Book Review—What It’s Worth

Hotel Business Value

QuickRead’s Technical Editor, Roberto Castro, reviews BVR’s What It’s Worth: Hotel Business Value.  There are few resources available for business valuation professionals that focus on the valuation of hotels.  The “go to” reference books have been Stephen Rushmore, MAI and Erich Baum’s Hotels & Motels: Valuations and Market Studies, a 2001 Appraisal Institute publication, and David Harper’s Valuation of Hotels for Investors, a 2008 EG Books publication.  BVR’s Special Report, What It’s Worth: Hotel Business Value, covers some of the ground included in these other publications but highlights opportunities available to business valuation practitioners and takes issue with approaches used by real estate appraisers relying on approaches espoused by Rushmore.

There are few resources available for business valuation professionals that focus on the valuation of hotels.  The “go to” reference books have been Stephen Rushmore, MAI and Erich Baum’s Hotels & Motels: Valuations and Market Studies, a 2001 Appraisal Institute publication, and David Harper’s Valuation of Hotels for Investors, a 2008 EG Books publication.  BVR’s Special Report, What It’s Worth: Hotel Business Value, covers some of the ground included in these other publications but highlights opportunities available to business valuation practitioners and takes issue with approaches used by real estate appraisers relying on approaches espoused by Rushmore.

Kimberly Scott serves as editor for this publication and she begins noting that hotel valuations are not the exclusive domain of commercial real estate appraisers.  Hotels and motels are not just pieces of real estate.  Hotel appraisal work involves the hotel and resort system.  The most common engagement is for pricing to make buy/sell decisions.  Other opportunities that emerge for business appraisers include: preparation of feasibility studies, portfolio analysis, purchase price allocation, impairment testing, eminent domain actions were the land is subject to a lease, real estate tax issues since many jurisdictions impose a tax on personal property but not on intellectual property, and cost segregation studies.

The special publication is geared towards appraisers interested in learning more about this industry and appraisal opportunities that may enable the practitioner to diversify or expand their income stream.

The special report is broken down into six sections.  These sections are as follows:

• Section I – Where is the Value in the Hotel Industry?
• Section II – Valuation Methods and Considerations for Hotels
• Section III – Current Market for Hotel Businesses
• Section IV – Selling and Succession Planning for Hotel Owners
• Section V – Financial and Valuation Data for Hotels
• Section VI – Valuation and the Court

Section I outlines areas where opportunities exist for business appraisers.  The section also focuses on “hotel drivers and considerations for hotel valuation.”  This latter section is adapted from the BVR webinar, Valuing Hotels, presented by Mark Dayman of FranIntel, Inc., a franchise consulting firm, and Kari Lazarova of Valuation Aspects, LLC.  So, what are the value drivers?  There are two drivers: tangible and intangible assets.  Tangible values include things such as land, buildings, and current assets and liabilities.  Intangible values include: the brand or “flag”, workforce/management, technology, noncompete agreements, customer lists, and goodwill.  The latter assets can be substantial.  Business valuation appraisers recognize the above, Dayman however, proposes that “(business valuation) appraisers give cursory consideration to 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 others in the competitive market where it stands.”

Dayman builds on this premise by discussing how occupancy, Average Daily Rate (ADR), and Revenue per available room (RevPAR) are measured and used.  Understanding the marketplace also requires that one have access to data from sources such as: Smith Travel Research (STR), Econometrics, PKF Consulting, Highland Group, HVS, Korpacz, and others.

In the remaining portion of the chapter, Dayman discusses: the different site visits, understanding the market share of the subject hotel, recognizing the various revenue streams and the associated costs, warns readers of the problem using certain benchmarks in the industry, and the importance of building a replacement reserve into the cash flow.

Section II of the special report delves into Valuation Methods and Considerations for Hotels.  In this chapter, Kari Lazarova, managing director and founder of Valuation Aspects, LLC, disentangles the real estate and business concerns.  “The controversy arises primarily from the fact that the underlying real estate is highly integrated with the business enterprise value.  The business valuation of a hotel provides the value of the entirety—including real estate, personal property, intangible assets, and so on.  It becomes important to split out the real estate component from other values.”

Lazarova discusses issues that arise when the Cost Approach is used in valuation.  The issues that may arise using the Cost Approach include: 1) what should be considered when the Cost Approach is significantly higher than the Income Approach; 2) how does one incorporate or recognize functional and/or economic obsolescence in the depreciation value; 3) what should be done if the hotel has excess land, and 4) should the rate used in the Income Approach be the same as the rate of return used under the Cost Approach?

The Market Approach also presents concerns.  Lazarova proposes, “the Market Approach or sales comparison approach may have serious data limitations since there may be insufficient transactions in the geographic area to develop a reliable Market Approach.”  Lazarova observes another limitation using this approach is “the properties that sold in the area may not be that comparable to the subject hotel and may require significant adjustments.”  The use of the Market Approach is discussed in more detail.

The Income Approach also presents challenges of its own to business valuation practitioners.  Lazarova discusses the discount rate and use of EBITDA, how the term “net cash flow” in real estate differs from how it is used in a business valuation, how capitalization rates are developed in a real estate engagement, and the importance of yield capitalization.

In the remainder of the chapter, illustrations are used to drive important points on the use of a DCF analysis, how to allocate earnings streams to the underlying real estate, and concludes noting common errors seen in reports.

The second section of the Special Report concludes with a chapter written by Franz H Ross, CBA, CVA, MRICS.  This chapter is titled, An Untapped Market: The Appraisal of Hotels as Going Concerns.  Ross writes:

This chapter explains why the dominant method for the appraisal of hotels is contrary to the main methods used for the appraisal of other real estate-centered enterprises (RECEs) and is therefore flawed.  Furthermore, this method does not mimic the way hotels are typically sold, and the real estate appraisal professions’ continuation of this method creates a vacuum for other (business) appraisers to fill, simply by appraising hotels the same way as nursing homes, golf courses, and C-stores—as going concerns.

Significantly, Ross proposes that the Rushmore approach may be the best approach when the hotel is operated under a third-party management contract but can result in “large valuation errors when there is no third-party management.”  Ross adds that the real estate appraisal industry’s wide use of this approach “creates an opportunity for those willing to provide a more useful (and perhaps more accurate) appraisal by valuing the going concern for hotels unencumbered by management contracts, which are clearly the majority of hotels.”  This discussion marks a departure from the earlier publications referenced at the beginning of this article.

The theme developed in Section III is the Current Market for the Hotel Business.  Information gathered from the American Hotels & Lodging Association (AHLA) and PwC’s industry outlook is presented.  The use of illustrations and charts reinforces how contributors approach an engagement in this industry.

Section IV focuses on Selling and Succession Planning for Hotel Owners.  This is a short chapter.  The views of Lloyd H. Rawls, founder and CEO of The Rawls Group, which specializes in succession planning for family-owned businesses, are presented and Jim Butler, a founding member of JMBM and Chairman of its Global Hospitality Group, are presented.  Both express a sense of urgency and need to address questions of the various constituencies, family members, and employees.

Section V provides information on Financial and Valuation Data for Hotels.  In this chapter, the editor presents hotel valuation multiples derived from Pratt’s Stats, pricing information based on rules of thumb, hotel financial metrics derived from BizMiner, and other resources specific to the industry.

Section VI, Hotel Valuations in the Courts: Cases of Note, discusses eight court cases.  Two of the eight cases deal with valuation issues that arose during divorce proceedings.  Three of the eight cases are bankruptcy cases where valuation, IP, and feasibility of restructuring are central to the court’s conclusion.  One case involves a shareholder dispute where the issue of who is qualified to resolve valuation issues and what constitutes competent financial evidence are addressed.  The final case is a California case where the key question addressed is how do you assess a hotel for property tax purposes?

In conclusion, this Special Report takes issue with earlier publications and makes the case that this is an area where business valuations have a role and can add value.  The publication is primarily aimed at business appraisers that are open to serving this industry.  This said, the sections by Ross and views expressed by Lazarova are more advanced, so this also aimed at more experienced practitioners.

The BVR Special Report, What It’s Worth: Hotel Business Value, is available for purchase at www.bvresources.com/publications.

Roberto H Castro, JD, MST, MBA, CVA, CPVA, CMEA, BCMHV is an appraiser of businesses, machinery and equipment and Managing Member of Central Washington Appraisal, Economics & Forensics, LLC. Roberto is also an attorney with a focus on business growth and succession planning with offices in Wenatchee and Chelan, WA (home to many small wineries). In addition, Roberto is Technical Editor of QuickRead.
Mr. Castro is knowledgeable of the industry and can be reached at (509) 679-3668 or by e-mail to either rcastro@cwa-appraisal.com or rcastro@rcastrolaw.com.