By Jacqueline Stuart, MRICS RV

Misinformation is rife

There is a great deal of misinformation in Slovenia about how to value trade related properties, in particular hotels. According to the global valuation organisation RICS, the essential characteristic of trade related properties is that they have been designed or adapted for a specific use, and the resulting lack of flexibility usually means that the value of the property is intrinsically linked to the returns that an owner can generate from that use. The value therefore reflects the trading potential of the property.

In 12 years of working in Slovenia, I have seen hotel valuations carried out on the basis of; 

1. The cost of building the property
2. The value/m2 of the property, compared to other similar hotel transactions
3. A cap rate applied to the current EBITDA
4. Benchmarking the EBITDA against a bond yield

None of these methods result in a trustworthy valuation of a hotel. Let’s look in detail at the drawbacks of each:

Cost approach is far from reliable

The cost approach is completely unreliable when valuing hotels. One only needs to look at the Kempinski Palace in Portorož. Redeveloped at a reputed cost of 85m€, sold for 25m€ in 2015. This is not an isolated case. Conrad Hilton acquired the Plaza Hotel in New York in 1943 for 7m USD. It had been constructed 36 years earlier at a cost of 12.5m USD. Hotels are expensive to build, with unpredictable trade, and it always takes at least three years to get them operating to their optimum level. The hotel development highway is littered with properties developed at great expense, and sold at a fraction of the cost when things did not go as planned, and the owners were not able to pay their debt. One experienced Austrian hotel operator once told me that a hotel has to go through two bankruptcies before it reaches a sustainable price level. This is of course an exaggeration, and does not apply to all hotels, but it is a good illustration of the unreliability of using the cost of a hotel to calculate its value.

Value/m2 not appropriate for hotels

The value per m2, compared to other hotel transactions is even less reliable than the cost approach. Hotels vary hugely in their layout and distribution. Some have large public areas and small rooms, others the opposite. The main drivers of revenue in hotels are typically rooms and food and beverage. However a larger room does not always guarantee a higher room rate. The number of beds in each room is a better indicator. A family of four nearly always pays more for a room with more beds than a solo traveller occupying a room with one bed, in the same hotel, regardless of the size of the room. Some hotels have extensive leisure facilities that add to the total built area of the hotel, but do little to improve the profit, due to the expense of operating them. The value per key (room), compared to other similar hotel transactions is a better method, but this also has its drawbacks and should be considered only a rough guide.

Income approach is of limited use

A cap rate applied to the current EBITDA has its merits, but is more useful for international hotels being sold to specialist hospitality institutional investors. There have been only two such sales in Slovenia, The Austria Trend in Ljubljana that was sold to CA Immo in 2006, and the same hotel that was sold to KD Skladi this year. Most hotels in Slovenia have little appeal in the international investment market. Institutional investors typically seek hotels with more than 120 rooms, run by a well known international operator. Most want city centre or airport properties with dependable, consistent income. Only a few will consider leisure hotels, which are considered to be vulnerable to weather and other factors. There are only a handful of hotels in Slovenia suitable for institutional investors, and none available for sale. However there is another even more important reason that the income approach is unreliable; hotels should be valued on the basis of their trading potential, not their actual trade. International valuation standards state that hotels should be valued ‘on the assumption that a competent operator is in place’. This is not always the case in Slovenia.

Bond yield is bonkers

Benchmarking the EBITDA against a bond yield is the least useful method of valuing hotels.  Benchmarking is a means of evaluating something by comparing it to something else, of relevance. Every investor has a choice of what to do with his or her money. I have sold 15 hotels in this region, and in the process come into contact with hundreds of hotel investors. I have never once experienced a hotel investor weighing up whether to invest in bonds or a hotel. Even institutional investors do not face this choice, they are typically specialised in their field and are either bond investors or hotel investors, or investors in some other niche. The link between the return on bonds and hotels is a tenuous one. This method is used only in Slovenia and other immature markets,  hotel valuers in more mature markets do not use it.

Coke can multiplier

In the US, the coke can multiplier method of valuation is sometimes used as a quick guide. It goes like this, every room in a hotel is worth 100,000 times the price of a coke in the on-floor vending machine, or in-room mini bar. This technique clearly has its flaws, but it is no more unreliable than most of the other methods commonly used in Slovenia.

Who are hotel buyers?

In order to understand how to value hotels in Slovenia, we have to first understand who the buyers are. They broadly fall into five categories:

1. Existing hotel owners wishing to expand
2. High net worth individuals who dream of owning a hotel
3. SME’s with cash to invest, who believe that investing in a hotel is a good way to diversify
4. Strategic buyers, such as a casino owner that has no accommodation
5. The ex-Yugoslav diaspora seeking to reconnect with their homeland

Each group of buyers has their own objectives but the one thing they all have in common is that they will likely need to raise bank finance for the acquisition. If they are in the fortunate position of being able to acquire a hotel with cash, they will want a certain rate of return. The single most important thing to understand when valuing a hotel is the trading potential of the property, and the amount of free cash flow that can be generated to pay off bank debt, or provide a return to the owner.

Every potential hotel owner has a dream

It is not straightforward to calculate the potential free cash flow of hotels in Slovenia. Very few are performing optimally, for various reasons. Some are overstaffed as a legacy of the socialist era. Others operate for only part of the year through the personal choice of the owners, even though they could generate additional profit by opening for more months. On the contrary, some hotels are open all year round, paying a huge amount for heating and personnel during months with no trade, and would benefit from closing for part of the year. Some hotel operators have limited sales and marketing skills and do not take advantage of yield management to ensure higher room rates in busier months. One important thing to understand in the world of hotel valuations is that every potential hotel buyer has a dream. In 12 years as a broker and valuer, I have never met a buyer who intends to acquire a hotel and operate it as it is. Even institutional investors take an opportunistic approach to hotel acquisitions, always looking for an angle to improve performance.

Other valuation factors

There are other important factors to be considered. Is it a company deal or an asset deal? Hotel buyers are obliged by law to employ the existing staff, how many will want to stay on under a new owner? How is the hotel performing compared to its competitors? What new hotel properties will come to market in the near future? Is any CAPEX required? Will any trade be lost as a result of the existing owner departing? Is there any opportunity to add value by renting out unused space or building a spa to generate trade in the shoulder season? Is there any alternative use for part or all of the property? What is the outlook for tourism and business travel in the area? Is the layout of the hotel consistent with its category? Could the performance of the hotel be improved by upgrading or downgrading the category? Does the Manager believe that there are factors that have been holding the hotel back? Where are we in the economic cycle? How does the hotel score on tripadvisor and booking.com? Are there any marketing channels not currently being used that could generate more trade, or more profitable trade?

Understanding hotel operations is key

In Slovenia it is often hard to understand the operational potential of properties because of lack of competition in the area. Recently 4 hotels in Bohinj were sold, all in need of refurbishment;  one derelict. Because those properties comprise a large percentage of the tourist accommodation round the lake, it is difficult as a valuer to assess how much additional trade could be generated by refurbished properties, assuming a competent operator is brought in to run them. If a hotel comprises only 1% of the hotel beds in a given location, there is a huge pie from which to take an additional share of business. When a hotel or in this case hotels comprise most of the accommodation in the area, you cannot assume that they will take sufficient business from competitors to ensure optimal performance. Nor can you assume that the pie will grow sufficiently in response to the upgraded properties.  Another challenge is valuing a hotel that is very different from the competition in the area. Vila Planinka is a 5-star property with only 23 rooms in Zgornje Jezersko. It scores 9.6 on booking.com, probably the highest in Slovenia. It is so different from anything in Gorenjska, that it would be difficult to find anything to benchmark it against. Because Slovenia is small with few transactions, we often have to look at transactions in neighbouring countries to find relevant comparables, and make adjustments according to the risk profile of the jurisdiction.

To summarise, understanding hotel operations is key when valuing a hotel. It is also important to understand that hotel buyers are often globally minded, and so availability and transactions in neighbouring countries should be considered. This is hard for real estate valuers in Slovenia, who do not specialise, and have to value all asset classes. Hotel valuers in more mature markets work only on hotels; just as valuers of office, retail and industrial do not value hotels.

Jacqueline Stuart is a Director of S-Invest. She is a licensed real estate broker in Slovenia, and a RICS registered valuer. She holds the certificate in hotel industry analytics, awarded by the American Hotel and Lodging Association.