Question

consider you are to determine the investment value a Hotel. Your estimation certainly will be based on several assumptions.

Present how you would identify the key assumptions and their sources (e.g. rental values, expenses, discount rate, etc) in a discounted cash flow (DCF) model.

(Word limit: 400 words)

Answer 1

Investment Ivalue Iis Ithe Iamount Iof Imoney Ian Iinvestor Iwould Ipay Ifor Ia Iproperty. IIt Irefers Ito Ian Iasset’s Ispecific Ivalue Ibased Ion Icertain Iparameters. IIt Iis Ian Iindividual’s Imeasurement Iof Ithe Iasset’s Iproperty Ivalue.

The Ireason Ian Iinvestment Ivalue Iis Iimportant Ito Ipotential Ibuyers Iof Ia Iproperty Iis Ithat Ithey Iwant Ito Icompare Ithe Iprice Iof Ithe Ireal Iestate Ito Ithe Ianticipated Irate Iof Ireturn. IWhen Ithey Ifind Ithe Ispecific Irate Iof Ireturn, Ithey Ican Imeasure Ithe Iinvestment’s Ifinal Iresults Iwith Ithe Iprojected Iprice Ithey Iwill Ipay Ifor Ithe Iproperty. IIt Iallows Ithe Iinvestor Ito Imake Iintelligent Ipurchasing Idecisions Ithat Iare Iin Iline Iwith Itheir Iinvestment Iobjectives.

How Ito IDetermine IInvestment IValue

Since Iinvestment Ivalue Idepends Ion Ithe Iinvestor’s Iobjectives, Ithe Ivalue Iis Iunique Ito Ieach Iinvestor. IDifferent Iinvestors Ican Iuse Ithe Isame Ivaluation Imethods Iand Icome Iup Iwith Idifferent Iinvestment Ivalues. IInvestors Ican Ichoose Iamong Iseveral Ivaluation Imethods Iwhen Idetermining Ithe Iinvestment Ivalue Iof Ian Iasset. IBelow Iare Ithe Imost Icommonly Iused Iinvestment Imeasures:

1. IComparable ISales

The Isales Icomparison Iapproach Iis Iused Iby Iappraisers Ias Iwell. IAn Iinvestor Iwill Icompare Isimilar Iproperties Ion Ia Iper Isquare Ifoot Ior Iper Iunit Ibasis.

2. IGross IRent IMultiplier

The Imetric Imeasures Ian Iinvestment’s Ivalue Iby Imultiplying Ithe Igross Irent Ia Iproperty Iproduces Iin Ia Iyear Iby Ithe Igross Irent Imultiplier I(GRM). IThe IGRM Ifigure Iis Iderived Ifrom Isimilar Iproperties Iin Ithe Isame Imarket.

3. ICash Ion ICash IReturn

The Icash Ion Icash Ireturn Ifigure Iis Icalculated Idividing Ithe Ifirst Iyear’s Ipro Iforma Icash Iby Ithe Itotal Iinitial Iinvestment.

4. IDirect ICapitalization

Direct Icapitalization Iis Ianother Imetric Iused Iby Iappraisers. IIt Iinvolves Icapitalizing Ithe Iincome Istream Iof Ia Iproperty Iand Iis Ia Icommon Imethod Iused Ito Idetermine Ithe Imarket Iand Iinvestment Ivalue Iof Icommercial Iproperty.

5. IDiscounted ICash IFlow I(DCF)

The IDCF Imodel Iis Iused Ito Icalculate Ithe Inet Ipresent Ivalue, Ithe Iinternal Irate Iof Ireturn Iand Ithe Icapital Iaccumulation Icomparison. IThe Iratios Ilisted Iabove, Iwhile Iproviding Iuseful Iinformation, Ialso Icome Iwith Iseveral Ilimitations. ISuch Iconstraints Iare Isolved Iby Icalculating Ithe Idiscounted Icash Iflow.

Investment IValuation Iof Ia IHotel

1. IIncome ICapitalization IApproach: IThe Ivalue Iof Ian Iincome-producing Iproperty Iis Idetermined Iby Ithe I“present Iworth Iof Ifuture Ibenefits” Ior Ia Imultiple Iof Iits Inet Ireturn. IWithin Ithis Iapproach, Ithere Iare Iseveral Itechniques Iand Iconsiderations Iwhich Iwe Iwill Inot Iconsider Iin Ithis Iarticle Ias Iwe Iwant Ito Iconcentrate Ion I“quick Iand Idirty” Iapproaches.

2. ICost IApproach: IMostly Iuseful Iin Idetermining Iif Iit’s Ibetter Ito Ibuy Ior Ito Ibuild. IThis Iapproach Iis Inot Iheavily Ifavored Ibecause Iit Idoes Inot Iconsider Iincome Ior Ieconomic Ifactors, Ijust Ithe Icost Iof Ibuying Ian Iexisting Iproperty Ivs Ibuilding Ione.

3. ISales IComparison IApproach: IIs Ithe Imost Iuseful Ifor Iour Ipurposes Ihere. IIt Ifocuses Ion Idetermining Iranges Iand Ipricing Imomentum Ibased Ion Iprior Isales Iof Icomparable Ihotels.

Room-Rate Multiplier

ADR Ior IAverage IDaily IRate Iis Ione Iof Ithe Ibetter Iknown IKPIs I(Key IPerformance IIndicators) Iof Ithe Ihotel Iindustry Iand Ithis Irule Iof Ithumb Iessentially Iassigns Ia Iworth Iof I1,000 Itimes Ithe IADR Iper Iroom, Ior Iif Iyou Iare Ifamiliar Iwith Ithe IRevPAR I(Revenue Iper IAvailable IRoom) Iit Ialso Isets Ithe Ivalue Iat I3.5 Ito I4.5 Itimes Ithe Iannual Iroom Irevenues I(RevPAR Ix I# Iof IRooms Ix I3.5-4.5).

Value I= IADR Ix I1,000 Ix INumber Iof IRooms

An Iexample Iwould Ibe Iif Iwe Ihad Ia Ihotel Icharging Ion Iaverage I$140 Iper Iroom/per Inight Iand Ia Itotal Iof I35 Irooms, Ithat Ihotel Iwould Ibe Iworth Iroughly I$4,900,000.

RevPAR Iis Icalculated Iby Imultiplying Ithe IADR Iby Ithe IOccupancy I% Ior Iby Idividing Ithe Ihotel’s Itotal Iroom Irevenues Iby Ithe Inumber Iof Irooms. IBoth Iof Ithese Iare Ihard Ito Iknow Ibefore Iengaging Iin Idirect Iconversation Iwith Ia Iprospect I(if Ilooking Ito Ibuy) Iand Ithus Idefeat Ithe Ipurpose Iof Ia I60 Isecond Ivaluation. IHowever, Iif Iyou Idon’t Ihave Ia Iready-made Idatabase Iof Ihotel Itransactions Iand/or IKPIs Ithat Iincludes Iyour Itarget I(which Iis Ihighly Iunlikely) Ithen, Ifortunately, Icompanies Ilike IChristie I& ICo Ipublish Ifree Igeneral Ireports Iwith IKPI’s Ifor Ithe Iindustry Iwhich Ican Iserve Ias Ibenchmarks.

The Iglaring Iomissions Iof Iusing Ia IRevPAR Imultiple Ito Ivalue Ihotels Iare Ithat Iit Idoes Inot Itake Iinto Iaccount ICPOR I(cost Iper Ioccupied Iroom) Ior Irevenues Igenerated Ioutside Iof Irooms Isuch Ias Irestaurants, Ievents, Iparking, Ispa, Ietc. IBut Iif Iyou Ihave Imore Ithan I60 Iseconds Ithen Iyou Icould Icalculate Ithe IARPAR I(Adjusted IRevenue Iper IAverage IRoom) Iwhich Itakes Iboth Icosts Iand Iadditional Irevenues Iinto Iaccount. IMoreover, Iif Iyou Ihave Ithe Itime Ior Iaccess Ito Ithese Iyou Ishould Ijust Igo Iall Ithe Iway Iand Ido Ia Iproper IIncome Capitalization Approach.

The Bottle/Can Soda Multiplier

This Iis Ia Ifun Ione Iand Ivery I“exact” Irule Iof Ithumb. IEach Iroom Iis Iworth I100,000 Itimes Ithe Iprice Iof Ia Ibottle/can Iof Isoda Ieither Iin Ithe Iin-room Iminibars Ior Iin Ithe Idispensing Imachines Iof Ithe Ihotel Iin Iquestion.

Value I= IBottle/Can IPrice Ix I100,000 Ix INumber Iof IRooms

Using Iour Iprevious Iexample Iand Iassuming I$1.5 Iper Isoda, Ithen Ithe Ihotel Iis Iworth Iroughly I$5,250,000 Iwhich Iisn’t Itoo Ifar Ifrom Iour Ifirst Iprediction. IUnfortunately, Iin-room Iminibars Iare Idisappearing Ias Ithey Iare Ia Iconstant Iheadache Ifor Ihotels Iand Inot Ireally Ia Iguest Ipriority.

Also, Iit’s Ia Ipretty Iwhacky Iapproach Ito Irely Ion. IMore Ithan Ianything, Iit’s Ia Icuriosity Ithat Idoes Ihave Ia Ismall Idegree Iof Icorrelation Iwhen Iit Icomes Ito Ihotel Ivaluations.

Price Per Room Sales Comparison

In Ia Isimple Iworld, Iyou’d Ibe Iable Ito Icompare Ithe Isale/purchase Iof Ithe Ihotel Iin Iquestion Ito Ia Iprevious Isale Iwith Ithe Iexact Isame Iconditions. IHowever, Isince Iwe Ilive Iin Ia Icomplicated Ione, Iwe Imust Isimplify Ias Imuch Ias Ipossible Iand Iwhen Iit Icomes Ito Ihotels, Iwe Imust Ibreak Iit Idown Ito Irooms Itypically.

This Itechnique Iallows Iyou Ito Icompare Iapples Ito Ioranges I(sort Iof) Iby Ibreaking Idown Ihistorical Ihotel Isales Ito Ia Iper Iroom Ibasis Imaking Ipossible Ithe I‘unfair’ Icomparison Iof Ia I100 Iroom Ihotel Isale Ito Ia I35 Iroom Ihotel Isale, Ifor Iexample. IEssentially Iall Iyou Ineed Ito Ido Iis Idivide Ithe Itotal Isales Iprice Iby Ithe Inumber Iof Irooms Ito Iarrive Iat Ia IPPR I(Price IPer IRoom) Ivalue.

PPR I= ISale IPrice/Number Iof IRooms

An Iexample Iwould Ibe Iif Iyou Iwere Iconsidering Ibuying Ithe I35 Ihotel Iwe Ihave Ibeen Idiscussing Iand Iyou Iknow/discover Ithat I6 Imonths Iprior, Ijust Ia Ifew Iblocks Iaway Ia Imuch Ilarger I100 Iroom Ihotel Isold Ifor I$14,500,000. IThis Iboils Idown Ito I$145,000 IPPR, Iso Ia I35 Iroom Ihotel Ishould Ibe Iaround I$5,075,000.

If Iyou Ihave Iever Ishopped Iaround Ifor Ian Iapartment Ior Ieven Ito Irent Ione Iyou Imight Iremember Ihow Ieasy Iit Iwas Ito Idetermine Ithe Imarket Ivalue. IEspecially Iif Iwe Iare Italking Iabout Ia Ihigh Irise Iwith Imany Ivirtually Iidentical Ioptions. IIf Iseveral Iwith Isimilar, Iif Inot Iidentical, Iconditions Iwere Iselling/renting Ifor Ione Iprice Iyou Iwould Inot Ipay Imore Ifor Ianother Iwithout Ia Ispecific Ireason Ias Ito Iwhy Iit's Iabove Ithe Imarket Iask. IThe Isame Iapplies Ito Ihotels Ibut Isince Irarely Itwo Iare Isimilar Ithis Iis Ia Ivery Igeneral Iapproach Ithat Iessentially Iconsiders Inothing Ibut Ihistorical Isales Iprice Idivided Iby Ithe Inumber Iof Irooms. IThis Iallows Ias Iclose Ia Iscenario Ias Ipossible Ito Ithe Iabove Imentioned Iapartment Ihunt Iwhen Iit Icomes Ito Ihotels.

The Idownside Iof Ithis Iapproach Iis Ithat Iit Iassumes Ithat Iall Irooms Iare Icreated Iequal, Inot Iconsidering Ivery Iimportant Ifactors Isuch Ias Ithe Irevenue Ieach Iroom Igenerates, Ithe Iquality Iof Ithe Iconstruction Iand IFF&E I(Furniture, IFixtures I& IEquipment), Isomething Ias Isubtle Ias Ithe Iunderlying Iincentives Iof Ithat Iprevious Ipurchase, Ior Ia Ipolitical Ievent, Isuch Ias IBrexit Ior Ianything Ithat Idoes Ihave Ian Ieffect Ion Ithe Imarket Iat Ithe Itime Ithe Icomparable Itransaction Iwas/is Itaking Iplace.

There Iare Imany Iother Imore Iprecise Imethods Ito Iconsider Iif Iit Iturns Iout Ithe Itransaction Iwarrants Ifurther Ianalysis.