War in Iraq to Have Limited Effect on Hotel Values

 by: David J. Sangree, MAI, CPA, ISHC (Contact David)

The start of the war with Iraq on March 19, 2003 is expected to have a negative impact on the hospitality industry by decreasing demand at most hotels and resorts throughout the United States and the world.  Particularly hard-hit will be upscale resort properties and business destinations which require travelers to fly instead of drive.  This article discusses the impact of the war on hotel values. 

Investor Survey: The author completed our firm’s annual Hotel Investment Survey of 27 hotel investors in January 2003.   The survey indicated that discount rates and capitalization rates for both limited service and full service hotels decreased since our Winter 2002 survey. The drop in both types of rates was due to increased confidence in the hotel market even though declines in occupancy and average daily rates in most markets have weakened hotels’ net operating incomes.  In addition, interest rates fell during 2002 allowing for a drop in the debt component of capitalization and discount rates. Full-service hotels achieved a larger decrease in rates as compared to limited service hotels. This larger decrease brings full-service hotel rates back to a level similar to our 2001 survey. The decreases occurred as the risk associated with hotel investments returned closer to normal levels following the impact from the terrorist attacks of September 11, 2001 on last year’s survey.  Additional results from our investment survey are included on our web site www.USRC.com.

Effect of War: We project that capitalization and discount rates will remain relatively unchanged due to the war issues.  However, the drop in net operating incomes due to lower occupancy and average daily rates during the war will have a temporary negative effect on hotel values for those operators needing to sell.  Hotels are typically valued by the Income Capitalization Approach through either the direct capitalization or discounted cash flow analysis. 

Many buyers focus on the most recent 12 months operating performance when determining their estimates of purchase prices.  In appraising a hotel during and after the war, the buyer/seller or appraiser will need to focus on not only the recent historical results but also the potential for improvement at the property once the war is over.  The length of the Iraq war is an important variable.  The longer the war occurs, the greater impact it will have on hotel values particularly in destinations which have higher numbers of international travelers such as New York City and Orlando.   

As the effect of war and its resulting impact on incomes is unknown, one needs to consider historical results from similar conflicts such as the period 1991 through 1993.  Following the Gulf War, hotels started to achieve income growth rates in excess of inflation following the downturn caused by the war.  However, hotels are currently in a downturn from the recession and reduction in travel from the terrorist attacks of September 11, 2001.  The current downturn has caused the industry to operate at more efficient levels which was not the case before the Gulf War.  As hotel values have softened in 2002 because of the decline in net operating incomes, we project relatively limited effect of the war on hotel values except for those sellers which must sell in a short time frame.

David J. Sangree, MAI, CPA, ISHC, a member of the International Society of Hospitality Consultants (www.ishc.com), is Director of Hospitality Consulting and a Principal with US Realty Consultants in Cleveland, Ohio (www.usrc.com).  He can be reached at 216-221-9191 or at dsangree@usrc.com.