With the U S. hospitality industry experiencing record levels of profitability, some hotels may have already achieved peak value or will do so in the coming year. For other hotels peak values will be attained over the next 24-36 months depending on future earnings and the level of investor interest. Accordingly, opportunistic hotel owners may wish to implement an information based portfolio management system sooner rather than later. In this way, they will be able to anticipate both the future earnings and the multi-ple of earnings ( "capitalization rate") that prospective purchasers will pay for a given hotel asset.
How long will profits and values increase? One must understand the industry's position within the hotel sup-ply and demand cycle in order to answer this question.
In general, hotel demand is sensitive to economic cycles, while hotel supply depends more on the availability of capital. Unfortunately, these two drivers rarely move in "sync," and have historically acted as follows: favorable markets produce industry trends that encourage industry profits, and thus values. As trends continue to improve, both debt and equity capital are attracted to the industry, sparking construction and increasing room supply. The market eventually turns, often caused by recession-induced demand declines or construction induced supply gluts. As a result, profits and market values decrease, thereby dissuading capital investment. Eventually, growth in lodging demand will exceed growth in supply, once again improving profits and attracting capital. The key to maximizing value is to sell hotels when profits are highest and capitalization rates are lowest. Within an investment portfolio, various hotels will be at different points along the hotel supply and demand cycle. One cannot generalize and assume that hotels, which vary according to product type and location, share a common "value point."
Future hotel values will be driven by a number of factors:
Also, one must be able to make an informed decision regarding the discount and capitalization rates that a future investor will utilize. These rates will be dependent upon the perceived "risk" of future cash flows relative to other investment alternatives. From a practical viewpoint, capitalization and discount rates will vary by type of hotel (brand, management, price tier) and location (specific sub-market, resort, center city. etc.). Three years from now, extended stay hotels, for example. may be out of favor and carry a higher discount rate, while downtown Los Angeles hotels, again for example, may be in favor and deserve a lower discount rate. The current investor/owner with savvy must be able to look beyond the present in order to draw some intelligent conclusions as to the future attractiveness of their hotel assets to prospective investors/buyers.
There is an interesting analogy between investing in stocks and investing in hotels. On Wall Street, the successful portfolio manager analyzes information for each company in his/her investment portfolio in order to gauge future profitability on a quarterly basis. This portfolio manager also closely monitors the relationship between a company's stock price and future earnings ("price/earnings ratio"). In this way. s/he can determine when a particular stock has reached its peak value. When earnings are reaching a plateau and when a future investor is willing to pay a high multiple of current earnings, sale proceeds will be maximized.
Similarly. a portfolio manager of hotel assets should evaluate the earnings potential of each hotel on a quarterly basis. This information should be compared against estimated capitalization rates (relationship between earnings and prices) in order to determine when peak values will be achieved for each hotel asset. The discipline which has been employed by Wall Street for decades can be applied to hotel real estate in order to maximize sales proceeds. And an integrated information - based portfolio management system can be a valuable tool more critical to larger, more diversified or more geographically dispersed hotel portfolios to time transactions and capture peak values.
In summary, it is important to monitor lodging investment cycles on a frequent and periodic basis, preferably quarterly. Now may be the right time to begin to examine assets that have achieved portfolio growth expectations and may be about to peak in performance value and consider replacing them with assets that can meet the portfolio's continuing growth objective's .
The Real Estate Report is published by KPMG's National Real Estate, Hospitality, and Construction Practice. © 1997 by KPMG Peat Marwick LLP All rights reserved. For additional information email KPMG.
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