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Comparisons made by Hotel Brokers International for the first four months of 2002 versus the same period in 2001 show not only a decline in the number of hotels sales, but a drop in average selling prices as well. Perhaps more than at any other time, the importance of a quality appraisal is now crucial. While historic and current performance is certainly a factor, there's much more to any appraisal, and hospitality work is especially complex. According to Florida Booth of Horwath Hospitality in San Francisco, now more than ever, present value is certainly dependent on future cash flows. The lending community, in general, is wary of hospitality assets in the best of times, and historically, it has been among the last segments lenders return to in a recovery. The experience of the appraiser and his or her familiarity with the intricacies of hospitality work can make a substantial difference.

Copyright Penton Media, Inc. May 15, 2003

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Our industry has been in a state of change during the past two years. 2001 looked to be a banner year for occupancy and ADR for most hotels and markets as those indices were climbing upward for the third or fourth year in a row. Properties were selling for higher average prices per room. New lenders entered the hospitality markets and liked what they saw. New development, particularly in the limited-service segment, was booming. Then came Sept. 11, 2001.

Comparisons made by Hotel Brokers International for the first four months of 2002 versus the same period in 2001 show not only a decline in the number of hotels sales, but a drop in average selling prices as well. These figures may be skewed by the fact that high-performing properties-those whose owners could ride out the bad times-might have been pulled from the market. Under that scenario, the under-performing properties, perhaps troubled before Sept. 2001, stayed on the market or were put up for sale and were the first sold in those early months.

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Occupancy dropped precipitously and immediately. Non-military air traffic in the U.S. came to a standstill for days. For an industry largely dependent on the traveling public, the impact was huge.

An owner with a property that was performing well through August 2001 was faced with a radically changed statement of operations by year-end. Suddenly, owners were met with a disturbing question: What is my property worth now? Visions of realistically expanding or selling in a very good market were now gone. Perhaps more than at any other time, the importance of a quality appraisal is now crucial.

HOW TO PICK AN APPRAISER

"It's difficult for people who are new to the appraisal industry to understand the complexities of an appraisal assignment given the current conditions. The gap between buyers and sellers today is huge," says Steve Rushmore, president of HVS International. "Veterans of the business have seen it before, in 1974 through 1976 with the energy crisis, and in the recession of the early 80's." According to Rushmore, an appraiser can't look at what is going on today. Rather than current performance, he or she needs to ask, "what are the trends?"

Apart from the disparity between what an owner thinks the property is worth and what a buyer is willing to pay based on current performance, today's situation is different than those earlier times. In addition to Sept. 11, the economy has been in a recession since early 2001 and corporate travel has been diminished due to those conditions, the collapse of the dot.com and tech markets and the audit/consulting crimes that have shaken many businesses at the highest levels.

As Rushmore notes, we've been in down times before; business has recovered and even flourished. But, what is your hotel worth today?

To consider all of the factors affecting value at this time, and to understand the importance of selecting the right appraiser or firm, I spoke to appraisers who specialize in hotels and to an asset manager who reviews between 250 and 300 appraisals a year-many of them for hospitality properties.

"Things are in a state of flux. Data is location-specific, and some locations are doing better than others," says Dave Butz, REO asset manager of Miami-based Lennar Partners. The problem of appraisers looking only at historic performance when recent performance has, in some cases, been weak was a common theme among those I interviewed. While historic and current performance is certainly a factor, there's much more to any appraisal, and hospitality work is especially complex. Butz recommends that "you want a specialist in the field; try to find experts in that niche."

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WHAT DOES AN APPRAISER CONSIDER?

Florida Booth of Horwath Hospitality in San Francisco, suggests caution in using sales immediately before or after Sept. 11 for comparison.

"Now more than ever, present value is certainly dependent on future cash flows," she says. "Look at a discounted cash flow and take it out 10 years. Use a ramp up for recovery."

She also believes a quality hospitality appraisal must go far beyond bricks and mortar, recent performance and the selling price of the hotel down the street. "The economy was going south before Sept. 11, but now it is starting to come back. Many Americans are only traveling in the U.S.; the airlines are waging fare wars. Hoteliers are discounting rates. We anticipate higher occupancy, perhaps at lower rates," she says. Another consideration appraisers should weigh, says Rushmore, is that "new supply growth stopped after Sept. 11." As markets improve, demand will face static supply for some time to come. The lending community, in general, is wary of hospitality assets in the best of times, and historically, it has been among the last segments lenders return to in a recovery.

VALUE OF A FLAG

Does a franchise affiliation automatically mean higher value? Not necessarily, according to some experts. Once more, the experience and depth of analysis utilized by the appraiser in the process come to bear. Market-specific, or more accurately property-specific, data came up again and again. The franchise fees paid by one property may be justified and in fact, returned many times over in that property. But for another hotel, with different circumstances, the franchise fees may not be justified and might make the difference between a profitable operation and just getting by.

Other considerations: How many years remain on the term of the franchise? What impact does it have on value? Will a renewal PIP be cost-prohibitive? Does the property have competent, professional management and marketing? Does management know if a franchise always adds value? Does your appraiser know and understand that it may be, but is not always the case?

Mike Slade, president of Florida-based Callaway & Price, says of the many property types, hospitality appraisals require explicit understanding of the industry, the hotel, its market and the market's characteristics. According to Slade, "All market value appraisals assume competent marketing and management; however, a hotel's operation is very management-sensitive and a hotel's operations can change-positively or negatively-very quickly. The distinction between competent and ineffective management is a more involved judgment in hospitality appraisals."

The distinction is often a result of the short-term nature, and therefore, the volatility of the revenue drivers in hotels, he says. Specifically, in an apartment building, lease terms are typically one year; for office or warehouse properties, lease terms range from one to more than 10 years. With a hotel, revenue generators are measured in days.

THE INCOME APPROACH

While all professionals surveyed indicated that the income approach to value is the most credible for hospitality properties, different methodologies present different opportunities and challenges. The experience of the appraiser and his or her familiarity with the intricacies of hospitality work can make a substantial difference.

Consider this example: A small property in a good market with yearly profits of $125,000 before Sept. 11 probably suffered greatly in 2002. Even though the owner and operator cut back on staffing and worked hard to reduce all expense categories, revenues fell and net operating income (NOI) in 2002 was only $100,000.

Direct capitalization is a valuable tool in valuation, and in examining this property an inexperienced appraiser might look to the few recent sales, see capitalization rates in the 12 percent range, and apply that rate to the 2002 NOI. As indicated in the chart, that would yield a value of $833,333. But, an experienced hotel appraiser familiar with this property's market will take into account several other considerations. One, no new product is coming on line; two, this motel fills an underserved market niche; three, business is slowly but steadily returning to this property (ADR is inching up, and occupancy is rebounding even more quickly). A projection that shows NOI increasing to a little more than 2001 levels over six years will indicate a very different value. Knowing that a direct capitalization of a single-year's income implies a holding period and that the market will probably change over that period, the experienced appraiser will test the direct capitalization with the discounted cash flow and likely use a lower capitalization rate, yielding a very different value indication. Perhaps, given the circumstances, the appraiser should have applied a capitalization rate of 10 percent, producing a valuation of $1 million. You can't overstate the importance of experience, insight and credibility in the appraiser you select.

WHERE TO GO FROM HERE?

Other considerations in choosing an appraiser include the overall quality of the appraisal product itself, the reputation of the appraiser and firm, and the acceptance/credibility of the value estimate in financial or buyer markets.

Our industry and your property have been buffeted enough recently. Don't take another hit when it comes to determining your property's value. Select an experienced, well-informed and ethical hotel appraiser, provide as much information as you can, and you'll learn what your hotel is really worth today.

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[Sidebar]

The Penn State Index is developed from an econometric model and a database of over 1,000 hotel sale transactions. It is updated quarterly based on actual changes in the performance of hotels. Unlike surveys of hotel sale transaction prices that can show unwarranted value variation depending on what types of hotels happen to be selling in a given year, the Penn State Index has the benefit of using the statistical correlation between actual hotel sales transactions (i.e., sale price) and actual performance (i.e., occupancy, ADR, profit, etc. at the time of sale) of the hotels themselves to estimate the values of all hotels based on the industry performance of all hotels. The Penn State Index uses projections of hotel performance to estimate future hotel values.

I'd like to thank Hospitality Advisory Services LLC, HVS International, PricewaterhouseCoopers, and Smith Travel Research for their assistance with the development of the Penn State Index.

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[Author Affiliation]

John W. O'Neill, MAI, CHE, Ph.D., is a professor in the School of Hotel, Restaurant and Recreation Management at The Pennsylvania State University and a licensed real estate appraiser. He previously held unit-level, regional-level, and corporate-level management positions with Hyatt Hotels and Marriott International. He can be reached at jwo3@psu.edu or 814-863-8984.

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