real estate (land and buildings/structures), tangible personal property (FF&E), and intangible assets (ofwhich working capital and assembled workforce have already been quantified). What remains, therefore, is the quantification of the contribution to going concern value from the name and reputation of HHT, combined with the effects of membership in the A Group (its "flag" or "brand"), plus the "profit center" profits.

Advance reservations and past customer lists help assure continued, uninterrupted operation of the hotel business following a change in ownership/ management. Conversations and interviews with knowledgeable hotel analysts and appraisers indicate that the contribution of these items would be subsumed within the value of the hotel's name, reputation, and franchise or "flag" affiliation (which may or may not transfer with the real property). Several recent studies have demonstrated quite clearly that name recognition, good reputation for high-quality service, and "brand" or "flag" affiliation can add as much as 20%-25% to the going concern value of a successfully operating hotel.21

One measure of that intangible asset is any indicated increase in total annual room revenues per available room (REVPAR) that can be associated with the name, reputation, and "flag" or "brand" affiliation of the hotel being appraised. That premium would also reflect such other intangible assets as advance reservations and past customer lists.

Competitive U.S. and Local Hotel Market Norms vs. Hornblower Hotel Towers. For "competitive market" analysis, room department revenues at HHT were compared with those of the top 25% of full-service hotels in the U.S., as reported in Trends in the Hotel Industry, for the Years 1992 through 1997. In addition, Smith Travel Research provided data on six local hostelries "competitive" with HHT. Each of the six comparable hotels contains at least 100 rooms, but only one is similar in size (590 rooms) to HHT. All are newer than HHT.

The comparative average percent occupancy (APO), average daily rate (ADR), and average revenue per available room (REVPAR) figures are shown for the sample as a whole and for HHT in Table 8. APO rates for the six competitive hotels fluctuated within a relatively narrow range from 1991 through 1996. At the same time, ADR increased each year, especially in 1996.

Operating figures for the "Top 25%" of U.S. full-service hotels, measured by REVPAR (Table 8) indicate that APO increased moderately between 1992 and 1994, with a substantial increase in 19951996. ADR was relatively flat in 1992-1993, but increased markedly each year thereafter. These results may be compared with those of HHT, which showed higher ADR, but a lower rate of increase, from 1992 through 1995. In 1996, however, ADR was flat at HHT (actually slightly lower in comparison with 1995), while it increased 6.6% among the submarket hotels, and a spectacular 13.0% for "Top 25%" full-service hotels in the U.S. Nevertheless, ADR at HHT remained substantially above the average for the submarket hotels.

APO also increased at HHT, but was still at a lower level than either the average for the local market, or (especially) the average for the Top 25% of U.S. fullservice hotels shown in Table 8. That spread with both the "Top 25%" and the "submarket hotels" decreased noticeably from 1992 to 1996, however.

Average Daily Rate/Average Percent Occupancy Trade-Offs. Hornblower Hotel Towers exhibits the ADR characteristics of a "luxury" hotel, but because of the high degree of seasonality in its market, a lower APO than the Top 25% of full-service hotels in the U.S. This dichotomy of operating results suggests a higher level of investment and operator risk for the owner-operator of HHT than for typical ownershipmanagement of otherwise similar, competitive hotels.

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HHT offers a range of amenities and services not typically found in hotels outside the "Top 25%" category. These services and amenities stem primarily from the quality of FF&E, and from personal services provided by a trained, skilled work force. In addition, profit centers such as restaurants, bars/ pubs, valet/laundry service and others are available at HHT. This demonstrates the importance of separating the revenue and expense figures for each of the service areas when completing a valuation analysis. Expenses associated with the TAG affiliation are most properly assigned to the room sales department.

Using the ADR and the APO figures, we derived daily REVPAR in the years 1992 through 1996, for the Top 25% full-service hotels in the U.S., the submarket of six Mar del Sol hotels, and HHT itself. These calculated figures are shown in the right-hand columns of Table 8. REVPAR is calculated simply by multiplying APO by ADR.

Table 8 also shows the comparative compound interest growth rates from 1992 through 1996, in APO, ADR and REVPAR for the Top 25% fullservice hotels in the U.S., the Mar del Sol submarket, and HHT. Both the Top 25% and local submarket hotels had higher growth rates in ADR than did HHT, from 1992 through 1996, but HHT's APO grew at over twice the rate of the others (3.5% vs. 1.6%) over that period.

Hornblower Hotel Towers had the highest REVPAR of the three study groups of hotels until 1994 (Table 8). Then the U.S. Top 25% group soared ahead. Its growth rate from 1992 through 1996 was 10.4%, nearly twice that of HHT (5.4%). The REVPAR at HHT was consistently higher than that for the local submarket over the five years studied, and grew at a higher rate of 5.4% vs. 4.6%.

While national or regional averages and trends in APO, ADR and REVPAR are useful in identifying industry standards and norms, hotel property markets are and remain primarily local in character and operation. This stems from the obvious fact that hotels must necessarily provide their services at a fixed location. Therefore, the most important comparisons of any hotel's operating results are with the 6 downtown hotels that compete with HHT in the local market environment. Accordingly, the comparative analysis emphasizes on the Mar del Sol hotel market.

Revenue per Available Room Comparisons. One important comparison of hotel operations that can be made is the impact of REVPAR differences on operating revenues. Since REVPAR is the product of APO and ADR, it is an important reflection or measure of both management effectiveness and the appeal of a hotel's name, reputation and "flag" (or group affiliation). These elements of the going concern create separately an identifiable intangible asset in comparison with the hotel's local competition.

We concluded that the best method to analyze the income attributable to the management effectiveness, name recognition and reputation of HHT is to normalize its room revenues. We did so by assuming that HHT had experienced the APO and the ADR typical of the Mar del Sol market. The market income that would be generated under these assumptions can then be compared to the actual REVPAR reported by HHT Table 9 reports the room sales revenue differentials achieved during 1992-1996. It compares actual annual room sales revenues with what would have been realized if APO and ADR at HHT had been the same as the averages for the six competing local hotels.

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The annual "premiums" or differentials are in the range of $1,000,000 to $1,200,000, except in 1992, when the excess was only slightly over $400,000. These premiums, which are derived from HHT operating statements and Table 8, directly compare actual versus market room revenues. They also reflect differences in the lengths of individual years and in room nonavailability not otherwise reported (e.g., closings for repairs and maintenance). They provide important information necessary to calculate the BEV of HHT, which is attributable to its peculiar attractions to potential guests seeking high-quality, full-service hotel lodging amenities and services.

Therefore, to establish the BEV, each year's revenue differential ("brand name premium") was capitalized at the appropriate business capitalization rate, which we concluded to be 20% (Table 10). This was done to reflect the greater risk associated with the volatile attitudes and perceptions of guests and customers toward HHT. Figures range from a low of $2,070,000 for the value of the Hornblower Hotel Towers name and "flag" as of January 1993 to a high of $6,125,000 in 1995. Each year's figure represents the amount to be deducted from going concern value to reflect the several elements of HHT's "brand name premium" in the Mar del Sol hotel market. This is an intangible asset, unrelated to the real property of the facility. It reflects superior management, superior service, and the resulting name recognition and reputation that attract guests to HHT rather than to competing local hostelries.

Establishing the Value of Profit Centers

The specific profit centers for which data are available at HHT include the food and beverage department (including banquets and event catering), the telephone system, and the health club owned and operated by HHT. Because the hotel owns no garage or surface parking lot (an adjacent multi-deck municipal facility is used), the usual parking service profit center is effectively nonexistent. Similarly, the self-service business center (free use of equipment, but no staff) and the modest valet/laundry concession have inconsequential impacts on both revenues and expenses for the going concern of HHT.

Table 11 summarizes the operating results of the food and beverage department, the telephone service and the athletic/health club for the years 19921996. Revenues have been both substantial and increasing. In order to reflect the opportunity cost of space occupied by these service activities, an allocation of proxy rent has been added to the reported operating expenses in each year: 8% of gross revenues for food and beverages; 5% of gross revenues for the telephone service; and 10% of gross revenues for the athletic/health club.

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The values of the three profit centers can then be calculated by capitalizing NOI at 20%. This is a pure business capitalization rate, reflecting the additional risks of a business enterprise. There is no surcharge for an effective property tax rate, since profit center income (an intangible) is not subject to property taxation. The value estimates for the three individual profit centers are summarized in Table 12, which also presents their combined estimated value for January 1, 1993 through 1997.

Summary and Conclusion

Following the mainstream literature on hotel valuation, we conclude and agree that a full service hotel is an operating business that utilizes real property (land and buildings), tangible personal property, and intangible assets to generate operating revenues and operating profits. When income capitalization is utilized to estimate the value of the real property of an operating hotel, it is necessary first to value the going concern, relying on actual operating revenues and expenses as much as possible. Management fees and replacement allowances may need to be adjusted to conform to market standards and indicators. The resuit of deducting total operating expenses from total operating revenues is net income from hotel operations, which is capitalized to going concern value.

Then the value of the tangible personal property (FF&E) and of the intangible assets (including the value of the hotel name and affiliation with TAG, as well as working capital and assembled/trained workforce) must be deducted from going concern value before the market value of the real property may be properly and supportably estimated. Additionally, the NOI of identifiable profit centers (adjusted to reflect proxy rent for the space they occupy) must be capitalized at an appropriate business capitalization rate (20% in this example) to derive the value attributable to this part of the investment. The profit center values are also deducted from going concern value less FF&E and other intangible asset value. The final remainder is the indicated market value of the real property of the hotel, for each year.

In the case of HHT, this procedure was followed, as described in detail in the preceding sections of this paper. The results of our analyses and calculations are summarized in Table 13 for the valuation dates of January 1, 1993-1997. Those figures show that the indicated market value of the real property of HHT ranged between 66% of going concern value (in 1994) and 71% in 1993 (mean 68%).

Thus, on average, non-realty assets (FF&E, intangible assets, profit centers) account for 32% of the going concern value of HHT. This finding has been developed by following, in particular, the precepts and guidance of the late, great James A. Graaskamp, as provided in his writings.

Graaskamp notes that "since Ricardo, a major premise and concern of urban land economists has been the proper attribution of net income [or] economic surplus to the instruments of production."22 He defines the allocation of productivity for the purchase of the going concern of a business (e.g., an operating hotel) as "land, structure, personalty, and intangible assets and good will plus artifactual profit centers for management." [Emphasis added.]23

Applied to Hornblower Hotel Towers, this means deducting the calculated value of FF&E, intangible assets, and profit centers from going concern value. Graaskamp characterizes the hotel business as "a synergy of marketing, management and technical expertise which involves a specialized piece of real estate equipment [sic]. In valuing the real estate component of such a business, it is necessary to carefully allocate income [and value] among management, marketing and promotion skills, and real estate attributes. "24 This recipe has been followed to value the real property of HHT. It works.

Moreover, the available published norms or standard ratios and trends for the hotel industry have been shown to be reasonable proxies for actual hotel operating figures. The standard sources (e.g., PKF Consulting, Smith Travel Services) may be used with confidence.

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[Author Affiliation]

William N. Kinnard Jr., PhD, MAI, CRE is the president of the Real Estate Consulting Group of Connecticut and professor emeritus, University of Connecticut. He publishes regularly in The Appraisal Journal and other leading professional and academic real estate valuation journals. His published works have earned awards from various professional associations. He has valued hotels, shopping centers, and other properties as part of a going concern for over 30 years. Contact: Real Estate Counseling Group of Connecticut Emeritus, University of Connecticut Storrs, CT 06268. (860)

429-1005; fax (860) 429-4468; email: recgc@mall.snet.net.

[Author Affiliation]

Elaine M. Worzala, PhD is an associate professor in the finance and real estate department at Colorado State University where she teaches an

introductory real estate course, real estate valuation, and real estate investment. She holds a PhD in Real Estate and Urban Land Economics (1992)

and an MS in Real Estate Appraisal and Investment Analysis (1984) from the Department of Real Estate and Urban Land Economics at the University of

Wisconsin-Madison. Before obtaining her doctorate, she was a commercial appraiser for several years and continues to have a strong interest in the

valuation area. Contact: Department of Finance and Real Estate Contact: Colorado State University Fort Collins, CO 80523. (970) 491-5564; fax: (970) 491

7665; email: eworzala@lamar.colostate.edu.