Hotel industry performance has picked up recently, albeit slowly, but there are still a number of stumbling blocks when it comes to valuing midscale hotels.
Howard Mathews, president of National Hotel & Motel Brokers, which is based in Discovery Bay, Calif., said that almost everything he's been selling is a default property, and owners are selling at one half to one third of what they bought the properties for originally. The fact that the hotels were foreclosed on makes it especially difficult to value a property, he said.
"If they were a foreclosure and the bank has owned it and the bank sells it, the bank generally doesn't have records of the property's income and expenses," he said. "To go to a new bank and get financing is virtually impossible without numbers from the operation."
Alan Brock, founder of Grapevine, Texas-based Brock Hotel Group, said a number of issues are working against midscale valuations.
"The factors most affecting midscale pricing are lack of hotel financing sources, weak but improving property-level performance and a glut of distressed property for sale," Brock said. "The lack of financing and leverage is the No. 1 factor affecting price."
The economic swoon caused a number of hoteliers to hold off on updating their properties, and this is another drag on hotel valuations, according to Brock.
"Property improvement plan cost, dictated by franchising requirements, is also a factor affecting the value of many midscale hotels," he said. "Often, these PIPs have been delayed a couple of years and frequently equate to 20 percent to 25 percent of a property's value."
Robert Fitzgerald, founder and president of Apostle Fitzgerald & Co. in Phoenix, said the recession has been especially unkind to older midscale hotels.
"Three years of deferred maintenance on underperforming midscale hotels is also having an unhelpful effect on the value of these hotels," he said. "With a long recession, which this has been, the gap between older and newer supply continues to widen, making higher valuation of older properties very difficult."
Increased activity is actually having a negative affect on midscale valuations, said Greg Meinhold, a hospitality specialist with Swoboda Hospitality Specialists, which is based in Phoenix.
"Due to declining revenue at property level and increased challenges with securing financing, cap rates have risen and values have decreased," Meinhold said. "Activity has steadily increased for 2011 and we are seeing more and more activity as lending institutions are liquidating their [real estate-owned] inventory, which will have a negative effect on valuation."
Cost per room and discounts to replacement cost are key valuation measures in the current economy, according to Brock.
"Midscale hotels are selling but pricing is key," he said. "Strong-performing upper midscale hotels, particularly those with Marriott and Hilton brands, can attract strong prices. Otherwise, prices are low relative to both the 2007 peak pricing and replacement cost."
After several years of handling pretty much only defaulted properties, Mathews recently listed a property that has had increasing income 11 of the past 12 months.
"It's the first one we've had in a long time that's a good investment like we would have sold back in '05, '06, '07," he said. "It's going to be interesting to see how it sits in the market."
Brock said the paralyzing fear about a double-dip recession is over, which is causing interested parties to lose a little bit of their reserve.
"Buyers are cautious and careful but also confident that operating numbers will improve over the next few years," he said. "Sellers are insistent that buyers should pay for improving fundamentals. Together, these factors cause valuations to focus more on future expected performance rather than the last year's actual performance."
ON THE HORIZON
"Until occupancy and rates start to recover in these weaker markets, we will continue to see an unenthusiastic, very flat recovery for this segment," Fitzgerald said. "Firming up operations and low interest rates will motivate and reinforce buyers' confidence in taking on new investments in the midscale hotel segment."
Valuations will stabilize gradually, and maybe increase slightly as income goes up, according to Mathews.
"As [people] travel more you're just going to gradually see the incomes start to move back up and the better operators will have their expenses in line, do good marketing and they'll gradually save their properties and keep them going," he said.
Brock said he expects 2012 valuations to be similar to 2011, at least for awhile.
"In the near term, increasing quantities of distressed hotels on the market will hurt achievable prices," he said. "A few years out, because of low new supply and an improving economy, valuations will be much higher and today's prices will look like bargains. Some general price inflation, which many economists predict, may make these increases even more significant."
Meinhold said that when real estate-owned inventory is reintroduced into the market and re-established, the market should see an increase of property-level income and fewer challenges with securing financing. He also said there will be a turnaround in cap rates and values.
"I've seen more banks come into the market now that weren't there six months to a year ago," he said. "They're still not doing much in the way of taking properties in projection, but they're starting to see that things are stabilizing. I'm getting calls from banks now that are looking to make loans and they're more liberal than they were a year ago–not nearly as liberal as they were in '08 but they're getting closer."
Source: Hotel Management