Hotel Values Catching Up to Replacement Cost

Every so often I like to look at the current relationship between a hotel’s market value and its replacement cost. This information is useful in setting strategies for new hotel development, acquisitions, when to buy and when to sell. It can also forecast volatility.

A hotel’s market value is the price at which it will sell in an open market where buyers and sellers are acting in their own self-interest without any pressure to buy and sell, and with full knowledge of the market. Market value for a hotel is generally estimated through an income valuation model where future net income is capitalized into value.

Replacement cost is the total development cost to build a hotel including the acquisition of the land, construction of the improvements and furnishing the property with furniture fixture and equipment.

I have been tracking the relationship between a hotel’s market value and its replacement cost since 1987 for two different classes of hotels: Luxury Hotels and Mid-Price Hotels. The following graphs show the change in market value and replacement cost over this period of time.

Before we evaluate each of these, a brief review of hotel economic trends over this period of time might be helpful:

• Between 1987 and 1989, the U.S. hotel industry was booming. The savings and loan industry coupled with highly favorable income tax benefits fueled a huge building spree.

• A massive recession and crash occurred in 1990 and ‘91 when the S&L industry experienced severe financial problems. Travel slowed, hotel values declined and the overbuilding sent hotel occupancies falling.

• The recovery between 1992 and 2000 was slow, with hotel values

• The events of 9/11 coupled with another recession drove values down again. A turnaround occurred in 2003 and by 2007 hotel values peaked at record levels.

• With the bubble bursting in the housing and banking industries in 2007 and 2008, values went into a freefall with many markets seeing declines of 30% to 50%. Today we are slowly starting to recover.

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