The Case for Lower Current Capitalization Rates in Hotel Valuation
By Gavin Davis Managing Principal, H-Fin Capital Advisors | February 15, 2010
If your gut reaction to paying an 8%, 7%, or 6% cap rate or even less is one of nausea, you have probably been comfortably sitting on the sidelines over the past couple of years. Today's capitalization rates can not be viewed in a historic vacuum. A confluence of three forces has driven hotel valuations to where they are today:
How long capitalization rates remain this low is a function almost entirely of what happens in the US Treasury market, assuming the operating environment continues its robust forecasted growth and supply remains constrained by historical standards due to higher real construction costs.
The Hotel Capital Glut
The largest net buyers of hotel assets based on transactional value are public and private REITs, public C-Corps and institutional real estate private equity funds. Each of these vehicles is beholden to the return criteria they have implicitly (public REITs and C-Corps) or explicitly (private equity funds, private REITs) promised their respective investors.
Based on forecasted improved operating fundamentals over the next several years and the general overall lodging recovery post-9/11, public hotel companies saw an expansion of their trading multiples as early as 2003. These companies capitalized on an opportune time to raise equity capital through follow-on offerings. At the same time, the IPO market was still largely closed to hotel offerings.
Ashford Hospitality Trust, who originally filed to go public in May 2003, had trouble finding a blue-chip Wall Street investment bank to lead manage the offering because of the blind pool nature of the offering. The eventual lead underwriter, Friedman Billings Ramsey (FBR), was able to lead a successful IPO for Ashford that closed in August 2003, which opened the window for the bulge bracket investment banks to bring to market several other successful hotel IPOs on behalf of quality companies and management teams with institutional real estate holdings.