Valuing Hotels During Extreme Trading Conditions

Posted by Colliers on 4th April 2022 -

At the beginning of the COVID-19 pandemic, the RICS recommended that commercial property valuers include a declaration that valuations were subject to a material uncertainty clause.

 

While the recommendation was lifted for most sectors later during 2020, it remained discretionary for the hospitality sector given that values are based upon trading performance, which continued to be badly impacted.

More recently and in a reversal of fortunes, many regional leisure hotels are experiencing very strong demand and on 3 March 2022, in light of the generally improving COVID-19 situation around the world, the RICS withdrew its Global COVID-19 Valuation Practice Alert.  

Andrew Pratt, Director in our Hotels Valuations team, discusses the considerations facing hotel valuers during periods of exceptional trading conditions.

It has been an interesting few years for those involved in the hotel and wider hospitality market; a period unlike any other where we have seen swings from relatively normalised trading conditions in 2019, to significant periods of enforced closure and trading restrictions resulting from COVID-19 in 2020 and 2021. This was then contrasted by periods of exceptionally high demand, particularly for regional leisure hotels, which have benefited from the staycation boom, initially in late summer 2020 and then following reopening from the second major lockdown in April and May 2021. While the demand has been less for city centre corporate/events-led hotels, the signs are that this sector of the market is now starting to recover which is encouraging.

So, how have these exceptional conditions impacted your valuation of hotels?

When considering how to value a hotel, the valuer must always reflect for current market conditions and the underlying methodology for hotel valuations remains the same i.e., that the value of a hotel is intrinsically linked to the sustainable returns that can be generated at that hotel. The valuation must be based upon the Fair Maintainable Trade (FMT) including the Fair Maintainable Operating Profit (FMOP), that is capable of being achieved by a reasonably efficient operator, which is then capitalised by applying an appropriate yield/multiplier.

When undertaking valuations at the height of the pandemic, so when a hotel was closed or barely trading, a valuer might be forgiven for being overly cautious, after all, the current and future performance was perhaps more uncertain than it had ever been. 

This is where the skilled specialist valuer came to the fore, always recognising that as we base our valuations off a maintainable trade, as opposed to the then current exceptionally low levels being achieved in the short term, the main consideration was how long will it take for the business to restabilise itself and reach its longer term sustainable position once more. Experience, knowledge, common sense and understanding of the sector were therefore critical in assessing value. 

The above aside, we were still valuing in an uncertain period and an element of “crystal ball gazing” was necessary, the inherent risk of which was reflected for in the adopted yield/multiplier. 

Whilst the inclusion of the risk factor, coupled with lower trading performance as the hotel re-builds its trade to a stabilised level, resulted in a reduction in value when we compared it to actual or hypothetical 2019 pre-pandemic value, in many cases, it reflected only a 5 to 15 per cent discount, with the proviso that the shortfall gap would close as trading conditions and so also the hotel’s performance improved back towards its stabilised levels. 

Many regional leisure hotels have experienced “best ever” trading results since reopening in 2021 – how has this been reflected when valuing hotels?

In stark contrast to the height of the pandemic, the UK regional hotel market is currently experiencing exceptional levels of domestic leisure demand following reopening and the relaxation of COVID-19 restrictions. This has resulted, in many hotels having occupancies and room rates often above those previously seen, particularly in the usually quieter months. It is our view that the market will continue to benefit from the staycation boom, which is expected to be maintained throughout 2022, however, as the international travel market rebounds, we would expect the domestic market to return gradually to its more usual seasonal patterns.

As we move further into 2022, it has been noticeable that the recent trading information we have seen shows very high levels of performance and in many cases, forecasts project performance well in excess of previously achieved levels. When considering these for the purpose of a formal valuation, we have to make a judgement as to whether they show a true reflection of the future sustainable trade, or do they represent exceptional trading conditions.

Revenue, of course, is just one part of the equation. Indeed, further to sometimes exceptional revenue levels, the industry has also seen an exceptional situation in terms of operational costs. Recent accounts shows the positive impacts that COVID-19 Government assistance has had, including the likes of the Coronavirus Job Retention Scheme (furlough), business rates support and VAT discounts, which will not be available to operators long term. In addition, there has been significant upwards pressure on labour and utilities costs and there continues to be inflationary and above inflation rises on costs across the board, all of which will impact the sustainable level of profit achievable at a hotel.

Whilst operators may well be able to achieve performance in line with their expectations in the short term, we are of the opinion that the market in the future may assess the sustainable level going forward more cautiously and, as valuers, we must follow the market and therefore reflect this in our assessment of Fair Maintainable Trade accordingly.

Does this mean that Fair Maintainable Trade is always based on pre-COVID-19 trading levels?

The above paints a cautious picture, however, we consider each individual hotel on its own merits and it is encouraging to note that many hotel owners and operators used the recent COVID-19 situation to undertake improvements and refurbishments which will hopefully allow them to drive occupancy and rate, thus supporting improved revenues. In addition, the increasing cost pressures meant many had to review their businesses and have implemented significant operational efficiencies compared to pre-COVID-19 trading. 

Therefore, when considering Fair Maintainable Trade in the current market, it is not uncommon for us to assume that a hotel will re-stabilise at a level higher than previously achieved, particularly in terms of revenues.

When it comes to valuing hotels, “one swallow doesn’t make a summer”, and this is true for both extremes discussed in this article.

Values must not exponentially reduce in times of exceptionally low performance (given that underlying demand remains) and similarly, the value of a hotel should not rise to unjustifiable levels following a period of exceptionally high demand, levels of which may not be sustainable in the long-term.

Notwithstanding the above, whatever the process, the resultant value must be assessed against a “stand back and look” basis, to consider if the results are in line with what the market would actually pay for the hotel.

Conveniently for the valuer, since the last quarter of 2021 there has been a significant increase in sales activity and therefore a good stock of comparable evidence to act as a hotel valuation guide. In the main, the evidence shows that pricing is strong and we therefore expect hotel values to remain relatively robust for the foreseeable future.