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Estimating hotel replacement cost.

This article analyzes the six primary sources of data available to an appraiser/consultant when estimating the replacement cost of a hotel. Included are specialized data available from market sources specific to the hotel industry. In addition, the authors have compiled a detailed hotel cost survey based on 1989/1990 development costs for over 135 hotel development projects to illustrate the ranges of typical costs for various hotel product types. A detailed development cost table based on Uniform Franchise Offering Circulars (UFOC) from 20 hotel companies is presented as well. The benefits and disadvantages of using each of the six available sources are compared.

During the 1980s, the growing economy, pre-1986 tax incentives, the abundant availability of debt and equity funding, and other growth-oriented economic factors caused the U.S. lodging industry to expand at a tremendous rate. Commensurately, the industry began an extensive campaign to develop new hotel product types to fill perceived market niches. As new product types were developed, the industry began to segment these products into distinct markets and submarkets. This concept was referred to in the hotel industry as product segmentation and was one of the dominant trends of the 1980s. As a result, hotel developers began building facilities targeted for specific users of overnight lodging allowing form (i.e., hotel design) to follow function (i.e., serving the target market). The hotel industry in the 1990s thus features a wide variety of facility types and concepts, many of which were unheard of ten years ago. Consequently, there is no longer such a thing as a typical hotel or motel in the current lodging industry, and many existing hotel structures feature new designs and layouts.

At one end of the hotel development spectrum is the hard-budget hotel. Hard-budget hotels (under affiliations such as Microtel) feature guestrooms of less than 200 gross square feet, including bathrooms, which contain cost-effective built-in furnishings. These hotels are designed with minimal public space and contain no restaurant, lounge, or meeting space. Near the middle of the segmentation spectrum is the extended-stay hotel. This type of hotel is designed to serve hotel guests who stay for five or more consecutive nights, and is exemplified by such hotel chains as Residence Inns by Marriott, Homewood Suites, and Summerfield Suites. Typically, guestrooms ranging in size from 450 to 950 square feet with full kitchens and fireplaces are featured. At the opposite end of the spectrum is the luxury, destination resort with expansive recreational facilities, meeting facilities, and public space. Throughout the spectrum there are many other unique and physically distinct property types.

Most real estate appraisers are not professional construction cost estimators capable of developing a replacement cost estimate based on a detailed analysis of a building's components. This lack of expertise is exacerbated by the complex structures characteristic of many modern hotels and motels. Lodging facilities often feature unique construction characteristics, large amounts of furniture, fixtures, and equipment (FF&E), extensive artwork, and expansive public and back-of-house facilities. Further, the detailed information concerning an existing hotel's construction necessary to perform a segregated cost analysis is sometimes not available. Often, clients either do not have or cannot locate data concerning hotel's structural components and construction materials. As a result, appraisers who attempt to estimate the replacement cost for a particular facility using the cost approach to value often encounter significant difficulty.

PURPOSE

The purpose of this article is to provide practical data sources and guidelines unique to the hotel industry for appraisers to use to derive a reasonable "ballpark" estimate of a lodging facility's replacement cost. Replacement cost is defined in The Dictionary of Real Estate Appraisal as "the estimated cost to construct, at current prices, a building with utility equivalent to the building being appraised, using modern materials and current design standards, design, and layout."[1]

Some common situations that require supportable hotel replacement cost information based on current lodging industry trends are examined in this article. In addition, six major sources of hotel replacement data are examined and the advantages and disadvantages of using each source are analyzed.

It should be noted that the authors of this article are not attempting to address the issue of whether reproduction or replacement cost estimates are more reliable in using the cost approach to value hotels. Because this article is intended solely to address the difficult problem of providing industry sources for hotel replacement cost information, it does not address other cost approach quagmires, such as the estimation of various forms of deterioration and obsolescence. In addition, this article does not address the issue of entrepreneurial (i.e., developer's) profit. Finally, the scope of this article is further limited in that it does not analyze the advantages or disadvantages of using various cost-estimating methods such as quantity surveys, comparative-unit or segregated cost (i.e., unit-in-place) methods in the hotel valuation process. These topics are inherently worthy of treatment in separate articles.

COMMON USES OF HOTEL REPLACEMENT COST ESTIMATES

In the valuation of hotels and motels, appraisers are typically involved in one of three situations that require an estimate of a hotel's replacement cost as new. The first situation is in the appraisal of a proposed hotel, when the replacement cost of a proposed facility must be estimated based on varying amounts of developer-supplied data such as architectural drawings, renderings, and construction budgets.

If a project has proceeded far enough the developer should have a fairly reliable budget. Even if a budget is supplied, however, how is it possible to ascertain whether the budget is in line and is not inflated or underestimated? In addition, if an appraiser performs an analysis early in a project's life, the developer may not have obtained a detailed budget from a construction firm or contractor. In the appraisal of a proposed hotel, the estimate of replacement cost can play a critical role in determining economic feasibility.

If a hotel is relatively new (i.e., one to three years old), an appraiser may be able to secure the actual development cost of the hotel either from data files or from the hotel's balance sheet. The cost can then be modified by construction cost adjustment factors or other applicable adjustments. A weakness of this approach, however, is that the balance sheet or actual development cost figures may not be sufficiently detailed to determine whether all typical development costs are included in the stated figure. In this case, the appraiser may want to refer to the other development cost information sources to obtain either current data or a more detailed breakdown of various cost components.

Third, an appraiser may be required to estimate the replacement cost of an older hotel. In this instance, the appraiser typically does not benefit from the existence of actual or budgeted construction cost data because the cost information is dated (5 to 15 years) or the property's construction features are obsolete. In such a case it is necessary to rely solely on third-party guidelines, industry trends, and statistics.

Beyond these more traditional uses, appraisers should find the sources and statistics in this article useful in such appraisal assignments as property tax appraisal and separation of the value of the personalty (FF&E) from the total property value. These sources and statistics may also be useful in hotel renovation assignments, when knowing the cost to build a hotel new can aid an analyst in estimating the amount needed to renovate the subject hotel, and whether a renovation budget exceeds the cost to build a completely new hotel. Further, appraisers who perform extensive litigation consulting are often required to estimate various components of hotel replacement costs. Reliable replacement cost estimates can be an important part of distressed hotel/workout valuations as well.

PRIMARY SOURCES OF HOTEL REPLACEMENT COST DATA

To estimate the replacement cost of a lodging facility, appraisers can refer to six different sources of data. It is best to refer to several of these sources and cross-reference the various estimates in the final decision process. The six sources of hotel replacement cost data available to appraisers include

* Development cost surveys for various hotel product types

* Uniform Franchise Offering Circular (UFOC) documents of hotel franchise companies

* Published data from cost-estimating services

* American Hotel and Motel Association (AH&MA) Construction and Modernization Report

* Developer's construction budget

* Professional cost estimator

DEVELOPMENT COST SURVEY FOR COMPARABLE HOTEL PRODUCTS

One of the best sources available for replacement cost estimation is actual development costs of comparable properties. In a perfect world, a hotel appraiser would obtain actual construction cost data on a hotel identical in every way to the subject property. This "perfect comp" would be located next door to the subject hotel and the construction would have been completed within the last week. In the real world, such a perfect comp is seldom encountered.

Unfortunately, unlike comparable cost data for single-family homes, apartments, or office buildings, comparable hotel construction costs are difficult to obtain. This is especially the case for appraisers who do not specialize in hotel valuation and accordingly do not maintain large databases of development cost information. In addition, the number of similar hotels located in any one market area is limited, and no two hotels are exactly identical in construction quality, layout, and design.

Table 1 contains summary data compiled from over 135 hotel development projects. The purpose of the survey is to provide ranges of development costs based on recent market data that can be referenced by appraisers.

The survey includes data on over 28,000 saleable guestrooms, representing 30 states, and is based on cost data from hotels that opened in either 1989 or 1990, because such property types as destination resorts and center city hotels take longer than one year to develop. For example, the development costs for a hotel that opens in March 1990 may be more reflective of 1989 construction costs while a property that opens in December 1990 will more likely reflect 1990 costs. To account for this situation, our survey of hotel development costs blends the results of both 1989 and 1990. As a result, the range should more adequately reflect average prices for that time period.

Overbuilding in many markets, the national recession, and the extremely tight hotel lending market caused hotel development in the last half of 1990 and all of 1991 to slow significantly compared with previous years. As a result, few hotels have opened in 1991 and therefore significant development cost data are not available. The development cost survey results for 1989 and 1990, however, should provide a reliable estimate of costs for 1991 because the lack of projects has forced contractors to aggressively bid for the limited jobs available. Development costs in 1991 thus are likely to be equal to or slightly less than those in 1989 and 1990. To make the development cost information easier to use, the source data has been segmented into ten hotel product types. Table 2 summarizes these product types and includes typical brand-name examples of each.

Using these categories as a base, the various hotel development costs have been sorted. A category for first-class hotels located in Manhattan (New York City) has also been included because of the area's unique locational attributes and the dramatic influence they have on a property's construction cost. For each product type, each individual expense item was then organized into one of the following six (non-land) cost categories. [TABULAR DATA OMITTED]

* Hard construction costs

* Furniture, fixtures, and equipment

* Preopening and working capital

* Financing fees

* Miscellaneous soft costs/developer fees

* Reserves and contingencies

In addition, a range of actual land costs per guestroom is listed. These ranges are not provided to serve as a method for valuing hotel land, but are included solely for reference purposes. Table 1 summarizes the survey results. [TABULAR DATA OMITTED]

In general, the information in Table 1 begins with lower cost-per-room hotel types. For example, a hard-budget hotel typically costs $20,000 to $26,000 per available room to build while a resort costs $174,000 to $351,000 per room.

It is interesting to note that some product types have relatively wide cost ranges even though the product itself is fairly homogeneous. Our research indicates that the geographic location of a hotel is one major contributor to this wide variance. For example, the low end of the hard-construction cost range for a garden court hotel is $34,250 and the high end is $71,250. The hotel that represents the low end of the range is located in a suburban southeast location, while the high-end hotel is in a large metropolitan, northeastern city. While the hotels cannot be considered identical, they are similar in terms of layout, design, and construction.

The use of actual development costs segregated by product type can be an effective method for estimating replacement costs because of its simplicity. Appraisers who are unfamiliar with the intricacies of the hotel industry should be able to determine to which category their subject property belongs by comparing it to the brand-name examples provided. The survey then enables appraisers to identify ranges of actual construction costs for a property's classification.

The ranges indicated in the survey provide appraisers with a reasonable, well-supported range of costs for specific hotel types. The survey, however, does have some limitations. First, it is not possible for the survey to explain all the components that influence each property's construction cost used in the range. Examples of these components include the total square footage of meeting and other public space; the number and size of food and beverage outlets; and the other hotel amenities or special features such as parking garages or extraordinary construction costs. Second, the survey does not indicate adjustments based on locational, regional, or market-specific characteristics. Further, while the 11 categories represent a large majority of the hotels currently built, it was not possible to evaluate all segments. For example, such segments as destination resorts, casinos, and corporate conference centers are limited in number and often include multiple components such as golf courses, residential communities, or marinas. It is thus difficult to obtain comparable usable construction costs on these types of facilities. Finally, appraisers should understand the characteristics and construction of the hotel products listed in Table 1 in order to compare them to subject properties and make appropriate and reliable adjustments.

Overall, the comparable development cost survey provides a reasonable source of data when the replacement cost of a hotel is estimated. An appraiser can use the ranges presented as a reference base and make adjustments based on factors such as geographic location and unusual design or contruction standards to reach a final estimate.

UFOC DOCUMENTS OF HOTEL FRANCHISE COMPANIES

A high percentage of hotels are affiliated with major hotel companies (i.e., franchisors) and operate subject to a franchise agreement. These franchise affiliations are "flags" that provide a brand name, a supporting reservation system, and other services to hotel owners. In addition, since the early 1980s most hotels were or are developed with a specific franchise or group of similar franchises in mind. Even if a hotel is built as an independent or is currently unflagged, the developer probably will have replicated a successful franchise property they have encountered or visited.

For the purposes of this article, it is important to note that each new hotel developed subject to a franchise affiliation is normally built under specific construction and design standards. The franchise agreement signed by a hotel developer often gives the franchisor the right to review and approve building design and construction. The franchisor may go so far as to reserve the right to approve the franchisee's architect and general contractor. As a result, most hotel franchisors' products are similar in terms of construction quality, facilities, layout, furnishings, and design.

All hotel companies in the United States engaged in multistate franchise sales are required to file certain information with state and federal regulatory agencies for submission to prospective franchisees. While the filing is completed on a state-by-state basis, the UFOC provides a standard disclosure format acceptable to all 50 states. The UFOC is supplied to the Federal Trade Commission and to various state regulatory agencies. The franchisor is obligated by law to provide the UFOC information to prospective franchisees prior to the execution of the franchise agreement.

The UFOC is a 23-item disclosure statement that contains the hotel franchise agreement and other important information. A standard item in the UFOC concerns estimation of a licensee's initial investment and other financial obligations to obtain a franchise. Based on a franchisor's experience and best available data, dollar estimates are made for hotel development costs under various categories such as land, construction costs, FF&E, preopening and working capital, and other categories that the franchisor may deem applicable. In general, franchisors are careful to file reliable information in the UFOC and to provide accurate development cost estimates. By law, the franchisor is required to state at the end of the "initial investment" section of the UFOC that "There are no other direct or indirect payments in conjunction with the purchase of the franchise (license)."[2]

As a result, the UFOCs for the various hotel companies provide an excellent source of information for an appraiser attempting to estimate hotel replacement costs. Table 3 summarizes hotel development cost estimates from 20 different hotel companies representing 52 different brand-name affiliations. The information is summarized based on data provided within the UFOC for each respective franchisor and is presented as a cost per saleable guestroom to aid in using the data for comparison purposes. With the exception of Days Inn of America Franchising, Inc., all of the data were presented by the franchisor in range format.

A tremendous amount of replacement (i.e.g, development) cost information is provided in Table 3. As noted, most hotel companies do not provide land cost estimates, because this cost is out of their control and can vary widely depending on location.

To highlight information contained in Table 3, Microtel Franchise and Development Corporation will be used as an example. Microtel's UFOC estimates the following costs for a typical Microtel (i.e., hard-budget hotel product).

* Land costs: $1,000 to $9,000 per room

* Construction costs: $12,000 to $15,000 per room

* Miscellaneous soft costs: $200 to $530 per room

* FF&E: $2,500 to $5,000 per room

* Preopening and working capital: $600 to $950 per room

* Signage: $75 per room

* Total costs (with land): $16,600 to $30,900 per room

* Total costs (without land): $15,600 to $21,900 per room

These ranges can be used as a starting point to estimate the replacement cost of a hard-budget hotel. Depending on how the hotel under examination compares and contrasts with a typical Microtel, an appraiser can make adjustments and derive a final estimate of replacement cost.

While use of franchise UFOCs will provide appraisers with reasonable estimates of hotel replacement costs, use of this data source does have limitations. First, hotel franchisors tend to present broad ranges for their estimates to cover all construction situations. Second, many hotel companies either do not franchise at all or offer brand-name affiliations by enetering into a management contract with the hotel developer or owner. As a result, UFOC-supplied data are not available from these companies. In addition, a greater percentage of first-class and luxury hotels do not franchise while most economy/midrate lodging facilities do. Accordingly, the data are more oriented toward the lower cost end of the development spectrum. Finally, the information presented requires that an appraiser be a hotel specialist knowledgeable about the lodging industry. The appraiser should fully understand the characteristics and construction of the hotel products listed in Table 3 to compare them to the facility under examination and make appropriate and reasonable adjustments.

PUBLISHED DATA FROM COST-ESTIMATING SERVICES

Several cost-estimating services (e.g., Marshall Valuation Service) publish data that can be used to estimate the current replacement cost of hotel improvements. The data provided by these services can be used to estimate replacement cost through either the segregated cost or unit-in-place methods. An appraiser well-versed in hotel building techniques and general construction methods who is also equipped with complete construction details about the subject property should be able to use published cost data in developing a reasonable estimate of replacement cost for a lodging facility.

Data from published services can be difficult to use, however, for complex hotel structures with extensive recreational amenities, meeting space, back-of-house support facilities, and large amounts of unique FF&E. Use of the segregated cost method often requires multiple assumptions that may or may not be supportable. For example, it can be difficult to ascertain exactly what hard, soft, and extraneous costs are included in the published data. Further, an appraiser may not have all essential information concerning the subject property, including actual construction material and quality, and may not be able to derive this information from a physical inspection of the hotel. Use of the unit-in-place method (on a per-room basis) is often too general to apply to the highly specialized hotel facilities found in the current lodging industry.

AH&MA CONSTRUCTION AND MODERNIZATION REPORT

The Allied Membership Department of the American Hotel & Motel Assocaition (AH&MA) in Washington, D.C., publishes monthly the Construction and Modernization Report. This document provides the following information on hotel renovation, expansion, and new construction projects in the United States and Canada.

* State and city

* Number of rooms

* Total cost

* Type (renovation, expansion, or new construction)

* Name of property

* Location of site

* Brief project description

* Brief facilities summary

* Contact name and address

* Project status and timing

The information published in this report is useful as a starting point for appraisers; however, the lack of detailed information to support the total cost estimate inherently limits the usefulness of the information in its present form. Necessary information such as specific land costs and a separation of hard from soft costs is not available. It also is not possible to ascertain whether the cost estimates are preliminary, final, or revised. Additional information can easily be obtained and data can be verified, however, by communicating with the contact person whose name is provided. [TABULAR DATA OMITTED]

DEVELOPER'S CONSTRUCTION BUDGET

When performing an appraisal for a proposed hotel, an appraiser is often supplied with the developer's construction budget. Usually the budget is the summary result of construction bids and contracts supplied by various construction contractors and subcontractors. A well-prepared budget can be an extremely reliable source of replacement cost information, as it is in effect "the ultimate comparable" and is based on detailed information from construction experts with intimate knowledge of the project under consideration.

Almost all appraisers who perform analyses of proposed hotels include the developer's construction budget as at least one factor that affects their estimates of replacement cost. For a proposed hotel, the estimate of replacement cost is one component of the estimate of value via the cost approach. This value is a tool that enables an appraiser to determine the financial feasibility of a project.

The problem with using a developer's construction budget is determining whether the budget is reliable. In some cases, a developer may be over- or under-estimating various costs and expenses for a variety of reasons. An appraiser should thus use one or more of the other replacement costs cited in this article as a countercheck to determine whether the developer's construction budget appears reasonable.

PROFESSIONAL COST ESTIMATOR

A professional cost estimator should be able to provide a highly reliable estimate of hotel's replacement cost. Because appraisers are not often experts on hotel construction and related costs, a cost estimator is in a superior position to calculate a replacement cost estimate. Whether a professional cost estimator has extensive experience in evaluating lodging facilities should be ascertained before he or she is employed.

The downside of using a professional cost estimator is time and cost. From a practical point of view, the client must be willing to pay for the additional professional service. Further, the appraiser loses some control over the project's timing and must manage the estimator as part of the engagement. Also, the relative importance of obtaining an expensive replacement cost estimate must be weighed in relation to the role that the cost approach plays in the valuation of investment-oriented, income-producing real estate such as hotels.

CONCLUSION

The six sources of cost data presented in this article generally represent information available to hotel appraisers for developing an estimate of replacement cost. Each of the sources inherently maintains certain advantages and disadvantages that should be considered by an analyst during the estimation process.

The process of estimating hotel replacement costs can be difficult and often necessitates that an appraiser be intimately involved with the lodging industry on a day-to-day basis. Appraisers should keep abreast of the rapidly changing hotel industry and the similarities and differences in construction costs, design, and layout between various lodging facilities. This hotel-specific knowledge, in combination with the guidelines and source data presented in this article, should greatly enhance the ability of a hotel appraiser to develop relatively reasonable replacement cost estimates to be used as a base for the cost approach method to value hotel real estate. [TABULAR DATA OMITTED]
COPYRIGHT 1992 The Appraisal Institute
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Cahill, Michael; Mitroka, Mark M.
Publication:Appraisal Journal
Date:Jul 1, 1992
Words:4193
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