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Hotel values remain a moving target
10 APRIL 2015 6:48 AM
Use local market conditions to establish a realistic value for an asset, sources say. By taking that approach, opportunities will arise in a landscape ripe for deals.
By Jeff Higley
ATLANTA—Hotel values are indeed determined by the eye of the beholder—and considering the current industry landscape, that means the potential buyer.
And while common sense says a hotel will sell for as much as the highest bidder wants to pay, it's not always cut-and-dried how a seller arrives at that price, according to panelists speaking on the "Hotel values in a rising market" breakout panel at the recent Hunter Hotel Conference. With the speakers agreeing that transaction volume should remain high during 2015, there will be plenty of opportunities for owners to learn the true value of their properties.
Lee Hunter, COO for Hunter Hotel Advisors, said many owners need to be educated about values in a particular market—even more so when it comes to submarkets. A common misperception by owners is belief that New York City or San Francisco levels of pricing apply nationwide, even when they asset is located in a secondary Midwest market.
"We're going to value it based on what a typical market is going to do," said Stacey Nadolny, senior VP and partner with HVS Chicago.
"As appraisers, we value (the asset) on what a competent operator would be. … No more, no less," added moderator Hank Staley, senior VP for PKF Consulting.
The valuation process is getting a little more delicate as the number of hotels in the development pipeline increases, according to Nadolny.
"With a lot of markets and the amount of new supply we're going to have, we're seeing some impact in our pro formas where we're going to have to be realistic about impact of new supply," she said.
Click here for full coverage from the 2015 Hunter Hotel Conference.
It's becoming clear the pipeline is a growing concern, but no one is panicking yet, panelists said.
"Every client I can think of has five to 18 hotels in their pipeline right now, and they're all in tertiary markets," Hunter said. "Construction costs are 25% to 30% higher than last year, but even at that cost they can still develop that asset for less than replacement costs. They can build it for $130 (thousand) a key or buy it for $170 (thousand per key)."
Read "Lack of land, labor among developers' dilemmas".
"The difference is that new supply hasn't reached the level of concern—it's at 80 or 90 basis points," said Russ Shattan, senior VP for MCR Development. "It's not happening enough on a scale that it's negatively tipping the RevPAR needle."
Michael Cummings, principal of Hotel & Club Associates, and Nadolny said about half the work at their shops involves development feasibility studies, which is double the normal level.
Tertiary markets can spell trouble
The tertiary markets that Hunter mentioned tend to be a hit-and-miss proposition, according to the panelists.
"Tertiary markets are giving us pause," Cummings said. "There's a lot of new development coming into tertiary markets that make me nervous."
"I take pause in those tertiary markets where there are four or five hotels in the pipeline and I get another call," Nadolny said.
Read "Panelists debate supply, cap rates, brands".
Nadolny cited the oil region of southeastern Ohio and western Pennsylvania as one area that raises concern because of existing pipeline and continued inquiries from potential developers.
"You have to consider valuations when looking 20 years from now in those areas," Nadolny said. "We're still seeing budget properties trading for $70 (thousand) to $80 (thousand) a key—way above replacement costs."
Cummings said looking at who holds the leases on oil fields is a big indicator of the long-term viability of a hotel project.
"Is it a company like Shell, or have they sold the leases to local companies?" Cummings said. "The thing to look at is who is controlling those leases. Once those big guys get out, look out."
Shattan said it really boils down to the individual market's dynamics.
"I like tertiary markets where I can walk outside the hotel and see the demand generators," Shattan said. "(A highway) interchange is not enough of a generator for me. … We look for recurring business when underwriting hotels in tertiary markets—is the manufacturing plant healthy, is it staying, is it consolidating with another company?"
The panelists agreed that one of the reasons for the interest in tertiary markets is the keen competition for product in urban markets.
Shattan said resorts were the driver of the last cycle, and urban is the driver this time around—particularly when the number of building repurposes and renovations are taken into consideration.
"That has driven a lot of the new supply into those markets," Shattan said. "These new brands are being focused to urban markets and price-per-key values for urban markets are high. People don't blink an eye paying $275 (thousand), $300 (thousand), $325 (thousand) a key for a Hampton Inn in those markets."
That benefits companies, such as MCR, that are looking for deals in secondary and tertiary locations, according to Shattan.
"It has allowed us to find hotels for $115 (thousand), $120 (thousand), $125 (thousand) a key," Shattan said.
Buyers beware
Those types of deals are out there if the asset is correctly valued, Shattan said. But, buyers have to be realistic about the upside, too.
"There are no 9-caps out there," Shattan said, adding that most of the bargains are "probably" gone because there's very few distressed hotels in the market.
Hunter said there's simple math involved when determining whether a deal makes sense: "What's my cap rate on my year two projection? … As long as it's 8, 8.5 or higher, where do I sign?"
Those types of deals can get done, providing the sponsor is experienced and the value is realistic.
Cummings said lenders are underwriting with trailing 12-month net operating income in mind instead of RevPAR projections.
That's where the opportunities arise, because there are underperforming or mismanaged assets available, according to Hunter
"If you're not bringing 35% NOI to the bottom line on a Hampton Inn & Suites, you're not operating it very well," Hunter said.
The environment will provide many chances for buyers and sellers to achieve their goals as long as they don't get unrealistic about values, the panelists said.
"It certainly got a lot busier," said Shattan, who started with MCR when it launched in 2010. "2015 will be a competitive year, just as '14 was a competitive year."
"2015 is a great time to sell assets … even if you sell it to the bank and refinance it," Hunter said.
Hunter said his firm's sales volume in 2015 will be about the same as last year, but the typical deal will involve more single assets as opposed to the portfolio sales in 2014.
"The profile of the seller has changed," Hunter said. "Last year the seller was institutional. This year it's the owner/operator. It's guys who develop assets themselves … that are recycling capital."
"If you're going to transact in the next five years, now's the time to do it," Hunter said.
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