Hotel Methodology

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Hotel valuation methodology
There are a number of different methodologies that are used across the world to calculate the
value of hotels, the most commonly used of which are outlined below. It is up to the valuer to
determine the methodology that best reflects the approach taken by the market in the location
and at the time of valuation.
The two key methods used to value hotels are the profits method of valuation and the
comparable method of valuation.
The profits method
Although the profits method is a specific and separate method of valuation, it is constantly
combined with the practice used in the comparable method, with almost each step in the
profits method being linked to comparable hotels (whether comparable trading levels or
comparable multiples being applied to profit levels).
There are two main methods for calculating the value of a property using the profits method;
the income capitalisation method and a discounted cashflow method.
Income capitalisation approach (or the income cap method)
The income cap method is one of the most common approaches adopted in calculating the
value of a hotel. The sustainable profit level or EBITDA (earnings before interest, taxation,
depreciation and amortisation) of the hotel is determined and a multiple is applied to these
earnings to determine the value.
Example 1: Hotel Jennifer (Freehold, VP hotel with stabilised

trading)
In this example, a freehold hotel with the benefit of vacant possession, it has been calculated
that the sustainable EBITDA for the 100 bedroom hotel is achievable in year 1 and has been
calculated as follows:
Forecast in present values
YEAR 1
Number of rooms 100
Rooms sold 25,550
Rooms available 36,500
Occupancy 70%
ADR 85.00
RevPAR 59.50
Growth (RevPAR)
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REVENUES ('000s)
Rooms 2,171.8 65% 2,171.8 65% 2,171.8 65%
Food 501.2 15% 501.2 15% 501.2 15%
Beverage 400.9 12% 400.9 12% 400.9 12%
Total food & beverage 902.1 27% 902.1 27% 902.1 27%
Room hire 0.0 0% 0.0 0% 0.0 0%
Leisure club 200.5 6% 200.5 6% 200.5 6%
TOTAL 3,341.2 100% 3,341.2 100% 3,341.2 100%
DEPARTMENTAL PROFIT
Rooms 1,563.7 72% 1,563.7 72% 1,563.7 72%
Room hire 0.0 100% 0.0 100% 0.0 100%
Leisure club 84.2 42% 84.2 42% 84.2 42%
Other income 23.4 35% 23.4 35% 23.4 35%
TOTAL 2,032.1 60.8% 2,032.1 60.8% 2,032.1 60.8%
DEPARTMENTAL COSTS 1,309.1 39.2% 1,309.1 39.2% 1,309.1 39.2%
UNDISTRIBUTED OPERATING EXPENSES
Administrative & general 300.7 9% 300.7 9% 300.7 9%
Sales & marketing 133.6 4% 133.6 4% 133.6 4%
Property operations & maintenance 133.6 4% 133.6 4% 133.6 4%
Utility costs 106.9 3.2% 106.9 3.2% 106.9 3.2%
TOTAL 674.9 20.2% 674.9 20.2% 674.9 20.2%
INCOME BEFORE FIXED COSTS 1,357.2 40.6% 1,357.2 40.6% 1,357.2 40.6%
FIXED COSTS
Reserve for renewals 133.6 4% 133.6 4% 133.6 4%
Property taxes 167.1 5% 167.1 5% 167.1 5%
Insurance 33.4 1% 33.4 1% 33.4 1%
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Management fees 100.2 3% 100.2 3% 100.2 3%
Head office costs 0.0 0% 0.0 0% 0.0 0%
TOTAL 434.4 13% 434.4 13% 434.4 13%
Incentive management fee 0.0 0% 0.0 0% 0.0 0%
As can be seen trading is anticipated to remain the same over the three year period, resulting
in a RevPAR of £59.50 in present values, based on a 70% occupancy rate and an £85 ADR.
The revenue mix also remained constant, as did department costs and undistributed operating
expenses.
A number of other hotels in the area and of a similar quality have been sold off a capitalisation
rate of 9% and it has been determined that this is the appropriate rate to adopt for.
INCOME CAPITALISATION
NET BASE CASHFLOW
EBITDA in 1 values in year 1 922,827
Capitalised at 9% 11.11 10,253,630
LESS Income shortfall -
Capital expenditrure -
Subtotal -
Gross value 10,253,630
Say 10,250,000
In simplistic terms the multiple for a property that has a capitalisation rate of 9.00% (in
perpetuity) is 11.11 (1/9.00%).
In this example there are no reductions for an income shortfall or capital expenditure.
The value is also reported gross of transaction costs in line with the guidance provided in the
Red Book.
The mathematical calculation has been rounded down to £10,250,000, which in this instance
reflects market practice. In choosing whether to round up or down, the valuer must take into
account the prevalent market practice.
Non-stabilised trading in year 1
There will be occasions where the trading of the hotel is not stabilised in the first year, indeed it
is more common for a hotel not to be at a stable level of trading. Listed below are just a few
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reasons that could lead to a hotel being unstabilised:
- the hotel has recently opened and is building up its trading base;
- the property has recently undergone a comprehensive refurbishment to improve the
bedroom product which should result in increased performance;
- the proposed purchaser is planning to invest capital expenditure in the property in
the future and this investment will improve the performance of the hotel. (It should
be noted that a personal plan to invest in a property will only be reflected in a market
valuation if the investment reflects the approach that the market would take when
looking at the property);
- a change in the supply dynamics in the local market has occurred, either with the
closing of competitor hotels, or with the opening of new hotels in the area;
- a change in the demand for hotels in the area, for example through new companies
opening in the area or changes in the road network or other transport links;
- changes occurring to the cost structure of the hotel, for example the need to employ
additional staff, introduction of a new employment regulation or a change in kitchen
equipment leading to operational savings that need to be reflected.
It is important to state that when using this method the valuer is working in present values.
When the trading has not already stabilised and is not anticipated to stabilise until future years
that growth in the income stream specifically excludes any growth attributable to inflation.
Example 2: Hotel Natasha (Freehold, VP hotel where trade has not

stabilised)
In this example a very similar hotel to that contained in Example 1 will generate a stabilised
EBITDA of £922,000, but as a new hotel it will take three years to achieve that level (in present
values) as shown below. The property is also a freehold hotel with the benefit of vacant
possession.
YEAR 1
Number of rooms 100
Rooms sold 18,250
Occupancy 50%
ADR 70.00
RevPAR 35.00
Growth (RevPAR)
REVENUES ('000s)
Rooms 1,277.5 65% 1878.3 65% 2,171.8 65%
Food 294.8 15% 433.5 15% 501.2 15%
Beverage 235.8 12% 346.8 12% 400.9 12%
Room hire 0.0 0% 0.0 0% 0.0 0%
Leisure club 117.9 6% 173.4 6% 200.5 6%
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TOTAL 1,965.4 100% 2,889.7 100% 3,341.2 100%
DEPARTMENTAL PROFIT
Rooms 919.8 72% 1,352.4 72% 1,563.7 72%
Room hire 0.0 100% 0.0 100% 0.0 100%
Leisure club 49.5 42% 72.8 42% 84.2 42%
Other income 13.8 35% 20.2 35% 23.4 35%
TOTAL 1,195.3 60.8% 1,757.5 60.8% 2,032.1 60.8%
DEPARTMENTAL COSTS 770.0 39.2% 1,132.2 39.2% 1,309.1 39.2%
Administrative & general 176.9 9% 260.1 9% 300.7 9%
Sales & marketing 78.6 4% 115.6 4% 133.6 4%
Utility costs 62.9 3.2% 92.5 3.2% 106.9 3.2%
TOTAL 397.0 20.2% 674.9 20.2% 674.9 20.2%
INCOME BEFORE FIXED COSTS 798.3 40.6% 1,173.8 40.6% 1,357.2 40.6%
FIXED COSTS
Property taxes 98.3 5% 144.5 5% 167.1 5%
Insurance 19.7 1% 28.9 1% 33.4 1%
Management fees 59.0 3% 86.7 3% 100.2 3%
TOTAL 255.5 13% 375.7 13% 434.4 13%
These projections are in present values and do not include inflation.
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The valuation of the property in this example shows the impact of this build up period until
stabilised trading is achieved. As can be seen we have deducted an Income Shortfall of
£504,685. This is the shortfall in the actual income received by the owner over the first two
years (until stabilisation) against what would have been earned if the property was earning at
its optimum level in the first year.
In this example the actual calculation is two years of stabilised income less the actual income
over the first two years £922,827 + £922,827- £542,839 - £798, 129 = £504,685.
NET BASE CASHFLOW
Capitalised at 9% 11.11 10,253,630
LESS Income shortfall 505
Subtotal 505
Say 9,750,000
However it is vital to state that comparable evidence is extremely important as an indication of

the capital value and the yields adopted in the market, and to set a basic tone for the valuation
that is being undertaken.
Example 3: Hotel Reiko (investment hotel - freehold subject to an

operational lease, with stable owner's income projections)
This example is a freehold hotel, let on a 20 year lease, paying £800,000 per annum to an
experienced operator, a level that is thought to reflect the full market rent value of the property
(and would be re-lettable at the end of the lease at the same rent).
Although the lease term in this example is 20 years, the £800,000 a year rent can be
considered the net income in perpetuity, in current values (i.e. the level that the hotel would be
considered to be re-let for in 20 years time).
In this example we are still concerned with the profitability of the hotel, although for the
purposes of the mathematical calculation it seems unconnected. The choice of the
capitalisation rate will depend on many factors including the affordability of the rent.
YEAR 1
Number of rooms 135
Rooms sold 36,956
Occupancy 75%
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ADR 70.00
RevPAR 52.50
Growth (RevPAR)
REVENUES ('000s)
Rooms 2,586.9 65% 2,586.9 65% 2,586.9 65%
Food 597.0 15% 597.0 15% 597.0 15%
Beverage 477.6 12% 477.6 12% 477.6 12%
Total food & beverage 1,074.6 27% 1,074.6 27% 1,074.6 27%
Room hire 0.0 0% 0.0 0% 0.0 0%
Leisure club 238.8 6% 238.8 6% 238.8 6%
Other income 79.6 2% 79.6 2% 79.6 2%
Rental 0% 0% 0%
Open revenue 4 0% 0% 0%
TOTAL 3,979.9 100% 3,979.9 100% 3,979.9 100%
DEPARTMENTAL PROFIT
Rooms 1,914.3 74% 1,914.3 74% 1,914.3 74%
Room hire 0.0 100% 0.0 100% 0.0 100%
Leisure club 100.3 42% 100.3 42% 100.3 42%
Other income 27.9 35% 27.9 35% 27.9 35%
TOTAL 2,472.3 62.1% 2,472.3 62.1% 2,472.3 62.1%
Administrative & general 338.3 8.5% 338.3 8.5% 338.3 8.5%
Sales & marketing 159.2 4% 159.2 4% 159.2 4%
Utility costs 127.4 3.2% 127.4 3.2% 127.4 3.2%
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TOTAL 784.0 19.7% 784.0 19.7% 784.0 19.7%
FIXED COSTS
Property taxes 187.1 4.7% 187.1 4.7% 187.1 4.7%
Insurance 39.8 1% 39.8 1% 39.8 1%
Management fees 119.4 3% 119.4 3% 119.4 3%
Rent 0.0 0% 0.0 0% 0.0 0%
Other costs 0.0 0% 0.0 0% 0.0 0%
TOTAL 505.4 12.7% 505.4 12.7% 505.4 12.7%
EBITDA 1,182.8 29.7% 1,182.8 29.7% 1,182.8 29.7%
Rent 800.0 800.0 800.0
Rent as a % of turnover 20.1% 20.1% 20.1%
Rent as a % of EBITDA 67.6% 67.6% 67.6%
As can be seen the rent equates to just over 20% of turnover and almost 68% of EBITDAR
(earnings before interest, taxation, depreciation, amortisation and rent) and the valuers
experience of the local market suggests that the property is fully rented.
We have calculated the EBITDA after the rent has been deducted to be just over 9.5% which
when the management fee has been added back means that the operator will earn
approximately 12.5% of turnover as their reward for operating the hotel.
The capitalisation rate that we have applied is based upon the lease terms, the value of the
tenant's covenant in the current market and the affordability of the rent.
NET BASE CASHFLOW
Capitalised at 6% 16.67 13,333,333
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LESS Income shortfall -
Subtotal -
Less transaction costs @ 5.75% 724,980
12,608,353
Say 12,610,000
It should be noted that in line with industry practice and RICS guidance we have deducted
transaction costs to arrive at the net value of the investment.
In this instance the transactions costs have been made up of 4% stamp duty, 1% agents fees
(including VAT) and 0.5% legal fees (including VAT). To calculate what these costs are it is
important to know that the gross value includes these costs already, and so to work out what
the costs actually are the formula is The Gross Value / 1+5.75%.
Transaction costs vary from country to country and will be determined by the various factors
that make up these costs; for example if stamp duty on property transactions was running at
10%, with agent's fees at 3% (inclusive of VAT) and legal fees at 1% (also inclusive of VAT)
then the transactions costs would be 14%.
Example 4 Hotel Nikki (Freehold investment property with a rent

review due shortly)
The fourth example is a hotel investment similar to the Hotel Reiko Example 3, although the
rent is reviewed to a market rent every fifth year, and the next rent review is due in one year's
time. For the purposes of this example the current rent passing is £650,000 per annum
although the market rent at the current stage is anticipated to be £800,000 per annum (in
present values).
YEAR 1
Number of rooms 135
Rooms sold 36,956
Occupancy 75%
ADR 70.00
RevPAR 52.50
Growth (RevPAR)
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REVENUES ('000s)
Rooms 2,586.9 65% 2,586.9 65% 2,586.9 65%
Food 597.0 15% 597.0 15% 597.0 15%
Beverage 477.6 12% 477.6 12% 477.6 12%
Total food & beverage 1,074.6 27% 1,074.6 27% 1,074.6 27%
Room hire 0.0 0% 0.0 0% 0.0 0%
Leisure club 238.8 6% 238.8 6% 238.8 6%
Other income 79.6 2% 79.6 2% 79.6 2%
Rental 0% 0% 0%
TOTAL 3,979.9 100% 3,979.9 100% 3,979.9 100%
DEPARTMENTAL PROFIT
Rooms 1,914.3 74% 1,914.3 74% 1,914.3 74%
Room hire 0.0 100% 0.0 100% 0.0 100%
Leisure club 100.3 42% 100.3 42% 100.3 42%
Other income 27.9 35% 27.9 35% 27.9 35%
TOTAL 2,472.3 62.1% 2,472.3 62.1% 2,472.3 62.1%
Administrative & general 338.3 8.5% 338.3 8.5% 338.3 8.5%
Sales & marketing 159.2 4% 159.2 4% 159.2 4%
Utility costs 127.4 3.2% 127.4 3.2% 127.4 3.2%
TOTAL 784.0 19.7% 784.0 19.7% 784.0 19.7%
FIXED COSTS
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Property taxes 187.1 4.7% 187.1 4.7% 187.1 4.7%
Insurance 39.8 1% 39.8 1% 39.8 1%
Management fees 119.4 3% 119.4 3% 119.4 3%
Rent 0.0 0% 0.0 0% 0.0 0%
Other costs 0.0 0% 0.0 0% 0.0 0%
TOTAL 505.4 12.7% 505.4 12.7% 505.4 12.7%
EBITDA 1,182.8 29.7% 1,182.8 29.7% 1,182.8 29.7%
Rent 650.0 800.0 800.0
Rent as a % of turnover 16.3% 20.1% 20.1%
Rent as a % of EBITDA 55.0% 67.6% 67.6%
As can be seen in the first year of trading (before the rent review) the tenant makes
significantly more profit from operating the hotel than after the rent review has been settled.
The lower rent received in the first year affects the value of the investment, as shown below.
NET BASE CASHFLOW
Capitalised at 6% 16.67 13,333,333
LESS Income shortfall 150,000
Subtotal 150,000
Less transaction costs @ 5.75% 716,824
12,466,509
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Say 12,450,000
When is the income capitalisation method used by valuers?
The income capitalisation method is used:
- for the majority of valuations of 2 to 3 star trading hotels that are valued with vacant
possession in the UK .The RICS Trading Related Valuation Group prepared a
Valuation Paper (no 6) which became effective in March 2004 called The Capital
and Rental Valuation of Hotels in the UK. In this paper they state: 'While it is
dangerous to over-generalise, the primary method for valuation for most UK
commercial hotels at 3 star and below would be on this basis (income capitalisation),
as would that for a number of 4 star units as well.'
- in conjunction with the DCF method as a check for most four - five star properties
with vacant possession in the UK and Europe .
- for many simple investment index-linked fixed rents deals in the budget and
mid-market sections of the UK market rather than turnover related or deals involving
future capital expenditure by the landlord.
- in conjunction with the DCF method for most investment deals in the UK and across
Europe .
The valuer should always use the income capitalisation method when it is the approach most
likely to be adopted by potential purchasers of the hotel.
Discounted cashflow
A discounted cashflow (DCF) is a projection of future earnings over a period of time to reflect
what the expected income will be over the period of the cashflow. It is normal practice in hotel
valuations to project earnings over either a five or ten0 year period.
The DCF approach is very similar to the income capitalistion approach, as both take the
stabilised EBITDA/Income of the property and multiply it by an appropriate rate to calculate the
value.
The main differences are that inflation/growth is explicitly included within the cashflow (rather
than bringing the earnings back to present values) and that the Discount Rate applied to the
stabilised earnings reflects this explicit assumption of growth.
Example 5: Hotel Alison (Freehold vacant possession hotel)

In this example a purchaser is looking to buy a property which has been poorly managed and
is intending to reposition it in the market, with trading anticipated to stabilise in three years
time.
YEAR 1
Number of rooms 85
Rooms sold 21,718
Occupancy 70%
ADR 52.50
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RevPAR 36.75
Growth (RevPAR)
REVENUES ('000s)
Rooms 1,140.2 60% 1,206.3 62% 1,285.7 65%
Food 380.1 20% 369.7 19% 356.0 18%
Beverage 228.0 12% 214.0 11% 197.8 10%
Leisure club 114.0 6% 116.7 6% 108.8 5.5%
Other income 38 2% 38.9 2% 29.7 1.5%
TOTAL 1,900.3 100% 1,945.6 100% 1,978.0 100%
DEPARTMENTAL PROFIT
Rooms 775.3 68% 868.5 72% 951.4 74%
Leisure club 45.6 40% 49.0 42% 45.7 42%
Other income 13.3 35% 13.6 35% 10.4 35%
TOTAL 1,065.3 56.1% 1,158.8 59.6% 1,229.0 62.1%
DEPARTMENTAL COSTS 835.0 43.9% 786.8 40.4% 749.0 37.9%
Administrative & general 190.0 10% 175.1 9% 168.1 8.5%
Sales & marketing 114.0 6% 97.3 5% 79.1 4%
Utility costs 60.8 3.2% 62.3 3.2% 63.3 3.2%
TOTAL 440.9 23.2% 412.5 21.2% 389.7 19.7%
INCOME BEFORE FIXED COSTS 624.4 32.9% 746.3 38.4% 839.3 42.4%
FIXED COSTS
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Property taxes 89.3 4.7% 91.4 4.7% 93.0 4.7%
Insurance 19.0 1% 19.5 1% 19.8 1%
Management fees 57.0 3% 58.4 3% 59.3 3%
Rent 0.0 0% 0.0 0% 0.0 0%
Other costs 0.0 0% 0.0 0% 0.0 0%
TOTAL 241.3 12.7% 247.1 12.7% 251.2 12.7%
The net cashflow over the five or ten year period is valued at the appropriate discount rate,
and is discounted back depending upon when the income is received. Determining the
appropriate discount rate is just as problematic as trying to determine the capitalisation rate to
apply in the income capitalisation method. Unless the valuer has evidence at hand of discount
rates that have been applied to similar properties (which is unlikely) the most prudent course of
action is usually to look at the more capitalisation rate evidence that has been used (which is
usually more plentiful) and then to adjust it through the use of the explicit inflation rate that has
been factored into the cash flow.
So for example if the appropriate capitalisation rate for the property is 9.5% and the cash flow
has assumed annual inflation of 2.5% then the discount rate would be 12.0%.
The residual value of the hotel is then calculated assuming that level of income in perpetuity
but discounted by ten years so that the delay in receiving that income is taken into account.
DISCOUNTED CASHFLOW
NPV Net Base Cashflow
Discounted at 12% 5,873,054
Say 5,875,000
Example 6: Hotel Penelope (Freehold Investment Hotel)

In this example the valuation is of a hotel let out on a turnover lease, with a fixed base rent of
£250,000, and an additional rent based upon the difference between the fixed rent and 22% of
turnover.
Year 1 4
No. rooms 150 150
Rooms sold 38,325 40,515
Rooms available 54,750 54,750
Occupancy 70% 74%
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ADR 52.50 60.31
RevPAR 36.75 44.63
Growth (RevPAR) 2.5%
REVENUES (000s)
Rooms 2,012.1 60% 2,181.9 62% 2,383.7 65% 2,443.3 65% 2,504.4 65%
Food 670.7 20% 668.6 19% 660.1 18% 676.6 18% 693.5 18%
Beverage 402.4 12% 387.1 11% 366.7 10% 375.9 10% 385.3 10%
Total food & beverage 1,073.1 32% 1,055.8 30% 1,026.8 28% 1,052.5 28% 1.078.8 28%
Room hire 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Leisure club 201.2 6% 211.2 6% 201.7 5.5% 206.7 5.5% 211.9 5.5%
Other income 67.1 2% 70.4 2% 55.0 1.5% 56.4 1.5% 57.8 1.5%
Rental 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Open Revenue 4 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Open Revenue 4 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Total Revenue 3,353.4 100% 3,519.2 100% 3,667.2 100% 3,758.9 100% 3,852.9 100%
DEPARTMENTAL PROFIT
Rooms 1,368.2 68% 1,571.0 72% 1,763.9 74 1,808.0 74% 1,853.2 74%
Total food & beverage 407.8 38% 411.7 39% 410.7 40% 421.0 40% 431.5 40%
Room hire 0.0 100% 0.0 100% 0.0 100% 0.0 100% 0.0 100%
Leisure club 80.5 40% 88.7 42% 84.7 42% 86.8 42% 89.0 42%
Other income 23.5 35% 24.6 35% 19.3 35% 19.7 35% 20.2 35%
Total profit 1,879.9 56.1% 2,096.0 59.6% 2,278.6 62.1% 2,335.6 62.1% 2,394.0 62.1%
DEPARTMENTAL COSTS 1,473.5 43.9% 1,423.2 40.4 1,388.6 37.9% 1,423.3 37.9% 1,458.9 37.9%
Administrative & general 335.3 10% 316.7 9% 311.7 8.5% 319.5 8.5% 327.5 8.5%
Sales & marketing 201.2 6% 176.0 5% 146.7 4% 150.4 4% 154.1 4%
Property operations & maintenance 134.1 4% 140.8 4% 146.7 4% 150.4 4% 154.1 4%
Utility costs 107.3 3.2% 112.6 3.2% 117.4 3.2% 120.3 3.2% 123.3 3.2%
Total expenses 778.0 23.2% 746.1 21.2% 722.4 19.7% 740.5 19.7% 759.0 19.7%
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INCOME BEFORE FIXED COSTS 1,101.9 32.9% 1,350.0 38.4% 1,556.2 42.4% 1,595.1 42.4% 1,635.0 42.4%
FIXED COSTS
Reserve for renewals 134.1 4% 140.8 4% 146.7 4% 150.4 4% 154.1 4%
Property taxes 157.6 4.7% 165.4 4.7% 172.4 4.7% 176.7 4.7% 181.1 4.7%
Insurance 33.5 1% 35.2 1% 36.7 1% 37.6 1% 38.5 1%
Management fees 100.6 3% 105.6 3% 110.0 3% 112.8 3% 115.6 3%
Head office costs 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Rent 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Other costs 0.0 0% 0.0 0% 0.0 0% 0.0 0% 0.0 0%
Total fixed costs 425.9 12.7% 446.9 12.7% 465.7 12.7% 477.4 12.7% 489.3 12.7%
Total rent received 737.8 22% 774.2 22% 806.8 22% 827.0 22% 847.6 22%
Base rent 250.0 7.5% 256.3 7.3% 262.7 7.2% 269.2 7.2% 276.0 7.2%
Additional rent 487.8 14.5% 518.0 14.7% 544.1 14.8% 557.7 14.8% 571.7 14.8%
EBITDA (61.7) -1.8% 128.8 3.7% 283.7 7.7% 290.8 7.7% 298.0 7.7%
As can be seen from the above table the two income streams have been separated and are
valued in the table below at different discount rates. This is to differentiate the level of certainty
to the investor that the income will be received.
Cashflow estimates - from profit & loss estimates
Years 1 2 3 4 5 6 7 8 9 10
Base rent 250 256 263 269 276 283 290 297 305 312
Additional rent 488 518 544 558 572 586 601 616 631 647
LESS capital expenditure
Net cashflow 738 774 807 827 848 869 891 913 936 959
In this instance the difference in risk attached to the different income streams has resulted in a
4% differential being applied, hence the 9% discount rate on the base rent and 13% on the
additional turnover rent.
DISCOUNTED CASHFLOW
NPV Net base cashflow
Page 16
Additional income
LESS costs @ 5.75% 449,887
Net value 7,824,117
Say 7,825,000
When are discounted cashflows used by valuers?
Discounted cashflows are often used:
- by most purchasers and valuers of mid-market and luxury hotels;

- in conjunction with the income capitalisation method for most 'branded' hotels; and
- for all but the simplest investment purchases.
The valuer should use the discounted cashflow approach to valuation when it is the approach
most likely to be adopted by potential purchasers of the hotel.
The comparison method - comparable evidence and prices per

bedroom
All valuers are taught as a basic first principle the best evidence is that set directly by the
market. However hotels are generally purchased because of their ability to generate profits
and as such this tends to dictate the price people will pay for a hotel.
Unfortunately in the case of hotels, it is extremely rare that two units are similar enough in their
trading patterns and potential to be used as direct comparable evidence.
Valuation information paper 6, The Capital and Rental Valuation of Hotels in the UK, prepared
by the Trading Related Valuation Group and published in March 2004 by RICS, stated the
following with regard to comparable evidence and its use:
- the comparables may differ in terms of location, facilities, trading records, business
mix, operating costs, size of property, trading opportunities, timing of transaction,
presence of special purchasers, and so on;
- the existing and potential competition and its impact on trade;
- the quality of the operation. This may or may not be reflected in its 'star rating', but
will be reflected in the size of rooms, the quality of fixtures, fittings, furniture,
furnishings and equipment, and the resultant trade;
- the existence of any franchise or management agreement;
- conditions attached to any planning permission;
- the existence of conservation areas and listed building constraints, and the impact of
these;
- the impact of any actual or potential contamination of the property;
- relevant lease provisions;
- means of escape in case of fire; and
- outstanding repairs, maintenance and renewals.
There are certain types of properties that are regularly purchased with reference to
Page 17
comparable evidence rather than profitability, and in these instances reference to direct
comparables will lead the valuer to the correct valuation. This is true for example of "lifestyle
hotels". A "lifestyle" property is a type of hotel that is usually owned and operated by people
who have based their decision to purchase a property on the desire to run a certain type of
hotel.
Example 7: Hotel Clare

In example 7 the Valuer is being asked to value the Hotel Clare, an 18 bedroom hotel in
Dartmoor, with a two bedroom owner's cottage to the rear of the hotel. In the last 12
months three broadly similar hotels have sold:
- Hotel Lynda was located in a comparable village with a similar tourist profile. It has
20 bedrooms and a 2 bedroom owner's cottage. It sold nine months ago for
£1,600,000 which equates to £80,000 per bedroom.
- Hotel Lesley was of a slightly inferior design and in a slightly less desirable
location.It had 12 bedrooms and a two bedroom owner's flat contained within the
actual building and sold for £720,000 which equates to £60,000 per bedroom, two
months ago.
- Hotel Lorelle is the most recent having sold one month ago. It had 15 bedrooms, a
2 bedroom owner's cottage and was in a slightly more desirable location and slightly
better condition.It sold for £1,500,000 which equates to £100,000 per bedroom.
So to summarise:
Property Date Size Price/bedroom
Hotel Lynda - 9 months 20 £80,000
Hotel Lesley - 2 months 12 £60,000
Hotel Lorelle - 1 months 15 £100,000
Hotel Clare 20 £ ?
The above comparable evidence suggests that the value of the property will be somewhere
between £60,000 - £100,000 per bedroom (£1,080,000 - £1,800,000) depending on how the
evidence is analysed.
It is essential that the Valuer has sufficient experience to be able to accurately analyse the
relevant comparable evidence.
In this particular example the Valuer was able to make the following adjustments:
Hotel Lynda
- + 5% for the time differential as the market has strengthened

- - 2% for slightly smaller property
- +1% for marginally better condition
- +0% for location
- + 4% total adjustment
Hotel Lesley
- + 0% for time differential

- + 15% for inferior location
- + 5% for smaller property
- + 10% for inferior owner's accommodation
- + 30% total adjustment
Hotel Lorelle
- + 0% for time differential
Page 18
- + 3% for smaller property

- - 8% for inferior location
- - 5% for inferior condition
- - 10% total adjustment
Summary:
Purchase price/bedroom Adjustment Adjusted value
Value/bedroom
Hotel Lynda £80,000 +4% £83,000
Hotel Lesley £60,000 +30% £78,000
Hotel Lorelle £100,000 -10% £90,000
On this basis the value of the hotel is likely to lie within a range of £78,000 - £90,000 per
bedroom (£1,400,000 - £1,620,000).
The Valuer will then be expected to further use their judgement to determine where within that
range this particular property would sit. In this instance it has been determined that the value
would be £85,000 per bedroom, equating to £1,530,000.
It should be noted that the appropriate level of adjustment will require a great deal of skill and
expertise by the valuer.In each case the appropriate adjustments will probably differ,
depending upon the prevalent market conditions.
When is the Comparison method used most often by valuers?
The RICS working paper for hotel valuations states that prices per bedroom are considered to
be at their most useful when valuing 'lifestyle' types of hotels or 'trophy' hotels.
Trophy hotels are those properties that are purchased in part because of kudos of owning the
property, leading to some transactions looking very expensive when analysed using normal
capitalisation/discount rates.
It is true that reference will be made to price/bedroom when valuing both lifestyle and trophy
hotels and that when there is a dearth of yield evidence in the market such comparables may
well influence the capitalisation rate adopted when undertaking the valuation.
It is also common, when purchasers of hotels know that the value is under-pinned by an
alternative use, for 'price per bedroom' measures to be employed, in preference to profitability.
Page 19

Hotel Methodology

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Hotel Methodology

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Hotel valuation methodology

The profits method

Income capitalisation approach (or the income cap method)

Example 1: Hotel Jennifer (Freehold, VP hotel with stabilised

Number of rooms 100

Rooms sold 25,550

Rooms available 36,500

Rooms 2,171.8 65% 2,171.8 65% 2,171.8 65%

Food 501.2 15% 501.2 15% 501.2 15%

Beverage 400.9 12% 400.9 12% 400.9 12%

Room hire 0.0 0% 0.0 0% 0.0 0%

Leisure club 200.5 6% 200.5 6% 200.5 6%

TOTAL 3,341.2 100% 3,341.2 100% 3,341.2 100%

Rooms 1,563.7 72% 1,563.7 72% 1,563.7 72%

Room hire 0.0 100% 0.0 100% 0.0 100%

Leisure club 84.2 42% 84.2 42% 84.2 42%

Other income 23.4 35% 23.4 35% 23.4 35%

TOTAL 2,032.1 60.8% 2,032.1 60.8% 2,032.1 60.8%

DEPARTMENTAL COSTS 1,309.1 39.2% 1,309.1 39.2% 1,309.1 39.2%

UNDISTRIBUTED OPERATING EXPENSES

Administrative & general 300.7 9% 300.7 9% 300.7 9%

Sales & marketing 133.6 4% 133.6 4% 133.6 4%

Property operations & maintenance 133.6 4% 133.6 4% 133.6 4%

Utility costs 106.9 3.2% 106.9 3.2% 106.9 3.2%

TOTAL 674.9 20.2% 674.9 20.2% 674.9 20.2%

Reserve for renewals 133.6 4% 133.6 4% 133.6 4%

Property taxes 167.1 5% 167.1 5% 167.1 5%

Insurance 33.4 1% 33.4 1% 33.4 1%

Management fees 100.2 3% 100.2 3% 100.2 3%

Head office costs 0.0 0% 0.0 0% 0.0 0%

TOTAL 434.4 13% 434.4 13% 434.4 13%

Incentive management fee 0.0 0% 0.0 0% 0.0 0%

NET BASE CASHFLOW

EBITDA in 1 values in year 1 922,827

Capitalised at 9% 11.11 10,253,630

LESS Income shortfall -

Gross value 10,253,630

Non-stabilised trading in year 1

reasons that could lead to a hotel being unstabilised:

Example 2: Hotel Natasha (Freehold, VP hotel where trade has not

Number of rooms 100

Rooms sold 18,250

Rooms available 36,500

Rooms 1,277.5 65% 1878.3 65% 2,171.8 65%

Food 294.8 15% 433.5 15% 501.2 15%

Beverage 235.8 12% 346.8 12% 400.9 12%

Room hire 0.0 0% 0.0 0% 0.0 0%

Leisure club 117.9 6% 173.4 6% 200.5 6%

TOTAL 1,965.4 100% 2,889.7 100% 3,341.2 100%

Rooms 919.8 72% 1,352.4 72% 1,563.7 72%

Room hire 0.0 100% 0.0 100% 0.0 100%

Leisure club 49.5 42% 72.8 42% 84.2 42%

Other income 13.8 35% 20.2 35% 23.4 35%

TOTAL 1,195.3 60.8% 1,757.5 60.8% 2,032.1 60.8%

DEPARTMENTAL COSTS 770.0 39.2% 1,132.2 39.2% 1,309.1 39.2%

UNDISTRIBUTED OPERATING EXPENSES

Administrative & general 176.9 9% 260.1 9% 300.7 9%

Sales & marketing 78.6 4% 115.6 4% 133.6 4%

Property operations & maintenance 78.6 4% 115.6 4% 133.6 4%

Utility costs 62.9 3.2% 92.5 3.2% 106.9 3.2%

TOTAL 397.0 20.2% 674.9 20.2% 674.9 20.2%

Reserve for renewals 78.6 4% 115.6 4% 133.6 4%

Property taxes 98.3 5% 144.5 5% 167.1 5%