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Hotel Valuation with Steve Rushmore

• Jeff Borman and Matt Brown

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Steve Rushmore can tell you everything, and I mean everything about your hotel. His "Rushmore Approach" for allocating a hotel’s total value is the stuff of lore, but how do you even begin to evaluate a hotel's worth? What are all the factors that go into it? What makes for a particularly difficult appraisal? Is the "income approach" really the best way to appraise a hotel? And is it true Steve can appraise a hotel in 60 seconds?

https://steverushmore.com/


Matt Brown:

Thank you. Hi everybody, welcome to no Show. I'm Matt Brown, joined as always by Jeff Borman. Steve Rushmore can tell you everything, and I mean everything about your hotel. Why? Because he is a legendary figure in the hotel business. That's legend in all caps. He is the founder of HBS, a global hotel consulting organization with more than 50 offices around the world. He is the founder of HVS, a global hotel consulting organization with more than 50 offices around the world. He has provided consultation services for more than 15,000 hotels during his 50-year career and specializes in complex issues involving hotel feasibility, valuation and financing.

Matt Brown:

He's a prolific author, speaker, idea generator and all-around expert on how and why hotels work the way they do. His Rushmore approach for allocating a hotel's total value is the stuff of legal lore. His ownership, with his wife, of a Park Avenue co-op is an epic some would say Shakespearean story of New York City real estate. He's a skier, he's a hiker, he's a pretty good cook, he's a dog lover, arctic adventurer and, on top of it all, he has a commercial pilot's license. Steve Rushmore, it is our absolute privilege to have you on no Show. Welcome.

Steve Rushmore:

Wow, I've never had an introduction like that. Thank you so much. You covered all the highlights.

Matt Brown:

I find that hard to believe because you've had a lot of introductions. Each time a hotel is bought, sold, developed, financed, refinanced, syndicated or assessed, parties to the transaction may require some type of market study and valuation to indicate its future financial performance. In simple words, for civilians, what is a hotel? Market analysis and valuation.

Steve Rushmore:

Good question. A valuation is an estimate of value and it can be an estimate of market value. It can be an estimate of investment value, assessed values. There are all different types of valuations, but you listed all the reasons why somebody would want to know how much their hotel is worth. Value is very simple it's the present worth of future benefits. So in a hotel, the future benefits of owning a hotel are the cash flows every year going out into the future and then the sale price when you ultimately sell the property. So those are the future benefits, and present worth means that you're going to discount that back to the present value at a discount rate. So essentially, to value a hotel, you have to determine three things. You have to determine what the future benefits are, which, as I said, are the cash flow and then also the sale at the end of the holding period, and then you have to forecast that out into the future. You have to determine what the hotel is going to sell for at the end of the holding period and then you have to have a discount rate or really a cost of capital that you discounted back to the present value.

Steve Rushmore:

So doing an appraisal, the first step is to determine what the future benefits are, and to do that you're going to be doing a projection of income and expense for the hotel. And income and expense let's first look at income. Income is basically your income from the sale of rooms. If you have a restaurant, it's sale of revenue for the restaurant, the lounge, the meeting space. All that depending on the type of hotel that you have. And so you have to determine what the revenue is going to be going into the future. And let's keep it simple. Let's just say it's a rooms only operation and so the revenue is made up of the future occupancy of that hotel and the future ADR. And to come up with rooms revenue you take the occupancy times, the ADR times, the room count times, 365 days a year, and that gives you your rooms revenue. So you have to come back to the basics that make up that equation, which is occupancy and the ADR. So the first thing you have to do in an appraisal is to project what that occupancy is going to be over the next three to five years.

Steve Rushmore:

And occupancy doesn't stay constant. It constantly changes depending on the supply dynamics of the local market that you're operating in. So if there's new demand coming into the market. For example, in Paris you had the Olympics and that was a huge amount of demand coming during a short period of time. In other markets you have new businesses coming in, you have new tourist attractions all different reasons why a market demand will increase. And then there's markets where the demand decreases, where a business gets relocated, manufacturing plant shuts down many different reasons why demand might actually go down. So that's the demand side. Then you also, equally important if not more important you have to look at the supply side, which is the competitive supply of hotel rooms in that market. And is the supply increasing, stay the same, or is it decreasing? If it's increasing, then that dilutes the market, which means that your occupancy, if the demand stays the same, will decline. So understanding what's happening with supply and demand is going to tell you what's going to happen with occupancy. Along with this, you have to look at what's happening with average rate. Average rate in the market will typically go up by inflation. Sometimes it goes faster than inflation, sometimes slower. Sometimes it even declines, like during COVID. So you have to project that out. So if you have the projection of occupancy and average rate, then you can tell what the revenue projection would be for the hotel.

Steve Rushmore:

The second component is that you now have to take that the expenses and you come up with a net income. You have to forecast out your expenses along with your revenue to come up with what your net income is. That is part of the future benefits, the present worth of future benefits and typically we do that over a 10-year period of time, but we're only estimating over probably three to five years. And then we assume that net income will go up by inflation, and so that gives us our 10-year cash flow. And then we assume that net income will go up by inflation, and so that gives us our 10-year cash flow. We then come up with a discount rate I like to use what's called the mortgage equity, because most hotels are bought with a mortgage or debt component and then equity component and that comes up with a discount rate that discounts it back to the present value and that is the value of your hotel.

Matt Brown:

Sounds entirely simple. No, it sounds very involved, and so much of hotel valuation is in the numbers. How do you account for intangibles in an appraisal? Is there even such a thing as an intangible when you're doing this work?

Steve Rushmore:

Sure, an intangible. A good example would be a franchise affiliation with a brand. You can have the same box, the same hotel right next to each other and you put one brand on one hotel and another brand on another hotel, or maybe not even put a brand on the other hotel, and that's going to have a different cash flow. Some independent hotels are really strong. If they have a great location, you don't need a brand, but a brand is a good example of it, intangible.

Jeff Borman:

We often hear the word unencumbered when we're looking at the buying and selling, and it could be of a management contract, you know, a 20-year management contract that the new owner would then take, you know, possession of or be encumbered by when they buy that hotel. A brand could be the same way. Is there a value positively to having unencumbered assets, like what is the value of given to an independent hotel because it does not have a branded flag that it owes another decade to, or a management company that it owns that it owes another decade to? Is there a bonus or a bump? You give the appraisal of that independent asset because the new owner can then go choose its path?

Steve Rushmore:

independent asset because the new owner can then go choose its path. Yes, for a lot of different reasons. If it's unencumbered, ie an independent hotel, or is it easily to become unencumbered? To become unencumbered like buying out the brand or the management company, or you have an agreement that if you sell the property, the management company or the brand doesn't come along with it. It could be as much as 20% difference in value. Having some unencumbered. The reason is is because it increases the type of buyers that would buy that property. So, for example, let's say you have a hotel that's managed by XYZ hotel management company and you can't get rid of them if you sell the property. Well, you can't sell that hotel to another management company or another owner or another brand if it's encumbered, so it just cuts down your opportunity of selling it to somebody who needs to take it unencumbered.

Jeff Borman:

You mentioned three methodologies to an appraisal and you kind of address the first two and I'll share those, but then you disregard them. The first is the cost approach, essentially what it would take to rebuild a hotel from scratch the land, the FF&E, the construction cost. The second approach is then the sales comparison approach, which I think you say is arbitrary, in your word, I remember was to triangulate value through real transactions. That was kind of interesting. But then you disregard those two for the method that ultimately you've developed. But why do you cast aside those two methods? I think most people think along those lines.

Steve Rushmore:

Basically, we're dealing with futures, projecting things out in the future, and we're making different types of assumptions along the way. Along the way, we can make assumptions based on facts and then we can make assumptions based on gut feel. An assumption based on gut feel would be a very subjective decision that you have to make along the way and as appraisers, we try to only deal with facts and we try to limit our subjective decisions along the way. So let's look at each approach. The cost approach sounds very simple. You just what is it going to cost you to build? That's easy to find out. What is the land value? That's very easy to find out. So to get to the total project cost is very objective. Okay, so we come up with the total project cost. Let's say it's $20 million. So that would be the value of a brand new hotel on that site.

Steve Rushmore:

However, let's assume most hotels are not brand new hotels. They're 3, 4, 5, 10, 20 years old and probably suffering from different types of obsolescence, depreciation and so forth. So, looking at a hotel that's not brand new, how much do you deduct because the roof is 15 years old and it only has a 20-year life? How much do you deduct because they just built a brand new hotel across the street from you. Because they just built a brand new hotel across the street from you. That's called external obsolescence. How much do you deduct? Because the bathrooms just have one sink and every other hotel in the market has two sinks. So these are all adjustments that you have to make and each one of those adjustments are subjective. So the problem with the cost approach is that you have a gazillion subjective decisions that you have to make.

Jeff Borman:

Each one could be wrong and therefore your value doesn't stand up and stand up If you were doing an appraisal or evaluation of where you are actually building from scratch. Are all the methods you just talked about the right ones, or would you discount them and depreciate them? Here is my brand new building. Here is my brand new bed and sink, and we know what that is. Today, it cost me to build it. In 10 years it'll be worth something else and it'll depreciate. You would do that and have confidence in that exercise. I would think why can't you do that in the reverse?

Steve Rushmore:

No, you're absolutely right. So for a brand new hotel, the cost approach is very important to do so. Feasibility is essentially this If a hotel is worth more by the income approach than the cost to build, it's feasible. If it costs to build more than it's worth when it opens, it's not feasible. When we do brand new hotels that haven't been built, we run an income approach and let's say the income approach comes out to $20 million but it's going to cost you $25 million to build, then it's not a feasible project. And that is the time that the cost approach is very important to do so.

Steve Rushmore:

The market, the sales comparison approach. You go and get other sales of other hotels in the market. You look it up and find out it's sold for X dollars per room. And the problem is is how do you adjust for differences between the subject property and a sale? You can't have an exact location, the same location, so there's going to be, at the minimum, a locational difference. But then there's a gazillion other differences. You could have different brands that have sold, you can have different size of hotels, you could have different condition of the hotels, different ages of the hotel, and each one of those differences you have to adjust to adjust the sale price to reflect the characteristics of the subject property.

Matt Brown:

You once wrote an article on how to value a hotel in 60 seconds, and it's stunning to me that you could pack all of this into 60 seconds. I, I, it's stunning to me that you could pack all of this into 60 seconds.

Steve Rushmore:

How can you give us a clue on how one would go about doing all of this within a minute? The easiest way is is the valuation thumb rule that, for every dollar average rate creates a thousand dollars of value on a per room basis. Creates a thousand dollars of value on a per room basis. So if you look in the market and the average rate of your Marriott is $250, then that hotel should be worth $250,000 a room. Just, it's a very rough rule of thumb, but it's surprisingly how often that works out. So that is the valuation thumb rule.

Steve Rushmore:

Then I have another rule of thumb for estimating what the land value is, so you don't have to go and pay too much for land. And essentially the way that works is you come up with the room's revenue, you multiply it by a ground rent percentage which varies somewhere between 4% to 10% of room's revenue, and then you divide that by your long-term mortgage rate, which today would be like 7%, and that gives you your land value. And then you can quickly determine whether you're buying the land too expensive or you're getting a good price for your land. So those are two thumb rules, and the third thumb rule which I came up with is called the soda can thumb rule, which says you go to the soda machine down the hall in a hotel A can of soda is selling for $2 a can. That hotel has to be worth $200,000 a room. You go to a Four Seasons hotel. They don't have a soda machine. You've got to order through room service. It's got to cost you $7, and so it's worth $700,000 a room.

Jeff Borman:

Steve, that was a minute and 55 seconds. We're going to have to rename your methodology, but I'm still pretty damn impressed. I have a question, though what makes for a particularly difficult appraisal, the most challenging valuation you've ever had? What's the curveball? The worst of them all.

Steve Rushmore:

Well, as I said, to do an appraisal you have to do a market study in order to project the occupancy. So whenever you're working in a market that doesn't have any hotels and that seems impossible, but there are a lot of islands in the Caribbean and so forth that don't have any hotels or maybe just have one hotel to appraise that and try to determine how much demand is going to come to that hotel becomes very difficult. I call it particularly a proposed hotel on an island that doesn't have any hotels. I call it a field of dreams appraisal, in that you know build it and they will come and you hope they will come. But those are tough and it's more than just looking at where the demand is coming from, is can the demand get to your hotel? So those become really, really tough.

Jeff Borman:

So those become really, really tough. One of the things I loved in your course and I did take the course about maybe eight months ago I love the way that you highlight an exceptional hotel at the beginning of each chapter, particularly the Oberoi Ude Villas in India. I love that when I saw that image behind you. I've been to that hotel and it was a great memory for me, so I love the way you tee that up with great hotels around the world. Yeah, in that chapter you prioritize selecting comparable hotels for the underwriting study with six criteria and what struck me is that you list them in this priority ADR facilities. Me is that you list them in this priority ADR facilities room count, management, company occupancy and geographic location. The order is what was counterintuitive to me. I would have thought the physical attributes of the property to be more indicative than ADR. So what is it about ADR that drives that to the primary position in your predictive analysis?

Steve Rushmore:

Okay, let me start off by telling you what that sequence of decisions are. I use it to determine a comparable financial statement for the hotel that I'm appraising financial statement for the hotel that I'm appraising. I call it the comparable statement selection order. So let's say I'm appraising a proposed hotel. It doesn't exist. There's no operating history. I have no idea of how well this hotel is going to do. I do my market analysis. I forecast out occupancy and ADR. Okay. Now what I need to do is determine what the expenses are going to be in order to come up with the net income that I'm going to do it this kind of cash flow line.

Steve Rushmore:

Okay, I have this stack of similar financial statements for hotels. You can, if you do a lot of appraisals of hotels, you get a lot of financial statements, or you can go to Smith Travel Research and ask them to run some comparable financial statements. Okay. So you have this stack of financial statements and what I want to do is figure out which financial statement is more like the hotel that I'm appraising than all the other financial statements, and to do that there's a selection order. Okay. So you might think why is occupancy so far down the list? The reason is is that the software that I developed. You can put in any occupancy and it will calculate, do the correct calculation.

Steve Rushmore:

What it doesn't work well is ADR. So it's very important that when you're projecting out and you're getting a financial statement, you want that financial statement to be similar to the subject property, with ADR being the number one. So it's intuitive in that if you're appraising a Four Seasons with an ADR of $500, you don't want to select a financial statement of a Hilton Garden Inn that's $250. There are two different types of hotels, two different levels of profitability. So you go through your pile of financial statements and let's say the subject property is going to have an ADR of $250. Then you pull together all the financial statements that are around $250. And that is the first level of comparability After the ADR. You have to remind me what the next one is on the list.

Jeff Borman:

It is facilities and then room count, which I think you accounted for in your answer already, that you can quite easily match those things up, yeah, so you know easily matched and geographic location matched. Actually, that all makes perfect sense, okay.

Steve Rushmore:

You can't compare a hotel with confection space, with limited service, with not so you get rid of those statements makes sense thank you.

Matt Brown:

It's time for the mystery question. Steve, you recently journeyed to the arctic circle. You're one of the few people in the world who's done this actually throughout history one of about 3 000 wow, amazing. Now that you've done it, now that you've checked that box, what's next? What's next for steve rushmore?

Steve Rushmore:

travel wise well, next week, uh, I get on a plane and we fly to bora bora in french polynesia. Stay, stay at the Four Seasons, one of those hotels over the water, and then we fly on to Papua New Guinea.

Matt Brown:

Jeff, we need to be making changes right now so that we can live Steve's life. Steve, thank you very much for being part of no Show. This is tremendous. We appreciate the time.

Steve Rushmore:

My pleasure and good luck to you guys.