HVS's Mixed-use appraisal expert Tim Sauer, MAI lays out some of the considerations for the evaluation of hospitality-focused mixed-use assets
By Tim Sauer
As Americans continue to “rediscover” urban areas, they not only seek-out these areas as places to live but also as places to stay when they travel. These walkable neighborhoods offer residents and visitors ready access to civic, economic, and social nodes, to which local hotels can provide access for guests. This results in demand from more segments of hotel guests than if the hotel were located near a single demand driver.
Additionally, hotels in these areas are often less susceptible to new competition due to the higher barriers to entry in more urban markets. These barriers include fewer development sites (and therefore more expensive land), more restrictive zoning, and restrictions put in place by historic preservation boards. These constraints often necessitate adaptive reuse of existing structures and the construction of structured parking (or leasing arrangements with nearby properties that have a surplus of parking).
In addition to structured parking, these assets may derive income from first-floor retail space or apartments that share the upper floors of the building with the hotel. By their very nature, each mixed-use property is unique. Therefore, HVS professionals consider a variety of factors when providing consulting or valuation services for these types of assets.
Highest & Best Use
As with any type of real estate, a determination of highest and best use is critical to the analysis of a mixed-use asset. However, while the highest and best use of a greenfield site in a suburban area is often quite obvious, the possibilities for an urban site are often more varied. Furthermore, an urban site or building could have environmental issues that are less common with suburban sites.
Another critical question when analyzing mixed-use assets is what type of person or entity would be interested in purchasing the property. Does the asset possess a combination of uses that effectively hedge against one another? Or are the asset’s uses so varied that there would be few buyers with the expertise and energy to manage such disparate income sources? Additionally, would the asset still appeal to traditional hotel investors, or are there so many other revenue streams that it no longer meets their investment criteria?
Finally, the appraiser must determine if the various sources of income could be split off and sold separately, and if doing so would result in a higher value than selling the entire property to a single buyer. The answers to these questions can affect the asset’s marketing and exposure times, as well as the yield rate.
Income Projection
After determining the most likely buyer of a mixed-use asset, the next step is to determine how that buyer would evaluate each of the asset’s income streams. For retail and office components, for example, it will be necessary to project market rents, occupancy rates, lease terms, escalations, and tenant improvement allowances. For properties with multi-family components, prevailing market rents or sale prices must be considered. Additionally, the appraiser must determine whether the residential units will be available to hotel guests via a rental pool. Operating expenses and/or selling expenses must also be evaluated.
In some cases, it may be appropriate to combine the income projections for the various components into a single consolidated income projection for the entire property. In other cases, the income projections are not combined because it was determined in the highest and best use that the various components would have more value if sold separately than if they were sold as one property. Furthermore, if a mixed-use property has condominium units, that income projection cannot be combined with the hotel’s income projection because the condominium income will diminish over time while the hotel’s income will continue over the economic life of the property.
Yeild Rate
After projecting the various income streams for a mixed-use asset, the appraiser must select a discount rate with which to discount those income streams to a present value. The selected discount rate must be consistent with the return expectations of the asset’s most likely buyer (as determined in the highest and best use).
In a case where the non-hospitality income is minimal, it may be appropriate to discount the ancillary income at the same rate as the hotel. However, in situations where the non-hospitality income is more substantial, it may be necessary to analyze the prevailing yield rates for each particular income stream. Additionally, if it was determined in the highest and best use that the asset’s unique characteristics severely limit the pool of potential buyers, investors or buyers may demand a higher yield rate to compensate them for the additional resources necessary to effectively manage the asset.
Conclusion
HVS is known for unparalleled expertise in hospitality valuation and consulting. However, we also have professionals with extensive experience in the valuation of other asset types, which we can leverage to value non-traditional hospitality assets. Hence, we encourage lenders, developers, and other stakeholders to take advantage of HVS expertise as they explore the opportunities in owning and developing mixed-use hospitality-focused assets.
