Whether you are interested in investing in a hotel asset or preparing to sell one, understanding its value is necessary to make a smart deal.
Hotel valuation methods have evolved significantly over time. In the 1960s, for example, quirky rules of thumb such as the Coke-Can Multiple, which valued each hotel room at 100,000 times the price of a Coca-Cola in the mini-bar, were surprisingly standard. Fortunately, today’s valuation methods are far more data-driven and sophisticated.
This article breaks down hospitality valuation and explores the pros and cons of the most widely used valuation methods for hospitality assets.
What is Hospitality Valuation?
Hospitality valuation is the process of determining the value of a hospitality asset, such as a hotel, resort, or serviced apartment. Fundamentally, the value of a hospitality property is what an investor is willing to pay, based on the risk associated with the asset and its potential to generate future income.
Compared to traditional real estate assets such as office buildings or residential properties, hospitality assets are more difficult to value due to the operational complexity that is inherent to them. Because hospitality businesses generate revenue, their value cannot be reduced to just the building or the land.
Accurate valuation is essential for making informed hospitality investment decisions, whether it’s around buying, selling, financing, or asset management.
Key Drivers of Hospitality Asset Valuation: What Affects a Hotel’s Value?
As complex entities of operational real estate, multiple operational and market-specific factors affect the value of a hospitality business, such as a hotel or resort. These include internal performance indicators and features such as location, branding, and capital markets.
Operational Performance and KPIs
How a hotel performs in its operations directly reflects how much revenue the business can generate. Some of the most common key performance indicators to look at are:
- Occupancy and ADR: A hotel’s revenues are primarily determined by the hotel’s occupancy levels and the average daily rate (ADR).
- RevPAR: Revenue per Available Room (RevPAR) indicates a hotel’s ability to fill rooms at profitable rates.
Hospitality businesses that can maximize revenue through effective revenue management, which includes balancing volume and price, are more valuable.
Brand Affiliation and Management Strategy
Whether a hospitality business operates independently or under the name of a global brand can impact the asset’s value. Hotel brands with global reach, such as Hilton and Marriott, benefit from customer loyalty and trust. Depending on the segment, branded assets see premiums in occupancy and ADR over independent hotels, which naturally is a value-add for investors.
However, a well-known brand is not a sure indicator of value. The way a hotel is managed can add or erode the worth of the asset in a significant way. Suppose the hotel has a sustainable cost structure and efficient operations. In that case, an independent hotel can be more valuable to an investor than a chain hotel, so all aspects must be contextualized.
Location and Seasonality
The location of a hospitality asset is one of the most critical features impacting its value. Hospitality investors are willing to pay more for properties in primary locations (also known as “prime” or “premium” locations), which are areas with high and stable demand drivers. Think of urban centres such as New York and London, financial districts, airports, or any location with a steady flow of guests.
Secondary locations, on the other hand, do not have as predictable demand and may not be as accessible, making the market risk higher. However, properties in these locations may benefit from higher margins due to lower land and operating costs.
Furthermore, some hospitality businesses are more sensitive to seasonality than others. For instance, ski resorts have highly concentrated demand peaks, whereas hotels in prime locations often have consistent bookings year-round. Generally, properties with less seasonal volatility tend to be more valuable due to more consistent revenue streams. That said, even a highly seasonal hotel can be a solid investment opportunity if it is able to manage costs effectively during the off-season.
Capital Market Considerations
Capital market conditions, meaning the overall environment of borrowing and investing, have a direct impact on hospitality valuations. When interest rates are higher and lenders are more hesitant, the cost of financing a hotel acquisition increases. This tends to reduce the prices buyers are willing (or able) to pay, which reduces asset values in the short term.
Higher borrowing costs also impact investor expectations. When capital is more expensive and the economic outlook is uncertain, investors expect a higher return to justify the risk they are taking on. This is directly reflected in valuation models as a higher discount rate, which, in turn, reduces the estimated present value of a hotel.
There are fewer transactions in this environment, and the bid-ask spread between buyers and sellers widens. In other words, the price of the same hospitality asset might be lower even if the property’s performance has not changed because capital market dynamics have changed the math.
Top Methods for Hospitality Valuation
Countless factors can affect a hotel’s worth, which is why two hotels on the same street can have dramatically different price tags. Hotel valuation methods offer a framework to navigate that complexity.
The most common hospitality valuation methods are:
- Cap Rate Method
- Income Capitalization Approach or Discounted Cash Flow (DCF)
- Sales Comparison Approach
Different valuation methods are suitable for different hospitality assets. Some methods are more focused on real estate value, while others are more business-focused and emphasize the business’s operational performance. We will explore each valuation method, their strengths and limitations, and how it fits different types of hospitality investments.
The Cap Rate Method
The capitalization rate method, commonly known as the cap rate method, is one of the most widely used techniques in hospitality real estate valuation. The method is based on the following equation:
Hotel value = NOI (net operating income) divided by cap rate
The cap rate (or yield) represents the investor’s expected rate of return and is often used as a quick benchmark of a property's value relative to its income. In essence, it is an inverse measure of perceived risk:
- Lower cap rates suggest investor confidence and lower risk (but lower return potential)
- Higher cap rates reflect higher risk, and thus higher expected returns
Hotel Industry Cap Rates
Hotels tend to have higher cap rates than traditional real estate sectors like offices or residential, mainly because they are operating businesses sensitive to economic cycles and market volatility.
In the U.S., average hotel cap rates rose to about 8% in 2023, up from 6% before the pandemic. This shift indicates that there is reduced investor confidence in the sector and, therefore, higher risk premiums due to uncertain demand recovery and rising capital costs.
Cap rates also vary significantly by hotel type. Value-add opportunities (that is, more risky investments requiring repositioning) can trade at cap rates above 10%. In contrast, prime assets in stabilized markets, like urban luxury hotels, can have cap rates in the 6-7% range (MMCG).
Understanding how cap rates reflect market sentiment and income risk is important for investors when comparing hospitality assets and evaluating investment opportunities.
How to Value a Hotel with the Cap Rate Method
To apply the cap rae method in hotel valuation, follow these key steps:
- Determine Net Operating Income (NOI): Calculate the hotel’s annual NOI by subtracting operating expenses (e.g., wages, maintenance, property taxes) from total revenue (rooms, F&B, ancillary services).
- Identify the Appropriate Cap Rate: Analyze recent sales of comparable hotel properties to derive a market-based cap rate. For example, if a comparable hotel sold for $1 million and had an NOI of $100,000, the cap rate is $100,000 ÷ $1,000,000 = 10%. Find a range of cap rates and adjust to fit your valuation subject by considering factors such as brand strength, location, and revenue stability.
- Calculate the Hotel’s Value: Use the formula Value = NOI ÷ Cap Rate. For instance, if your hotel’s NOI is $500,000 and the selected cap rate is 10%, the estimated value is $5 million.
Even though cap rates are market-derived, this method is considered a reliable income-based approach for stabilized hotel assets when sufficient comparable sales data is available.
Pros and Cons of the Cap Rate Method
The cap rate method is widely used in hospitality valuation because it is simple and based on income data. It is especially suitable for valuing standard properties with stabilized revenues, and for benchmarking in established hotel markets where comparable sales and NOI figures are accessible.
However, the method assumes stable incomes and that assets are comparable, which is not always the case. Unique, premium, or development-stage hotels may not fit well within the standard cap rate ranges, and applying the method without adjusting can distort value.
In short, the cap rate method is efficient for stabilized assets but limited when comparability or income predictability is limited.
The Income Capitalization Approach: Discounted Cash Flow (DCF) Method
The discounted cash flow method (DCF) hotel valuation method accounts for the future earnings potential of a property and is widely used for appraising all kinds of real estate assets. Unlike simpler methods based on current income, DCF looks ahead by adjusting a hotel’s projected income to reflect its present value.
A DCF model generally assumes a holding period (often 10 years) during which the hotel generates income, followed by a sale of the asset at the end. It is considered one of the most accurate hospitality valuation methods.
How to Calculate Hotel Value Using DCF
Here are the key steps to valuing a hotel using the DCF approach:
- Project Future Cash Flows: Estimate the hotel’s annual Net Operating Income (NOI) over by forecasting future demand, occupancy, and ADR over a set investment period (typically 10 years).
Example: Let’s assume $1,000,000 in annual NOI for 5 years
- Determine the Discount Rate: This rate reflects the return investors expect, given the risk of the investment. Common models include:
- Weighted Average Cost of Capital (WACC): Reflects both debt and equity costs
- Capital Asset Pricing Model (CAPM): Focuses on equity return expectations.
- Market Data: Cap or yield rates can also be found from sources such as PwC, Deloitte, CBRE, or JLL.
Example: Let’s assume a 9% discount rate.
- Discount Future Cash Flows: Apply the discount rate to each year’s cash flows using the present value formula:
Where:
- PV = present value
- NOI = net operating income
- r = discount rate
- n = year
Example:
- Year 1: $1,000,000 ÷ (1.09)^1 = $917,431
- Year 2: $1,000,000 ÷ (1.09)^2 = $841,051
- Year 3: $1,000,000 ÷ (1.09)^3 = $772,523
- Year 4: $1,000,000 ÷ (1.09)^4 = $708,743
- Year 5: $1,000,000 ÷ (1.09)^5 = $650,684
Total Present Value of 5-Year Cash Flows = $3,890,432
- Estimate Terminal Value (Sale Price): Since hotels are often sold after a set holding period, the terminal value represents the expected proceeds from that future sale, which can significantly influence overall valuation. Two common ways:
- Perpetuity Growth Model: Assumes perpetual, long-term growth in cash flows, making it suitable for mature and stable assets.
- Exit Multiple: Applies a market-based multiple, such as the EBITDA multiple. Suitable for transitional or growing hotels.
Example: let’s assume a terminal value of $10 million
- Discount Terminal Value: Bring the projected sale price back to present value using the same discount rate.
Example: $10,000,000 ÷ (1.09)^5 ≈ $6.5 million
- Calculate Total Value: Final Hotel Valuation = Present Value of Cash Flows + Present Value of Terminal Value
Example: Estimated Hotel Value = $3.89 million + $6.5 million = $10.39 million
Pros and Cons of the Discounted Cash Flow (DCF) Method
The greatest strength of the DCF method is that it can account for the nuances of hotel operations by modelling projected future cash flows. It is highly versatile and suitable for nearly any hospitality asset class, even hotel developments or assets with irregular income patterns. For example, cash flow inputs can include a ramp-up period after opening or any planned capital expenditures.
However, the DCF method is highly sensitive to assumptions. Even small growth rate, occupancy, or ADR changes can lead to vastly different valuation outcomes. If enough reliable data is not available, the results can be misleading. Additionally, building a robust DCF model can be complex and time-consuming.
That said, the beauty of the DCF method is that you can make it as detailed and nuanced as you like. You can simulate different kinds of demand scenarios with a high level of precision. Just remember: the accuracy of the DCF model is entirely determined by the quality and realism of your assumptions, which should always be based on credible market data.
Sales Comparison Approach
The sales comparison approach assumes that an informed buyer will pay for a hotel only as much as the cost of acquiring a comparable, recently sold property. By analyzing transaction prices of similar properties, you can derive a value range to benchmark your subject hotel.
How to Value a Hotel with the Sales Comparison Approach
Valuing a hotel asset with the sales comparison approach is based on finding finalized transactions of similar and comparable properties. Factors that determine comparability include:
- Location: city, proximity to demand drivers such as airports or tourist attractions, market tier
- Hotel Class and Brand Positioning: Segments such as luxury or economy, and affiliation with a hotel brand
- Size and Number of Keys: The number of rooms impacts operations and how much revenue potential the hotel has
- Age and Physical Condition: The building year or last renovation influences ADR and capital expenditure needs
- Operating Performance: Performance across metrics like occupancy, ADR, RevPAR, and NOI or EBITDA margins. Similar buildings with very different performance levels may not be comparable
- Ownership and Operational Structure: Whether the hotel is franchised, third-party managed, or owner-operated impacts fee structures and profitability
It is useful to create a comp set of properties that closely resemble the subject asset and conduct a hotel competitor analysis to evaluate benchmarks. Adjustments should then be made to account for differences between your subject property and the comp set. For example, a better location or newer renovations may justify a higher valuation.
Common Sales Comparison Metrics
Transaction data is often expressed in industry-standard terms such as:
- Price per Key: Sale price ÷ by the number of rooms; most common benchmark.
- Price per Square Meter/Square Foot: Sale price ÷ gross building area; useful for physical comparisons.
Understanding these metrics allows for quick benchmarking.
Pros and Cons of the Sales Comparison Approach
The sales comparison approach can be a helpful indicator of what investors are willing to pay in the market, given that there is reliable information available. It is especially suitable for limited-service and select-service hotels that have fewer variables (such as spas or extensive meeting spaces), which makes them easier to compare with other properties. The sales comparison approach is also ideal for chain-affiliated properties that follow uniform brand standards, as the same room count and brand strength make comparisons more valid.
Unfortunately, hospitality sector transaction data is often limited or confidential. Moreover, relying solely on comparable sales can overlook significant operational or contextual differences. Each hotel is unique; adjustments should always be made when applying comparable benchmarks.
What to Do When Data Is Sparse
In cases where recent transaction data is unavailable, hospitality real estate indices (such as those from STR, CBRE, or HotStats) can offer useful benchmarks. These indices track changes in asset values across segments and locations, which can give a directional view of market trends.
Because they average across hotel types and ignore many nuances, they are not precise enough for valuing individual assets. That said, indices offer a speedy macro-level view of the hotel sector and can help validate valuation assumptions, especially when other data is limited. They are instrumental in the early stages of valuation when conducting a full appraisal is not feasible.
Hospitality Valuation Best Practices: Tips for Accurate Appraisals
There are many ways to value a hospitality asset, but not all methods are created equal. Some are quick and simple but lack nuance, while others are more complex. Each approach comes with its strengths and caveats.
Using multiple valuation methods in tandem is considered best practice for a more accurate appraisal. Relying on a single method will more often than not be limiting and lead to blind spots. This is especially the case for the hospitality industry, which is highly cyclical. The results from different valuation methods will give a realistic range of prices, which can also help you be more confident in the outcome.
Finally, just like the industry, hotel values are not static and will be influenced by market conditions, interest rates, and global events. Value shifts can be significant even over a short period. This is why valuations should be refreshed regularly to stay up to date with current realities.
.jpg)
