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Jay Litt is principal of The Litt Group, which is focused on
hotel-project management and consulting. He previously
served as executive vice president at Waramaug Hospitality
Asset Management in Boca Raton, Florida, and as executive
vice president of operations for Wyndham International and
Interstate Hotels. Over the past 45 years, Litt has overseen
large portfolios involving three- and four-star hotels and
world-class luxury resorts. Reach Litt at (561) 988-0451
What’s That Hotel Worth?
Valuing a hospitality property involves assessing it
as an asset and as a business operation
By Jay Litt
How can commercial mortgage brokers and the clients they represent determine the value of hotel assets that are being eyed for acquisition? To answer that question,
we must first know what tools are available to assist
commercial mortgage brokers.
In terms of the financial realities, it’s best to think of
hotels as having two lives. One life involves the real
estate property itself: the actual building and the
value of the real estate from the vantage point of what
a replacement of the hotel would cost.
The other life revolves around the financial performance of the hotel. Let’s first address the easier one
— the value of the hotel as an asset — and explore it
in more depth.
The cost of building a hotel is determined by the status
of the hotel. Simply put, there are five levels, from one
star to five stars. To make it a bit more confusing, there
are several “types” of hotels, such as economy, select,
extended-stay, convention, resort, boutique and more.
So, step one is to understand the differences among
the levels and types, as well as the costs related to
developing each. If a loan is being requested on an
existing hotel, then the crucial factor is the replacement
cost. It should be intuitive that if an existing hotel has a
replacement value of X, and the price of the hotel that
the borrower is looking to buy exceeds the replacement value, some yellow flags should be raised.
Of course, this is a broad generalization. The property
could be in a location that is one of a kind and hard to
duplicate. That creates value. Also, the business perfor-
mance of the hotel could be very strong with no end
in sight. If that can be determined, then this also raises
the value of the hotel. Another major factor is the
condition of the hotel. Hotels must be renovated, and
the cost of this renovation must be added to the price
and compared to the replacement value.
So, let’s assume a 100-room, Holiday Inn Express
property is for sale. The cost of building a new hotel,
including land-acquisition costs, is $130,000 per room,
or a $13 million total expense for new construction.
You then get a loan application involving the purchase
of this Holiday Inn Express.
The purchase price is set at $15 million. The loan
application is for $11 million, and the borrower must
put up $4 million in equity. The hotel is 15 years old.
There is a property-improvement plan drafted by the
hotel-management company to improve the condition
of the asset. It calls for installing brand-standard
upgrades and refreshing the asset at an additional cost
of $4 million. With closing expenses, this deal has a
total cost of $20 million.
As the mortgage broker on this deal, you should
feel some sense of caution because the total cost of
the deal is about 35 percent higher than the property’s
replacement value. As the lender, your concern is how
the buyer will one day retire the loan. What is the exit
strategy? Will the buyer be able to find a future buyer
willing to pay a price that is a much higher percentage
of replacement value?
The second approach to understanding the value of
a hotel, and to determine whether financing can be
arranged, is to understand the financial realities of the
business. This second approach works in tandem with
an analysis of the real estate’s value.
A hotel is an operating business as well as a real
estate asset. The operating business involves renting
rooms and, in some cases, additional revenue comes
from the sale of food, beverages and other items. All
these revenue sources create the total revenue of the
hotel and impact its value beyond the value of the real
estate itself. In other words, a well-performing hotel
property — all other things being equal — is worth
more than a poorly performing property.