One of the best-known adages of hotel development analysis is the often quoted, yet often disputed, �Rule of Thumb Method� of determining feasibility. ¹The simple measure of one dollar of room revenue supporting $1,000 of hotel value is regarded as the cost naive benchmark for determining feasibility for a hotel development or acquisition, but it is still utilized. The inverse of this method is set forth as a means of setting room rate. Described in the 1997 Hotel Investment Handbook, the theory is illustrated as follows: 
 

Of course, in these days of sophisticated spreadsheet modeling of hotel investment cashflows and underwriting, the �rule of thumb� method is full of flaws. It does not consider occupancy, other sources of revenue, or expenses, and it assumes a stabilized operation. Despite these obvious shortcomings, the �rule of thumb� method does come up from time to time. Its persistent presence begs the question: Does the �rule of thumb� still hold weight in today�s market? In order to answer, the operating performance of sample hotel brands was ascertained. The December 1999 issue of Hotel and Motel Management provided much of the data that was used in our analysis. The eDirectory of Franchising Fees listed 1998 average rate and annual occupancy for many of the major franchised brands as well as typical development costs for the brands� properties. The Development costs were adjusted to include an estimated land component of 15% of the published construction cost. The averages for each brand derived from the data are illustrated in the Table 2, which lists the average rates and occupancies from the eDirectory. This data was used to calculate RevPAR. When the construction costs from the eDirectory represented a range, the average was derived. A 15% land cost was then calculated based on the average construction cost. Next, the �rule of thumb� analysis was applied, which involved dividing the average rate by the total cost, then multiplying by 1,000. Clearly, there is no discernable trend for any particular property type (limited-service, full-service, or extended-stay), or for any market position (mid-rate, luxury, economy). However, the data does show that the weighted average of $1.04 of average rate to $1.00 of development cost is surprisingly close to the �rule of thumb�. While this may not be a precise test of feasibility, it is a general benchmark that survives the test of time, inflation, and hotel development cycles.
 

¹ Stephen Rushmore, Dana Michael Ciraldo, and John Tarras, Hotel Investment Handbook
(Boston: Warren, Gorham & Lamont, 1997)
 
 

The Canadian Lodging Report Outlook is a joint monthly publication of Smith Travel Research and HVS Intenational, Vancouver and Toronto, Canada