Deductions for Hotel Values

[jwalters]

Hi- This is primarily for commercial appraisers-
I have seen hotel appraisals recently with deductions applied after their indicated value(s) called "capital deductions" or under other names. I have seen the deductions applied under the Cost, Income, and Market approaches. The premise apparently is that these expenditures are needed above and beyond structural reserves or reserves for replacement in order for the hotel to remain competitive in their competitve set.
An example would be:
Income value: $12,000,000
Capital Deduction: $4,000,000
"As Is" value $8,000,000

Historically, these would be seen as capital improvements, and the deductions would be inappropriate. Any thoughts or ideas? Thanks, Joe

 

[Michigan CG]

Your question will get a lot more responses in the Commercial area of the forum as some commercial folks only check that area. I have moved it there.

As to your question, do you have some of the verbiage from one of those appraisals you could post to make your question easier to answer?

 

[CANative]

I'm working on a 300 room property near a major international airport and major sports/entertainment venue. It's in a redevelopment corridor. It's been closed since 2005 and needs approval for a CUP because it's been vacant for more than a year. They have approval by the jurisdiction but a trade union has been appealing the decision for a couple of years.

Meanwhile it just sits there and gets older and has not kept up with competitive properties. There going to need millions to make it competitive once it re-opens.

Is your concern merely about where this adjustment is presented?

 

[jwalters]

The two appraisals that I have seen these deductions on were for open and operating hotels. Essentially, the appraisers looked at their actual income for the past three years and their declining NOI's. They gave an indicated value based on their income streams and then deducted the amount needed for renovation to be competitve in the future. One of the appraisals did a DCF and gave a 2013 estimated value after renovations.

My concern is if this is an appropriate deduction to be made. Wouldn't reserves allow the hotel to remain competitve? Is this an acepted adjustment to change the indicated value of the property by the amount needed for renovation? Thanks

 

[nstanbru]

Not seeing the explanation provided in the reports leads me to just make a guess. Allowances for reserves would provide for replacement of items as needed. The amount they're allowing for renovations may be for remodeling/updating. This figure would be in excess of merely replacing items as needed. Agian, just a guess without being able to see the reports.

 

[jwalters]

Thanks for the reply-
So this is an accepted procedure or adjustment for hotels that need updating = take the amount needed for updating off of the bottom of the indicated value, for wahtever approach you are using?

 

[Financially Feasible]

Hi- This is primarily for commercial appraisers-
I have seen hotel appraisals recently with deductions applied after their indicated value(s) called "capital deductions" or under other names. I have seen the deductions applied under the Cost, Income, and Market approaches. The premise apparently is that these expenditures are needed above and beyond structural reserves or reserves for replacement in order for the hotel to remain competitive in their competitve set.
An example would be:
Income value: $12,000,000
Capital Deduction: $4,000,000
"As Is" value $8,000,000

Historically, these would be seen as capital improvements, and the deductions would be inappropriate. Any thoughts or ideas? Thanks, Joe

On the surface, it sounds to me like the the difference between "as stabilized" and "as is" values. The capital deduction would need to be inclusive of the actual cost of the capital improvements, any lost income (room rental income, restaurant income, other income, etc) due to the required improvements and entrepreneurial incentive (if applicable).

Think about it this way, Joe. You have the option of buying 2 hotels, each listed for $12,000,000, and are identical in every way except for:

Hotel A is in perfectly fine shape and doesn't need a thing.

Hotel B needs $4,000,000 in improvements.

Which would you pay $12,000,000 for? Chances are, Hotel A. Therein is the reason for the necessity of the capital deduction to arrive at the "as is" value. The "income value", as you had called it, assumes that there are no major capital improvements required and that things are functioning on a stabilized basis (with normal vacancy rates, etc, etc).

Hope this helps!

 

[PL1957]

Thanks for the reply-
So this is an accepted procedure or adjustment for hotels that need updating = take the amount needed for updating off of the bottom of the indicated value, for wahtever approach you are using?

It's likely that the deduction is for a required PIP (Property Improvement Program). These are often required by specific chains in order to maintain affiliation.

 

[Phil McDonald]

PIP Deduction

PL1957 is correct. Any franchised hotel will have a PIP (Product Improvement Plan) which includes the correction of any deficiencies required to meet current standards as well as any additional items required to meet new standards. While a hotel is continuing to operate under the same ownership these items are often phased in over a period of time to avoid a single large investment in capital improvements. When the ownership of a property transfers the franchise will conduct an inspection of the property to identify any undiscovered deficiencies and will often require that the previously known deficiencies scheduled to be complete over time, any newly discovered deficiencies and any new standards that were scheduled to be phased in over time all be completed as a condition of transferring the flag to a new owner. The result is a large capital improvement investment at the time of transfer. All things are negotiable and often times the timing of completion of the PIP list can be negotiated, however it must be assumed that it will be required upon transfer, if a negotiated agreement is not in place.

The amount of the transfer PIP has a direct impact on the value of the property. A property with trailing income figures supporting a value of $4,000,000 that would require an additional investment of $500,000 in PIP upon transfer is not worth $4,000,000 since the additional investment of $500,000 would be required to preserve the historical property performance trend which is the basis for the value conclusion. The PIP investment does not result in additional or higher revenue and only preserves the existing revenue by maintaining the same flag.


The definition of Market Value requires that the transfer PIP be given consideration without regard to the specific transaction (purchase or refinance).

It is also important to note that while reasonable estimates can be made regarding the amount of the transfer PIP based on a review of previous QA reports and new standards, until the transfer inspection is complete it is a bit of a WAG.


Keep in mind that PIP items are not exclusive to the real estate and often involve non real estate items such as new bedding packages, case goods, etc.. However, the real estate and non real estate items are both required to generate the revenue which is the basis of the value conclusion. I have seen an after value conclusion deduction for the value of the non real estate items to arrive at a value of the real estate. In my opinion, this is a flawed approach when valuing a hotel, but I understand why this is done.

 

[studyhard462]

Keep in mind that PIP items are not exclusive to the real estate and often involve non real estate items such as new bedding packages, case goods, etc.. However, the real estate and non real estate items are both required to generate the revenue which is the basis of the value conclusion. I have seen an after value conclusion deduction for the value of the non real estate items to arrive at a value of the real estate. In my opinion, this is a flawed approach when valuing a hotel, but I understand why this is done.

I have seen hotel appraisals which deduct an amount for the non-real estate items (FF&E) to get down to a value of the real estate only. How would you account for these items?