Without a clear industry recovery on the horizon, hotel appraisers are taking it one week at a time when conducting property valuations.
REPORT FROM THE U.S.—The COVID-19 pandemic and its widespread impact has created a complicated new dynamic for the hotel valuation process.
Hotel appraisal experts are saying valuations require both deep expertise and a much more short-term analytical process than employed in the past. Instead of forecasting hotel performance many years in advance, some appraisers are now reviewing property history and making projections one week at a time.
It’s a situation that’s challenging for even the most veteran appraisers. In the past, hotel valuation was often more science than art, following a clear-cut analytical process that could be systematically taught to junior appraisers. Now the prospect of conducting a hotel valuation in the COVID-era world is far more complicated, demanding a considerably deeper skill set.
“It’s really requiring appraisers to have senior-level knowledge and abilities, versus somebody who is a year into the business,” said Mike Cummings, managing director at Horwath HTL. “It’s really challenging for those entry-level appraisers to be able to see through everything and forecast based on what they see. It’s really dependent on the folks who have 15- or 20-plus years of experience, plus an economic and finance background, to be able to get a good understanding of what’s currently going on.”
And as if that wasn’t enough of a tall order, there are also the difficulties caused by current travel restrictions and risks. Much of the fieldwork that was previously conducted in-person by appraisers—including site inspections, interviews and market research—cannot be performed from the office.
“It’s challenging to visit properties. … You’ve got to be careful in that situation,” Cummings said. “Are you actually going to try to value it from your desk? That’s extremely difficult, because now it’s even more important that you have those interviews with the competition and your property managers and get a real sense of the market. Somebody who only appraises a couple of hotels a year could really miss the boat, versus somebody who does nothing but hospitality appraising. Specializing in the hospitality industry really is needed today.”
The speed of change
One of the biggest changes is the way the COVID-era hotel business has forced appraisers to rely on weekly performance metrics, rather than monthly or annual reports, in order to analyze trends and make forecasts. At the moment, there’s just not enough certainty to project too far into the future. That’s making timely data delivery more crucial than ever.
“We’re really having to delve into weekly STR reports. That is the guide to how your hotel is performing,” Cummings said. “You know the current occupancy that week and where has it been for the last couple weeks. In this unusual situation, you can kind of see a trend as far as are they still declining or (have) they’ve kind of bottomed out a little bit. So those weekly reports really help you set the baseline and the tone for what you’re looking at. Then you have to take that and almost go on a weekly forecasting model situation, versus your standard yearly forecast.”
(STR is the parent company of Hotel News Now.)
Beyond that, experts say it’s best to focus on where the property’s cash flows will likely be in three years, hopefully well after the pandemic has subsided. The global hotel appraisal firm HVS is referencing a model seen during the post-2008 downturn, when investors obtained loans at lower loan-to-value ratios at the market’s bottom, then refinanced at higher LTVRs three years later, when normal cash flows returned. That future refinancing also provides one’s return on investment.
“We’re dusting off that model and working to implement it on valuations now,” said Anne Lloyd-Jones, senior managing director at HVS and director of consulting and valuation at its New York office. “Basically you’re looking at the potential down the road and acknowledging that things aren’t great at this exact moment, but that three-year window that you’re looking at down the road enhances the opportunity today.”
Running on fumes
Another way in which hotel valuations are changing to reflect the COVID-19 pandemic is in how appraisers review and forecast operating expenses, which are a core element of cash flow analysis. The near-overnight shift from hotels performing at high occupancy to being empty or near empty creates an entirely different level of expenditures at a property.
“For hotels that are operating with skeleton crews, your traditional methods of applying fixed and variable operating ratios aren’t adequate, so you really have to get dialed-in on what the actual costs are of operating in this interim period and then what it may look like as we emerge,” said Tommy Crozier, EVP and national hotel practice leader with CBRE Hotels Advisory. “It’s not a simple answer, and it takes a little more focus and getting granular on these projections.”
Conversely, the new costs associated with operating in the post-COVID-19 world must also be factored into valuation analyses. For now, appraisers must assume these new costs will remain in place for at least the near future.
“When hotels reopen, they have some unique costs related to cleaning, maintenance and inventory, including being required to have PPE on-site,” Crozier said. “I’ve heard anecdotally from European counterparts that insurance companies are requiring some level of satisfactory cleaning for rooms before they will provide insurance on the asset. There are going to be some expenses and other capital costs that we will learn about as this unfolds a little more.”
The road ahead
Although hotel appraisers are currently struggling to assess the present risk and short-term performance of hotels as they arrive at valuations, their longer-term outlook remains positive. This professional optimism is reflected in their methodologies.
When tasked with quantifying a longer-term perspective—which is still vital when appraising multimillion-dollar hotels assets for investors looking to turn a profit—appraisers are modeling the post-COVID-19 recovery on prior downturns. At the moment, sources are confident a recovery will happen; they’re just unsure of the exact timeline.
“The industry recovered from each past downturn and ultimately emerged stronger than it had been prior to the downturn, so you take guidance and comfort from that, quite honestly, and then use those examples and patterns as models for what this recovery could look like,” Lloyd-Jones said. “But, it’s tough to come up with a specific model until we know that we’ve reached the bottom. Until you know what your starting point really is, it’s difficult to model. … We have the template. We’re just waiting to apply it.”