Hotel Market Favors Smart Money

NEW YORK CITY-Hotel sales are ticking upward again for the first time in three years, with first-quarter totals of $1.5 billion coming within shouting distance of the $2.5-billion tally for all of 2009. Yet that’s still only a fraction of the $15.6 billion recorded for 2004, let alone the colossal $79.8-billion tally seen in 2007.

Given the still-meager deal flow and depressed NOI levels, how are investors arriving at valuations? Through estimates backed by judgment and experience, Cushman & Wakefield’s Eric Lewis says in a new report.

“If history has taught us anything, it is that the hotels are a highly cyclical asset class, subject to wide swings in revenue and profits due to the daily lease-up of rooms and re-pricing of ADRs,” writes Lewis, executive managing director and national practice leader of C&W’s hospitality & gaming group. “Seasoned investors are acutely aware of this and are placing little stock in existing property-level NOIs.”

Instead, Lewis writes in C&W’s “On the Minds of Hotel Investors” report, buyers are pricing assets based on projected NOI figures, typically on a nominal as opposed to inflation-adjusted basis, “with a return to peak levels forecast anywhere in three to five years.” He adds that the relationship between existing and projected NOI depends on the quality of the asset and its market.

Making such projections of an asset’s intrinsic value in the absence of many comparable sales may sound like winging it, but Lewis tells GlobeSt.com that’s not really the case. “Knowledgeable buyers are as diligent now as they’ve ever been, if not more so,” he says. “But because of the lack of transactions, and NOI levels being so depressed, they have to look to other metrics and other techniques that are not nearly as hard-and-fast as what they’ve used in the past.”

Effective use of the tools in that toolbox means knowing how to use them, suggesting that the current lodging market favors the prepared mind. “The less experienced investor is always at something of a disadvantage relative to the smart money,” says Lewis. “In this market, that’s probably even more the case. A less experienced investor may not be able to comfortably or accurately gauge where NOI levels will be for a given property.”

Judging a property’s intrinsic value is based mainly on replacement costs and peak values, Lewis says. “The thought is that if it would cost $300,000 per room to replace this property, it’s got to be worth $150,000 per room,” he explains.

An appetite for acquisitions—or a compelling need to put capital to work—motivates investors to find buying opportunities even when it means using unorthodox valuation methods. The latest trend is that any institutional-grade hotel property on the market will garner several highly competitive bids, says Lewis. That means capitalization rates of less than 6%, requiring a leap of faith that is easier to make with a property that has more of a track record.

“Recent significant transactions overwhelmingly involve assets with longer operating histories,” Lewis writes. “This indicates a preference for seasoned assets with demonstrated operating performances that offer buyers greater confidence in their projections.”