Can I offer Coke Cans or Green Houses for Your Hotel?
If you ask any Monopoly player what the value of a hotel is, they will tell you that one hotel is worth five plastic, green houses. Unfortunately, outside of the Monopoly world, a hotel’s value is not so straight forward to determine.
There are myriad ways to undertake the valuation of a hotel. From the so-called ‘10,000 rule’(1), methodologies that utilises comparable multiples, historical and replacement costs, hotel yields divided by an appropriate capitalisation rate, to undertaking market-value and fair-value calculations that incorporate the expected future earnings, or discounted cash-flows.
Each method has its own uses and limitations, and it can, understandably, cause confusion and uncertainty when one simply wants to know what the value of their hotel is.
Hotels are unique amongst other forms of real estate in how they generate revenue, and how the basis of their value is measured. For example, when looking at commercial or residential property the basis of measurement is a square metre (or square foot). Offices and floors are leased out based on this unit and the basis of revenue measurement is determined using the same unit. Not so with hotels.
Hotels generate their cash-flow through:
- Rooms;
- Food and beverage facilities;
- Gym, spa, and health centres; and
- Other operating departments like KTV and entertainment centres, conference facilities etc…
Trying to value hotels against commercial and residential property techniques would not be an efficient way of determining the true value of a hotel. When an individual or organisation commissions a hotel valuation they want the certainty of knowing the method of valuation chosen was appropriate.
Hotels are valued for a variety of reasons, including, but not limited to that fact that:
- Many companies are required to value their assets annually to satisfy regulatory and listing requirements;
- If a hotel is being put forward as collateral on a loan, having a reputable company of valuers undertake a valuation provides certainty to the lender and borrower as to the value of the collateral;
- Investors may be interested in purchasing a specific hotel and want it valued as an indication of where they should start their offer;
- A hotel owner may want to sell a specific hotel and want it valued as an indication of what sort of offer they should accept; and
- The value of a hotel may have increased since it was acquired and the owners wish to track the increase, or decrease, in value of their investment.
The purpose of valuation may also influence the choice of methods.
As stated earlier, there is no shortage of hotel valuation techniques, however, these techniques can be categorised into three groups.
Cost Approach: This is based on the principle that no one would pay for an assets than the cost to acquire or replace an asset with a similar asset in new condition. Adjustments from the new replacement cost are made for factors such as age, condition, changes in technology and economic factors which affect the whole hospitality industry. Valuation methods such as Depreciated Replacement Cost and Optimised Replacement Value fall under the cost approach.
Market Approach: This looks for comparisons across similar transactions and how the market has priced them. Consequently, if one wanted to value a 4 star hotel in Central, Hong Kong, one would look at other similar 4 star hotels in Central, Hong Kong, which have recently been sold, to act as a basis of comparison. Valuation methods using relative value include the Per Room Comparable, the EBITDA Multiple and the Capitalised Earnings method.
Income Approach: This is determined by the cash-flows one expects the asset to generate over its useful life and the certainty that the cash-flows will eventuate. Accordingly, assets with high, stable cash-flows should be valued higher than assets with low and volatile cash-flows, though assets with high and unstable cash-flows are interesting. Valuation methods based on the concept of the income approach include the Discounted Cash Flow method and the Adjusted Present Value method.
The 10,000 ratio method is not actually a valuation method at all, it falls under the heading of “Rules-Of-Thumb” and should be avoided at all cost.
Typically, valuations of hotels are performed using methods derived from both the market and income approaches. The market approach requires sufficient comparable transactions to have occurred and for all relevant information relating those transactions to be available for analysis; unfortunately this is seldom the case, which is why such methods are not commonly used in isolation.
Income approach methods such as the discounted cash flow method are frequently adopted as they can overcome the numerous problems encountered by other methods due to limited market data or lack of transparency. However, like all models; garbage in, garbage out – due consideration needs to be given to all the relevant factors.
All income approach methods require four factors to be carefully assessed; namely:
- Cash-flows from existing assets;
- Expected growth in these cash-flows;
- The discount rate; and
- The time taken before the business becomes mature.
These factors are found across all income approach methodologies, and in addressing the factors mentioned above, it is important to have as much historical data regarding the market the valuation is taking place in, and the property itself. The difference between rack rates and average room rates can vary greatly from market to market and season to season, as can occupancy rates, F&B covers, average food check and other operating parameters. Unfortunately, reliable hotel data and hotel sales information are not always available. This is particularly true in China, where market data is harder to find or is incomplete.
Appraising a hotel is a complicated undertaking, and not to be taken lightly. If your business is hotels and hotel investment, you need a team of consultants behind you providing key advice to ensure the success of your investment. Censere is a firm of value consulting specialists with extensive expertise in hotel valuation throughout Asia Pacific. We are able to provide you with independent and impartial advice, provide certainty, and give a true and fair value for your hotel; whether you want it measured in Coke cans, green houses or $.
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- This highly scientific and technical method involves multiplying the price of a can of coke from the hotel mini-bar by 10,000 to get the value of each hotel room. The number of rooms in the hotel are then multiplied by the ‘room rate’ to value the hotel.