Hotel Industry Experiences Higher Capitalization Rates

by: David J. Sangree, MAI, CPA, ISHC and James A. Piwarun

The Winter 2000/2001 USRC Hotel Investment Survey of 22 hotel investors indicates that hotel discount rates and capitalization rates have increased since our 1999 and 1998 surveys. The increases are due to higher interest rates and supply increases.  Both the prime rate and interest rates charged for hotel loans have increased between 1999 and 2000. The supply of hotel rooms continues to outpace demand in some markets.  While most markets are absorbing the large influx of room supply developed in previous years, hotel investors and lenders have become more cautious towards future performance with the threat of an economic downturn.

 

 USRC Hotel Investment Survey

 

Winter 2000/2001 Limited Service

Winter 2000/2001     Full-Service

Summer/Fall 1999    Limited Service

Summer/Fall 1999      Full Service

 Direct Capitalization Rate

Average

12.2%

10.7%

12.1%

10.5%

Range

11.0%-15.0%

8.0% – 13.0%

9.5%-15.0%

8.0% – 13.0%

 Terminal Capitalization Rate

Average

12.9%

11.0%

12.2%

10.6%

Range

11.0%-15.0%

9.0% - 13.0%

10.0%-15.5%

9.0% - 12.5%

 Discount Rate

Average

14.5%

13.7%

14.4%

13.3%

Range

13.0%-18.0%

12.0% - 17.0%

12.5%-17.0%

9.0% - 20.0%

Selling Expense

Average

3.3%

2.3%

3.1%

2.5%

Range

1.0%-5.0%

0.5% - 4.0%

2.0%-5.0%

1.0% - 4.0%

Management Fee Expense

Average

3.6%

3.1%

N/A

N/A

Range

3.0% - 5.0%

2.0% - 4.0%

N/A

N/A

ADR Growth

 

 

 

 

Average

3.7%

3.6%

3.7%

3.6%

Range

0.0%-6.0%

0.0% - 6.0%

2.0%-10.0%

2.0% - 10.0%

 Expense Growth

Average

3.0%

3.2%

2.8%

2.8%

Range

2.0%-4.0%

2.0% - 4.0%

2.0%-4.0%

2.0% - 4.0%

 Holding Period

Average

6.5

7.0

7.4

7.5

Range

3 - 10 years

3 – 30 years

2 - 10 years

3 – 10 years

 Marketing Period

Average

7.4

9.3

6.6

6.9

Range

3 - 12 months

3 – 36 months

2 - 12 months

1 – 12 months

 Room Revenue Multiplier

Average

2.9

3.1

2.6

3.2

Range

2.2 – 3.5

1.8-4

2 - 3

2.5-3.5

 Source:  US Realty Consultants, Inc.

         

Capitalization Rates

Our 2000/2001 survey demonstrates the continued trend of higher capitalization rates that investors require for limited-service products. The direct capitalization rate for limited-service hotels of 12.2% is 150 basis points higher than the average for full-service hotels of 10.7%.  These figures represent a trend reflecting increases for both types of hotels over the past two years.  The range for each was wide and depended upon the quality of product and its location.  Upper-end, luxury, full-service hotels in locations with strong barriers to entry had capitalization rates of 8% to 10%.  Terminal capitalization rates for both categories were higher than for direct capitalization rates because these rates are used five to ten years in the future.

Discount Rates Higher for Limited Service Hotels

Discount rates for limited-service hotels averaged 14.5% and for full-service hotels averaged 13.7%. Discount rates are lower for full-service hotels due to the higher barriers to entry for these properties with higher development costs. These rates reflect increases annually since 1998 due to higher interest rates and the withdrawal from the hotel acquisition market of the publicly held hotel companies which had dominated the market in 1997 and 1998. The holding period for users utilizing a discounted cash flow analysis for limited-service hotels were 6.5 years, while for full-service hotels was 7.0 years.

Selling Expenses Range

The selling expense ranged from 1% to 5% for limited-service hotels, and from 0.5% to 4% for full-service hotels.  The average selling expense was slightly lower for full-service hotels as these transactions are typically for higher amounts, and brokers are willing to reduce their commission percentage.  The investors we surveyed indicated that they project that ADR growth rates will be higher than operating expense growth rates for both categories of hotels.  The expense growth rates showed an increase from the 1999 survey, indicating continued concern of higher labor-related costs due to the tight job market in many parts of the country.

Management Fee Expense Range

Management fee expenses averaged 3.6% of total hotel revenues for limited-service hotels and 3.1% for full-service hotels.  Management fees are typically higher on a percentage basis for limited service hotels due to the disparity in total revenues and operational differences versus full-service hotels.

Marketing Period Increases

The marketing period for both types of hotels was higher than last year’s survey.   The average was 9.3 months for full-service hotels and 7.4 months for limited-service hotels, an increase of 35% and 12% respectively from our Summer/Fall 1999 survey.  The trend may indicate a softening of demand for existing hotels.   The room revenue multiplier was typically used by limited-service hotels buyers and averaged 2.9 with a range of 2.2 to 3.5 times room revenue.  Only a few of the investors utilized a room revenue multiplier for full-service hotels and this averaged 3.1 with a range of 1.8 to 4.  This was highly dependent upon the type of property.

Hotel Interest Rates Increase 

 DEBT PARAMETERS

 

Winter 2000/2001

Summer/Fall 1999

 

 INTEREST RATE

 Average

9.5%

8.7%

 Range

8 - 13%

7% - 10%

TERMS

 Average

9.5

9.6

 Range

3- 25

1.5 – 10

YEARS AMORTIZE

 Average

22.0

23.2

 Range

13 - 25

15 – 25

DEBT COVERAGE RATIO

 Average

1.45

1.4

 Range

1.2 - 2.0

1.25 – 1.5

LOAN TO VALUE

 Average

66.5%

72.5%

 Range

50% - 80%

60% - 85%

The average interest rate of 9.5% for the Winter 2000/2001 survey increased from 8.7% as illustrated in our Summer/Fall 1999 survey.  The range of rates from 8% to 13% was 100 to 300 basis points higher than the range indicated in the 1999 survey.  The average term of 9.5 years was slightly below our 1999 survey.  The years amortized of 22.0 years represent a decrease of 5.2% from our 1999 survey, while the range from 13-25 years was similar to the previous year’s range.   The debt coverage ratio of 1.45 was slightly higher than our survey in 1999 and previous years.  The loan-to-value ratio of 66.5% was significantly lower than the 72.5% loan-to-value ratio in the 1999 survey, indicating that lenders are requiring more equity.  Investors continued to indicate that financing is difficult for both larger full-service projects and limited-service projects in markets where oversupply is an issue.

Major Concerns

Economic concerns, oversupply, financing concerns, and labor shortages are the major concerns of the investors in the survey.  Economic slowdown and recession fears were echoed by many of our respondents.  New hotel supply is outpacing demand increases in many markets nationwide where there is available land for development.  Financing concerns from a tightened lending market with higher interest rates and more stringent equity requirements face today’s hotel investors. The January 2001 rate cut by the Federal Reserve will allow for lower interest rates and cost of capital. The availability of a viable labor pool in many markets was discussed as a deterrent toward new development and is not forecasted to improve as wages for competitive jobs continue to rise.

Respondents to the survey include:

§         Boykin Lodging

§         LaSalle Hotel Properties

§         Commonwealth Hotels

§         Colliers International

§         Bass Hotels & Resorts

§         Hotel Source, Inc.

§         Accor

§         Hodges Ward Elliott

§         Wyndham Hotels

§         CIBC Chicago Real Estate

§         TIAA/CREF

§         Vitale Realty Advisors

§         Lend Lease

§         Cornerstone

§         Hunter Realty

§         Stonehenge RE Investors

§         Prime Hospitality

§         Marcus Hotels and Resorts

                §             Tharaldson Development