Hotel Values and PIPs

[Funky Obsolescence]

I saw a good old thread on hotel valuation and PIPs.

https://appraisersforum.com/forums/threads/deductions-for-hotel-values.170814/

I had some follow up questions.

So you've got a hotel that is listed for sale at $5M but it has $1M in PIPs. $200K of that is FF&E. Would you deduct the entire $1M off the value? Should the FF&E be treated any differently?

What if the owner decided they didn't want to do the PIP. They might lose the flag but they could sell it to another brand. Would this call into question just deducting the $1M off of the value? My guess is this could be further complicated by the fact that if the owner refuses to do the PIP and cancel the license agreement, I assume there would be some sort of cancelation fee.

Long story short. Some of these PIPs can be a very high number. So I just want to make sure I'm doing this correctly if I'm going to knock it off the overall value.

 

[Terrel L. Shields]

So you are saying that the sale would require the buyer to upgrade to latest standards and that 20% of that is furnishings? Or is the seller going to do the upgrades? I would say the "as is" value would be value sans any improvements but is the lender asking for the value assuming the PIPs will be done? Which begs the question of what the value of the soon to disappear personal property is. Is it zero to keep the flag?

I am not sure about any cancellation fee but there would be a cost to remove the old franchise logos and signage.

 

[Funky Obsolescence]

Thank you for your reply. This is a hypothetical example. So no lender involved. My guess is that the owner could do the PIP and sell. Or sell at a discount to a buyer who would then do the PIP. Good point about the existing personal property. I wouldn't likely be $0.00 but it probably wouldn't be much. The cancelation fee would depend on how much time is left on the agreement. But I know these fees do exist. Still trying to ascertain if the PIP value should be subtracted from the overall value dollar for dollar. Seems like it should be if you are looking at this from an investor's perspective.

 

[Terrel L. Shields]

Seems like it should be if you are looking at this from an investor's perspective.

I run into the exact issue with poultry farms. With the sale, unless sold under a longer term contract, a chicken farm will be required to update the barns to the integrator's specs, be that the current integrator or that the buyer has arranged for a new integrator (chicken company) to take the birds. My neighbor's chicken farm went under. The new buyer had to modify the barns to suit a new contract which was a free range contract so he had to build little doors to open so the birds would wander outside during the day. Then they had to shoo them back inside at night.

 

[KHS445]

Lots going on in this situation. First thing is you will need to consider all three approaches to value, both pre and post the anticipated PIP. I will assume it is a newer property as it is flagged, and a PIP is being required to maintain that flag. So, the cost approach should be fairly straightforward. Sales approach would require that you look at pre and post PIP sales for properties with similar quality/reputation flags. See how a lack of how a PIP affected these sales. When it comes to the income approach it is going to get much more detail and probably require three or more scenarios be worked thru. First would be value as is based on current income and expenses. Second would be value after the PIP, keeping in mind not only the expenses of the PIP, and depending on the age and condition of the existing improvements, room rates and occupancy may increase after the PIP is completed. Also depending on how extensive the renovations are R&M may decrease. Then you will want to consider what would happen if the PIP were not completed. What impact would there be if the property became unflagged, what would happen (to room rates, occupancy, R&M expenses) and what would happen to costs, occupancy, room rates, possibly fewer required updates, R&M expenses, etc. if the property were converted to a different flag?

Keep in mind the franchise flag that flies in front of the property is very important, not only based on reputation but a big one is the reservation system and loyalty rewards program associated with a particular flag. I didn't fully realize how important a flag can be until a developer was building a new hotel across the street from our public beach. Many of the locals, including the Planning Commission and City Council, pushed for a smaller project and suggested a couple of alternative flag options. The developer was adamant that the flag he was proposing was the only one that made financial sense in the situation. Long story short, the project is completed and based on my nearly daily observation of the parking lot it does not appear they are even close to hitting their stated occupancy goals and the publish room rates are below projections. But I am not surprised as in an open meeting I had provided the developer with three years of monthly occupancy and the ADR for three other national franchised hotels in the community. Yes, the information I shared was with permission of the hotel owners.

 

[Funky Obsolescence]

Thank you KHS445! Great point about R&M expenses possibly decreasing after a PIP. I'm guessing the cap rate would also decrease. The challenge is to find good data. The ideal is to find sales of similarly flagged properties with income/expense data in the subject's market area that have before and after PIP numbers. Ha! Good luck, right?! But we do the best we can with the info we have.

 

[KHS445]

Thank you KHS445! Great point about R&M expenses possibly decreasing after a PIP. I'm guessing the cap rate would also decrease. The challenge is to find good data. The ideal is to find sales of similarly flagged properties with income/expense data in the subject's market area that have before and after PIP numbers. Ha! Good luck, right?! But we do the best we can with the info we have.

Depending on your market you may have to expand your search to cover areas that are similar in Illinois or even similar areas in adjoining States. I will occasionally complete an appraisal on a non-flagged mom and pop type property, but I generally refer flagged properties to an MAI located in Traverse City. He has been doing hotel/motel appraisals all over the State, from major metropolitan areas to Mackinac Island to the most remote areas of the Upper Peninsula. When I was in banking, he was my go-to person for hotels/motels. He has 30+ years of experience and has literally completed 100's of hotel/motel appraisals. I have a great deal of respect for him and his work.

 

[Terrel L. Shields]

One of the worst situations I saw a fellow in was an older motel in a town whose population was about 50k but within a few hundred of its 1950 population. Sleepy town. Developer proposed and built a dog racing track. It lasted one year, but 3 new franchise motels built in town along with a bunch of fast food franchises. The old motel sported a decent cafe which suddenly got no business and closed. He cut rates to $29 but when Super 8, Holliday In Express, etc. were suddenly without the dog track, they slashed rates too. So had the park been successful perhaps he could have competed on price, but lasting only one year, the town was suddenly over-supplied with motel rooms. No PIP is gonna fix that.

 

[Funky Obsolescence]

Wow. That's quite a story. I would have never thought that dog racing would have the drawing power to bring in a Super 8, Holiday Inn Express and fast food chains. Fun fact I found online. Today, the only states that still allow greyhound racing and have active tracks are Alabama, Arkansas, Iowa, Texas and West Virginia. There are four states that do not have active racetracks, but still have laws legalizing greyhound racing. Those states are Wisconsin, Connecticut, Kansas, and Oregon.

 

[Terrel L. Shields]

Wow. That's quite a story. I would have never thought that dog racing would have the drawing power to bring in a Super 8, Holiday Inn Express and fast food chains. Fun fact I found online. Today, the only states that still allow greyhound racing and have active tracks are Alabama, Arkansas, Iowa, Texas and West Virginia. There are four states that do not have active racetracks, but still have laws legalizing greyhound racing. Those states are Wisconsin, Connecticut, Kansas, and Oregon.

This was Kansas. A buddy used to make W. Memphis and there was a park in Colorado Springs. Dogs run truer to their racing form than horses. Horses are too prone to have jockeys hold back a horse so their buddies can get in the money to pay their part of the motel bill...or the owner wants to hold back the horse so their get better odds in the race they want to let them run. That came from a horse groom who worked the circuit for several years. So he preferred to bet the dogs. If he could pick 2 dogs to win, he'd bet every combination in the Pick Six or Trifecta. Won $1800 with $200 bet once.