Mr. Pastore

Finance & Investment

Use Valuations of Hotels & Resorts

By Thomas E. Pastore, CEO & Founder, Sanli Pastore & Hill

While motels and hotels are real property assets similar to commercial properties in terms of the location of the specific asset and long economic life (usually 20 to 50 years) they differ from typical commercial properties because:

In terms of financial operations, motels and hotels and commercial properties differ because:

In valuing a hotel or resort, it is important to determine which business operations are increasing business value and which operations are decreasing business value. A well-run hotel will have separate profit and loss statements for each of its business components. In fact, it is not unusual to have separate ownership for some or all of these components. For example, the hotel's real property owner may subcontract out lodging operations to a qualified management company and the spa may be part of a recognized health club chain.

Separating out the financial performance of each business component is essential to arriving at proper valuations for these components and the hotel itself. Net income (earnings) and cash flow are usually the preferred financial performance measures to determine value. A hotel appraiser must be able to identify the earnings and cash flow of each business component of the hotel to determine which operations are enhancing or detracting from value. The following provides a hypothetical example of two hotels identical in total overall annual revenues and number of rooms. We have furnished the annual earnings of each business component for the respective hotel.

If the above earnings for each business segment were expected to remain stable into the foreseeable future then we would expect Hotel Pinnacle to be more valuable than Hotel Grande. Hotel Grande's convention business losses are a drain on its cash flow. However, Hotel Grande's lodging and restaurant earnings exceed those of Hotel Pinnacle. If Hotel Grande could turn around its convention operations or divest them, it could have potentially greater value than Hotel Pinnacle.

The sales comparison method is often used to value commercial real property, and many appraisers use it to value hotels or resorts. In this method, the appraiser will select a selling price to hotel revenues ratio based on sales transactions of comparable hotels. This ratio is applied to the revenues of the hotel being appraised to determine its value. However, there are inherent weaknesses and flaws of the sales comparison approach, particularly in its application to value hotels. Under the sales comparison approach, the appraiser only considers the gross revenues of the hotel and not the earnings or cash flow. The sales comparison approach does not provide a purchaser of a business with information on a business' return on investment and this can result in a misleading and faulty valuation.

The sales comparison approach does not consider the earnings generated by each separate business unit. A simple example using the data on Hotel Grande and Hotel Pinnacle will illustrate how the sales comparison approach can result in misleading valuation conclusions.

Based on hotel sales transactions, an appraiser determines that a selling price to sales ratio of 2.5x would be appropriate to value hotels comparable in number of rooms and revenues to Hotel Grande and Hotel Pinnacle. Applying the ratio of 2.5x to each hotel's total revenues ($10,000,000 x 2.5) results in the same value, $25,000,000, for each hotel. The appraiser has arrived at the same value for two hotels, which have substantially different earnings streams, particularly for the convention business segment.

At the beginning of a hotel appraisal assignment it is very important to identify each business operation, ascertain the historical and expected future performance of each operation, and apply appropriate valuation methods. Simply valuing a hotel like a commercial property may result in inaccurate valuation conclusions.

Mr. Tom Pastore is Chief Executive Officer and co-founder of Sanli Pastore & Hill, Inc. He has been involved in financial consulting for more than 20 years, specializing in investment and financial analysis, litigation consulting and public accounting. Extensive experience encompasses valuing numerous businesses in a wide range of industries including retail, services, manufacturing and holding companies. He has served as an expert witness in federal and state courts for business litigation cases in California, Arizona and Nebraska. Mr. Pastore can be contacted at (310) 571-3400 or tpastore@sphvalue.com Extended Bio...

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