Due Diligence Procedures for Hotel Appraisals
By Thomas E. Pastore CEO & Founder, Sanli Pastore & Hill | June 15, 2010
What is the first thing that comes to mind when you hear the phrase "business valuation"? Mathematics? Formulas perhaps? Maybe even WACC (weighted average cost of capital) for those of you with a MBA. The end product of an appraisal is often a numerical value and people sometimes perceive the process to be math intensive. Although it is true that the use of formulas and equations is essential to the valuation procedure, due diligence procedures encompass far more than mathematical models. The importance of due diligence research cannot be overlooked because of its crucial role in justifying the outcome of a valuation.
There are many factors that directly influence the value of a subject business or hotel, and they can generally be classified under the following three main areas contributing to value: company environment, industry dynamics and economic conditions. These factors then form different aspects of due diligence research. In the following paragraphs, we will discuss the three areas of due diligence research in more detail.
Company research encompasses several different factors, and in most cases, these have the most direct impact on a company's day-to-day operations. Some examples of company research are customer demographics, management/directorship structure, suppliers, advertising and intellectual property. In order for the appraiser to gain detailed understanding of a business from a financial standpoint, extensive reviews of the financial statements are required. Site visits and management interviews are also standard practices for the appraiser to obtain critical information on the operations side of the business.
In particular for the hotel industry, it is vital to grasp the nature of the subject business since there are many industry segments with various income sources, such as lodging, casinos, restaurants and spas to name a few. On a site visit, the appraiser inspects the location of the subject hotel property, which can greatly affect its visibility and customer base. One well-known example of that is the difference between being on "The Strip" and off in Las Vegas. Management, intellectual property, supplier and employee relations are just some company-specific items that can generate positive or negative results for the company's bottom line.
When it comes to industry research, one of the most significant factors is competition. In a fiercely competitive environment such as the hotel industry, it is imperative for the appraiser to identify all the competitors within the market segment and assess their influence over industry dynamics. Some of this can be accomplished over the management interview. However, more often than not, rigorous independent market research and analysis prove to be necessary for the valuation process. Other considerations for research on the hotel industry include occupancy rates and prices, related industries, customer makeup, seasonal and regional trends, and growth outlooks. The impact of e-commerce and the changing demographics of the U.S. population are further topics that should be taken into consideration.
Based on data compiled by the American Hotel & Motel Association (AHMA), the U.S. lodging industry had roughly 4.4 million guestrooms at approximately 47,000 properties in 2004, about one hotel room for every 68 U.S. residents. The lodging industry totaled $113.7 billion in sales in 2004 with $52.90 revenue per available room. The overall occupancy rate averaged about 61.3%, and the average room rate was $86.24 in 2004, up from $82.52 in 2003 and just under the high of $88.27 achieved in 2001.