RSBA & Associates 
Hospitality Consulting Services
400 Spear Street, Suite 106
San Francisco, CA 94105
Email: [email protected]
Web site:
 In Today’s Hotel Acquisition Market, 
How Much Do Cap Rates Matter?

When this year comes to an end, there will be a lot of post-game analysis
on what buyers over- or under-paid for various hotel assets.

by Rick Swig, January 2006

There has been much discussion over cap rates and if they make sense. Whether a cap rate for an asset was 5%, 8%, 10% or 12% may be less important than the consideration of other factors such as the property’s physical condition; its location within its market; the brand or lack thereof; and management.

There probably is no right or wrong answer as to what an ideal cap rate is since individual assets and the differing needs of investors determine their own thresholds of risk.  More than ever, the sensitivity analyses regarding the individual characteristics of the deal become the defining activities.  It is now more important for buyers to understand the hotel business and operations in conjunction with their own expectations for return and exit strategy than to do a regression analysis on a crystal ball reader’s forecasts.  The hotel business has now matured to the point where there is ample data to research and review the trends of even the smallest neighborhoods within a given market.  Whereas Randy Smith of Smith Travel Research provided the hotel investment community with simple monthly market data barely 15 years ago, now that same source will supply daily and weekly analyses of both competitive sets in general and within individual segments.

Data from other sources, such as TravelClick, will let an owner, operator or prospective investor understand customer buying habits and an asset’s market penetration through electronic channels, plus the third-party sources of that business, booking lead times, product pricing, average length of stay and other key measurements.  Using that information, a buyer can determine the strength of a market and an asset, the relative customer base and its buying habits. Each of these elements can reflect the relative value of an asset beyond a cap rate and determine the potential for upside growth.

There have always been considerations regarding barriers to entry, including the potential for new supply based on available sites, brands or other product-driven issues.  The latest and most important barrier to entry has become the cost for new construction or conversion from another use. New construction may be placing the costs of new hotels at cap rates of 1% or 2%, which certainly is not attractive to return-oriented investors. Investors are trying new and creative structures with timeshares, condo hotels or other mixed-use ventures in an effort to leverage projects to a reasonable investment level. Although conceptually exciting, these structures may just not have the necessary market fundamentals to perform.

It all comes down to performance. While it’s true that hotels in most markets have shown significant increases in revenue, these same markets may not be performing at adequate levels to support new construction.

This brings the discussion back to smart acquisition tactics and the criticism that 2005 has been stigmatized by the significant overpayment for hotel assets. Once again, there is a risk for a pitfall due to overgeneralization.

The issue really is whether perceived overpayment is actually a value purchase. With a prime location, the acquisition at a premium becomes more justifiable.

Additionally, there may be a general shift in the hold period of a hotel asset—three- to five-year hold strategies may be an outdated concept. Historically, owners of great baseball franchises have always sold the teams for more money than they originally paid, while in between the two transactions there may have been some years with lower-than-desired returns on their investments. Some sports transactions are linked to other purposes, such as cheap programming for a media outlet or the need to sell more beer through a brewery. The hotel business may be moving in a similar direction, where the back-end yield is more important or the hotel is a catalyst for the success of a related or mixed-use project.

Regardless of the motives, success in hotel acquisition and development requires forward vision about assets and individual markets plus solid belief in historic trends.
The views expressed in this article are those of the author and not Real Estate Media or its publications.

Rick Swig is president of RSBA & Associates, a hospitality industry consulting firm based in San Francisco. He may be contacted at [email protected].

RSBA & Associates
400 Spear Street, Suite 106
San Francisco, CA 94105
E:mail:   [email protected]
Tel:  (415) 541-7722
Fax: (415) 541-5333

Rick Swig Article Index:
Lodging Business in Transitional Year, But Challenges Will Remain After ’05; A Hotel with Truly Unique Attributes Is Worth a Premium / Rick Swig / October 2005
Despite Lack of Long-Term Data, Hotel Developers Favor Hybrid Projects; The Fractional and Condominium Component Not a Proven Solution to Development Prosperity / Rick Swig / June 2005
Travelers Prefer Innovation, Creativity Over Predictability, Discount Pricing / Rick Swig / March 2005
Recent Occupancy, ADR Growth Still Do Not Spell Post-9/11 Relief; Total 2% revenue growth over four years has not kept up with national annual average inflation growth of 2.5% / Rick Swig / RSBA Associates / November 2004
Hotel Success Hinges on Relationship Between Owner, Asset Manager, GM / Rick Swig / August 2004
Hotel Operators Can Gain Market Share Through Distinctive Brand Images; A 100-room boutique hotel can develop more identity within a market than its 1,000-room competitor  through customer impact points / Rick Swig / May 2004
Hotel Operators Must Share Blame with the Economy for Stagnant Performance / Rick Swig / RSBA Associates / January 2004
Investors Seeking Opportunistic Hotel Buys Are Likely to Come Up Empty Handed  / November 2003
Hotel Sector Remains in the Game Despite Reaching Strike Three; Occupancies are now beginning to improve compared with last year and a poor first half of 2003 / September 2003
Some Stability Has Returned to the Hotel Sector, But Its Staying Power Is in Question; The Plundering of Lower Market Tiers Has Cost Upscale Hotels / May 2003
New Business Practices Essential to Lodging Companies’ Success / February 2003
Unreliable Market Trends Yield an Uncertain Direction / October 2002
The Bigger They Are, The Harder They Fall / September 2002
News of Boutiques’ Demise Is Greatly Exaggerated  / May 2002
Management by Spreadsheet Erodes Full-Service Hotel Core Values / Feb 2002
Hotel Lenders Face Challenges In Tough Climate / October 2001
Where We Are Now Depends on Starting Point / Summer 2001
Solid Management Practices Can Improve Franchise Value / May 2001
Hotel Market Stagnation To Continue / January 2001
Here Today…but Tomorrow? / November 2000
Ready, Willing, and Unable? / August 2000
Independent Hotels: The New Brand Alternative / June 2000
Ankle Biter Syndrome / January 2000
Redefining a Mature Hotel Sector / November 1999
Focus On Operations Is Not Enough / August 1999
What’s Next?? / May 1999
Growth Through Management  / Feb 1999
Expect a Subdued Market in 1999 / Feb 1999
Hotel Real Estate: Back to Fundamentals / Nov 1998
The Hotel Investment Barometer For Institutional Investors / 1998
The State of Independents / 1998
Success (or Survival) of Boutique Hotels and Resorts / 1998

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