Expert’s Voice: Hotel buyers – don’t wait, buy now

by | 01 May 2020 | People

Corona’s bright side: a new buying opportunity (Credits: Unsplash by Scott Graham)

After Covid19, a significant recovery will take place in a relatively short period of time. There has not been a buying opportunity like this since 2010, writes Steve Rushmore, Course Developer and Instructor at Hotel Learning Online.

Despite the impact of Covid19, hotel values have not declined as much as you might think.

While we are going through a horrendous period for the hotel industry, the good news is this decline is a demand induced decline, not a supply induced decline. Historically hotels recover significantly quicker from a decline in demand rather than an oversupply.

Most investors purchase hotels based on a discounted cash flow procedure where the annual cash flows are discounted to the present value and added to the discounted value of an assumed sale at the end of a 10-year holding period.

About 40% of the total value comes from the assumed sale of the property. Thus, an investor looking at a hotel today might see 2 to 4 years of low cash flow, but most hotels will recover quickly and ultimately sell for a good price at the end of the holding period.

Let’s look at a side-by-side example.

An investor looked at purchasing a hotel on January 1, 2020 — not knowing it will be adversely impacted by COVID-19. The hotel was operating at a stabilized occupancy and generating a net income of $1M per year. The net income was expected to increase at 3% per year during the 10-year holding period. The investor valued the hotel using the mortgage-equity appraisal model.

The same investor looked at the same hotel — this time in March 2020. The hotel had closed and was not expected to open for 6 to 9 months.

The following is a side-side comparison of the projection of net income, the valuation parameters and the estimated values for pre-virus and post virus.

The pre-virus projection shows a 3% yearly increase in net Income. The post virus projection shows no net income during 2020. In 2021, the net income is expected to recover to 50% of its stabilized level — $500K. In 2022, the net income is projected to grow to $750K. By 2023, the net income will recover to the initial level of $1M. After that it will grow in tandem with the pre-virus projection.

The mortgage-equity appraisal model uses a weighted cost of capital to value the hotel. The parameters of the debt and equity financing are set forth below. The parameters for the post virus valuation take into account the greater risk and the higher cost of debt capital. After the recovery, the debt and equity parameters were returned to the pre-virus levels.

Using the mortgage-equity appraisal model with the projections of net income and the mortgage-equity parameters set forth above — the following table shows the market value of the hotel each year under the pre-virus and post virus assumptions.

As this table shows the value of the post virus assumption shows a decline of 24% during 2020. In 2021, the decline in value recovered to 16%. By the end of 2024, the value of the post virus hotel equaled the value of the pre-virus hotel.

Based on my experience in downcycles dating back to 1972, I think while hotel values have declined somewhere between 20%-30% as shown in these calculations, I think the value recovery will be shorter and most hotel markets will regain their values by 2022.

The bottom line

If you are a hotel owner: hold on, don’t sell. Don’t give your hotel to your lender — a significant recovery will take place in a relatively short period of time. If you are a hotel buyer: don’t wait, buy now. There has not been a buying opportunity like this since 2010.

 

Steve Rushmore
Steve Rushmore

Course Developer & Instructor at Hotel Learning Online

As a leading authority and prolific author on the topic of hotel feasibility studies and appraisals, Steve Rushmore has written six textbooks and two seminars for the Appraisal Institute covering this subject. He has also authored three reference books on hotel investing and has published more than 300 articles.

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