of what we engage in as established practice may seem to make sense at
the start but later prove less practical. For a hundred years, we have
made use of a typewriter keyboard with the familiar Q-W-E-R-T-Y
arrangement of letters on the belief that this arrangement promotes
fast typing, only to find lately that other arrangements are much
faster. Since the agrarian revolution that turned us from
hunter-gatherers into farmers, we have based our diet on starches like
potatoes and grains. Now we learn that these same starches are prime
culprits in diabetes. Looking for safety in cars, many of us chose
SUVs. But later it turns out that, of all cars, SUVs have the worst
tendency to flip and roll.
We may do a thing one way for a long time, only to find that the thing
makes less sense in the end than it did at the start. So it is with the
valuation of hotels. As appraisers, we have traditionally presented our
hotel analyses as valuations of real estate. A hotel is clearly real
estate, at least in part. But in recent decades something else has
become clear: a hotel has a business component. Part of the value of an
operating hotel is a going concern. The distinction can be important:
the real estate is taxable as real estate and the furnishings (a second
component) as personal property. But the business, the third component,
is not taxable. We don't impose a real estate tax on the billiard
parlor, the hair salon, or the convenience store that operate out of a
retail strip. Why should we impose a real estate tax on the business
component of a hotel?
If the world were arranged to make life easy for real estate
appraisers, all the information needed to make a good appraisal would
be available, in abundance. To help the lender who wants an appraisal
of just the hotel's real estate, not its business component, we would
have numerous comparable sales of hotel buildings that are stripped of
their furnishings and are out of business. We would have comparable
leases of hotel buildings, so that we could analyze them as we do
retail and industrial properties, through the Income Approach. We would
have local construction cost data for all the various types of hotels.
But as it happens, information as useful as that is rarely available
for hotel valuation.
The primary data for the valuation of a hotel is the hotel's history of
income and expenses. This is the data on which the market of buyers
makes its decisions. It allows buyers and appraisers to value the hotel
as a whole. For some purposes, that answer is all that is needed. For
others, it is not. What that valuation leaves un-answered is, what is
the value of the real estate?
To separate out the "FF and E" component (the furnishings) is
relatively simple: for this, book value likely provides a reasonable
approximation. To separate out the business can be more complex.
A hotel restaurant that produces more than break-even income is a
business, and its value requires extraction. The same goes for other
profit centers like the news stand and the fitness center. Bookings
have value. So does the working capital without which the hotel could
not function. The investment in the training of a fully trained staff
is a business asset. One by one, these items and others can be isolated
and allocated to the business. Appropriate methods for measurement and
allocation are discussed in an extensive literature on the topic of
BEV, or business enterprise value, published in The Appraisal Journal
and other industry outlets since the 1980s. Analysts argue that the
business component of a hotel may bear a value that exceeds 30% of the
value of the whole.
What is true for a hotel can be true for other assets that mix business
and real estate. Gas stations, car washes, and restaurants all involve
equipment and may involve going concerns. Having created the tools for
measurement of BEV, appraisers can apply them to other types of real
estate. Some make a strong argument that BEV is a component of a thing
that seems as exclusively real estate as a shopping mall. The question
arises, then: is BEV a component of the value of all real estate?
Certainly, all real estate benefits from good management. But good
management and a going concern are different things. Most real estate
has a value that is independent of the value of the businesses that
operate from it. Three identical office buildings that are occupied by
businesses with differing worths likely have very similar values. For
most investment real estate where business and real estate are already
well separated, the answer to the question, "Is BEV part of the value
that you have measured through your traditional methods?" is "no."
Eric T. Reenstierna, MAI