Over the life of an individual hotel property - from building to buy out to bulldozer -appraisals  may be needed for a variety of reasons, including buying or selling, refinancing, ad valorem tax purposes (i.e., taxes based on a percentage of a property's value) and, in some cases, for litigation.

Today's property can expect to be appraised an average of every one to three years. A smart hotel operator needs to understand the importance of these appraisals, the procedures involved and the methodologies used in estimation of value. Probably the most important factors are the appraisal firm itself and the ap-praiser's expertise with hotels.

Robert J. Callaway, a founding partner of Callaway & Price, an appraisal firm headquartered in West Palm Beach, FL, states that when "appraising hotels, as with other commercial real estate, the integral component of the variables is the quality of the appraiser's data and the appraiser's ability to work within that database. Fur-ther, hotels are a different real estate animal than, say, a warehouse or an office building. An appraiser who understands the special factors that contribute to a hotel's success or failure can deliver a more viable appraisal product."

An appraiser works with hard data, i.e., current and historic operating numbers; working capital; furniture, fixtures and equipment; and the real estate itself. Harder to quantify, but unquestionably just as important, is the impact on value of more abstract factors such as location, management and - if any - franchise affiliation. Finally, according to Callaway, "consideration must he given to overall economic and market-specific conditions. These have a significant influence on the appraisal assignment because a property is analyzed in the context of this host of shifting factors."

Complete Understanding.

For these reasons, a good hospitality appraiser must do more than understand the jargon; there needs to be an understanding of current conditions and trends within the lodging industry, as well as full comprehension of the specifics of the subject property, and the supply and demand characteristics of its market.

An initial step in the appraisal process is to establish the "highest and best use" of the property. In determining this, along with other general tests of use required by Appraisal Institute standards and prudent methodology, Callaway considers the following with regard to hospitality properties:

• Its location and market characteristics;
• Quality of the facility;
• The operation itself;
• Franchise affiliation, if any; and
• The competition.

"An appraiser looks at a lot more than basic real estate," Callaway says.

The physical plant is a major consideration. Here, the appraiser looks at the age, quality and condition of the property. Has critical maintenance been put off? What would it take to put it back in top form? Are some deficiencies incurable? Is the property over-improved  for its market? 

A franchise affiliation can be an important factor when developing an appraisal value. In
some cases, it could give the property an edge simply because a franchise-affiliated property is required to maintain certain standards. In dealing with a non-affiliated property, the appraiser is basically working with an unknown quantity. This same perception carries to curb appeal, where the potential guest expects a certain level or standard of service based on the franchise flag a property carries.

While in most cases an appraisal is based on "as is" conditions and cannot take into account changes or improvements which have not been made, an appraiser can derive and report suggestions from the market that a franchise affiliation is not market-supported and that a repositioned (i.e., reflagged) property might perform differently.

Improved Access. 

Further value considerations for a franchise-affiliated property may be access to such things as an automated reservations system, marketing and advertising support services, and training programs, all of which can improve its operational performance. A franchise affiliation alone is not enough to portend a greater estimate of value. It has to be the right type of franchise for the subject property. A franchise may add value if:

• The brand name has strength in the market;
• The franchise is associated with a desirable guest profile for that
• The tradeoff between fees paid and rooms delivered by the franchise, as well as other types of support, work in the property's favor. 

The old maxim in the real estate industry that stressed "location, location, location" in site selection or in estimating value isn't good enough anymore. Callaway says an appropriate addition is "location of the competition." How close are the competitors? What are the conditions of those properties? For franchised properties, are there other franchisees in the area? What is the total market? What is the subject's market share?

One approach to value typically used for hospitality properties is the sales-comparison or market-based approach, where timely sales of similar properties are researched, analyzed, adjusted if necessary, and compared to the appraised subject.

The lifeblood of an appraisal firm is its market data and, once again, the quality of the appraiser's existing database, research and analysis capabilities and confirmation process are important at any time.

"When it comes to appraisals, a lot has to do with changing times," says Callaway. In a typical business cycle, he explains, good economic times go away unexpectedly and then "come galloping up behind you" as they return.

Relatively speaking, in most areas, following a period of substantial overbuilding, there has
been very little new construction of hospitality properties over the past five years. National indicators are that most markets are seeing recovery of occupancy and average daily rate, as well as increased sales activity, although sales prices have not yet begun an upturn.

These over-built conditions, in concert with the recessionary climate of the overall economy, have created some new problems for hospitality appraisers. Callaway says that although
supply and demand are moving toward balance in the hotel industry, two phenomena have placed even greater weight on the professionalism and integrity of the appraiser.

The first, the "wholesaling" of properties by governmental or quasi-governmental agencies like the Resolution Trust Corp., has seen properties bundled together and sold in groups. A thorough analysis of the terms of such sales, the decision-making process of the participants and the impact of such wholesaling on sales price must be considered before using or rejecting these sales as factors in the sales-comparison approach to value.

The second by-product of the recession and prior overbuilding, which makes analysis of market data more difficult, are the many "distress sales" and foreclosure-related transactions prevalent in the industry over the recent past. According to Callaway, it's possible that distress sales do represent the market in some instances; in other cases, a market can have two or more tiers of comparable sales.

For instance, the economy segment of a certain market may have good performance, while the luxury segment is overbuilt and most properties in that segment are under-performing and have been acquired by lenders. In the second case, distress disposal may be the only market.

The other valuation method generally used for lodging properties is the "income approach," and involves either a discounted cash flow or direct capitalization of the property's net operating income (or both).

The income approach uses a pro forma operation statement of income and expenses for the subject. Regarding reliance on the operational history of a property, careful analysis is required. Callaway cautions that, "A hotel may have had a handful of different operators and just as many asset managers, each with different philosophies, management plans and record-keeping. To what extent has this affected performance?"

Understanding Roles. 

"A good appraiser understands the pivotal role management plays in a successful hotel operation," Callaway continues.  "He or she must look at the quality, as well as the type of management, and weigh that in the overall equation. When a property has not had good or consistent management, an appraiser may have to rely on other data, such as performance of comparable hotels in the same market, in order to establish a reasonable array of market assumptions."

Selection of either the discount rate to be used in the discounted cash flow or the capitalization (cap) rate should be derived from con-sideration of market-based data from comparable sales and input from active market participants, as well as those active in the lending community. Once again, the expertise required in conversion of this empirical evidence into selected rates is critical to the reliability of the appraisal process.

Recently published national trends indicate that the range of cap rates, which has been very wide during the unsettled period of recent years, is narrowing substantially. Still, Callaway is quick to point out, "there are no rules of thumb; the abstraction of a cap rate is an independent exercise for each appraisal assignment, dependent on the specifics of the property."

Finally, when faced with the need for an appraisal, there are certain things an owner or a manager should do. First, cooperate. There is nothing to be gained by playing games or trying to hide information that may be interpreted as detrimental. An appraiser is charged with using what-ever resources are necessary to establish a reasonable opinion of value. According to Callaway, information provided by the competition, the market, public records, local, regional and national vehicles is all analyzed and considered, in addition to data supplied by the owner. Aberrations from certain norms or expectations should be questioned and considered in the framework of the appraisal assignment; historical data are not the only resources used by reputable appraisers.

"Appraising, particularly within an industry as complex as the hospitality field, is as much art as science," according to Callaway.

Certainly, an appraiser with an in-depth knowledge of hotels and their operation can cast a clear eye on the problem of estimating the value of a given property. 

Stephen P. Taylor, CHA, is president of TaylorGroup. His 25 years of hospitality experience provide an invaluable background for clients and readers alike.