The Inn Crowd

A new study examines the traditional method for valuing hospitality properties.

By John W. O\'Neill, MAI

As the hospitality sector wobbles toward recovery, investors are taking notice. Last year they spent more than $6 billion on hotel properties, with the average price per room nearing $118,000, according to Jones Lang LaSalle Hotels. Large companies are disposing of nonessential assets in secondary and tertiary markets, popularly known as drive-to destinations, giving individual investors opportunities to add hotels to their portfolios.

In 2003, secondary and tertiary market per-room sales prices averaged about $80,000, well below the total mean. This difference may indicate some bargains in those markets where recovery is gaining steam this year.

As investment specialists help clients determine profitable buy and sell strategies, hotel valuation gains greater importance. Historically, the real estate industry has relied on the valuation rule that hotels should command $1,000 per room in market value per each dollar of average daily rate, with a minimum ADR of $1 per $1,000 of investment. This helpful tool allows brokers to estimate sales prices quickly; for instance, an $85 ADR means an $85,000 price per room, or a rough sales price of $4.8 million for a 56-room property.

However, as the hospitality sector has broadened into different segments over the years, this minimum has shifted. A study examining the valuation rule's viability shows that it remains remarkably accurate, but not all hotel segments conform to the $1 per $1,000 convention.

ADR Still Rules
The study confirmed that ADR is the overall best hotel sales price predictor, even better than a property's net operating income. Of course, investors purchase hotels as much for their net income potential as their actual historical net incomes, so using an achieved ADR as an indicator of a hotel's quality level and its ability to generate future revenues is critical to its selling price.

The study evaluated the ADR rule by hotel type � economy, midscale, full service, all-suite without food and beverage, and all-suite with food and beverage � as well as in the aggregate. For all five categories, ADR remained a stronger price predictor than NOI, occupancy percentage, sale date, and property age. Though both capitalization rate and room-revenue multiplier information were contained in the data, those variables were not analyzed as sales price predictors because both actually are a function of sales price.

ADR in Action
The average U.S. hotel generates $1 in ADR per every $809 in room value, according to the study. While no hotel segment averages significantly greater than $1,000 in room value per dollar of ADR, some segments are much closer to the ADR rule than others.

Specifically, for all-suite hotels without food and beverage, such as Marriott's Residence Inn and Hilton's Homewood Suites, $1 in ADR correlates with a mean of $1,003 in room value. As a group, the mean value per room per ADR dollar has a relatively small standard deviation of $205, indicating that such hotels' values usually do not vary significantly from the $1 per $1,003 average. The relatively high per-room value figures could be the result of the large, all-suite accommodations these hotels provide.

On the other hand, midscale hotels, such as Holiday Inn and Ramada, are furthest from the rule of thumb, with each dollar in ADR correlating with a mean of $634 in value per room. Several factors may contribute to these relatively low valuations. These operations constitute the oldest median age of the five hotel segments studied. Not built to current space utilization economies, many midscale hotels are functionally and physically obsolete. Also, many support restaurants and lounges, which typically generate only modest profits, as well as meeting space that requires marketing and sales efforts, resulting in relatively inefficient business models.

Full-service hotels, such as Marriott, Hilton, Sheraton, and Four Seasons, are fairly close to the ADR rule of thumb; each dollar in ADR correlates with approximately $948 in value per room. Similarly, each dollar of ADR at all-suite hotels with food and beverage, such as Embassy Suites and Hyatt Suites, correlates with approximately $910 in value per room. For economy properties, which include Motel 6 and Microtel Inn & Suites, each dollar in ADR correlates with approximately $720 in value per room.

The study also calculated the hotel's ADR that corresponds with $1,000 in value per room for each of the sales transactions. When analyzed by hotel type, the results are similar to those above except that mean figures are not exactly reciprocal (because the calculation of an average is influenced more by some numbers, such as outliers, than others), whereas median figures are reciprocal between the two analyses (because outliers do not influence medians, or the middle number in a series of numbers, as they do means).

For example, while all-suite hotels without food and beverage generate a mean of $1.05 in ADR per $1,000 in value per room, midscale hotels must generate almost twice as much in ADR � $1.99 per $1,000 in value per room. Essentially, midscale hotels must achieve substantially higher room rates to generate values comparable to other hotel types.

In general, the study supports the continued use of the ADR rule to estimate hotel value. The ADR rule of thumb has validity when it is applied as shown to the five hotel types presented. However, real estate professionals must remember to apply this rule by hotel type and to use it only as a sanity check for more sophisticated analyses, such as discounted cash flow, during meetings, or in the field when sophisticated computer analyses may be difficult.

Brokers and investment specialists should weigh the practicality of relying on a rule of thumb that may vary in accuracy against the ease with which they can remember and use it. Although the rounded-off numbers in this analysis are slightly less precise, they are easier to remember.

John W. O'Neill, MAI, is an assistant professor at Pennsylvania State University 's School of Hospitality Management in University Park , Pa. He has held management positions with Hyatt and Marriott and has served as a consultant to numerous hotel companies. Contact him at (814) 863-8984 or jwo3@psu.edu.

Hotel Sales Data
A database of more than 1,000 verified U.S. hotel sales transactions, including each property's operating information for the 12 months prior to its sale, was used as the basis of the study. Collected during the past 12 years, the transactions cover a full economic cycle and represent all hotel types and regions of the country.

For the 12-month period prior to each sales transaction, the data included the following factors.

• average daily rate (mean: $83.15)
• occupancy percentage (mean: 68.7 percent)
• net operating income (mean: $1,721,277)
• capitalization rate (mean: 10.7 percent)
• room revenue multiplier (mean: 3.21)
• number of guest rooms (mean: 219)
• sale price (mean: $74,020 per guest room)
• property age (mean: 16.1 years)
• hotel type
• region of the country
• metropolitan area size (less than or more than 1 million permanent residents)
• sale date