Hurting in Hospitality
In conducting our cap rate analysis of the various real estate sectors, we kept running into resistance when trying to discuss lodging cap rates. The sector has been among the hardest hit during the recession. In normal times, extremely low prices and high cap rates (13 percent or higher) would imply that a property required a major renovation, according to industry observers. On the other hand, extremely low cap rates (8 percent or less) generally meant that a renovation was in progress and operators could not rent out a normal quotient of rooms.
Today, however, war and terrorism have created even more perceived risks in the hospitality sector and thrown standard analyses into question. After the terrorist attacks of Sept. 11, 2001, the category fell into a virtual depression. At that time, the hotel business was already trending down due to the slowdown that began in March 2001.
Toni Viens, director of data collection and research with HVS International, tracks cap rates in each of the major hotel sectors. In March 2003, her research showed the following average cap rates for 2002 based on transactions in the luxury, upscale, and mid-scale categories of hotel real estate.
- Luxury Hotels: During 2002, the lowest cap rate on a transaction tracked by Viens was 8.2 percent, and the highest was 12.9 percent, for an average of 10 percent. This compares with 2001 luxury hotel cap rates ranging from 6.8 percent to 12.2 percent, and averaging 9.9 percent.
- Upscale Hotels: According to Viens, 2002 cap rates in this hotel category ranged from a low of 6.1 percent to a high of 11.5 percent, and averaged 10 percent. In 2001, the category low was 7.9 percent and the high was 12.8 percent, with an average of 10.6 percent.
- Mid-scale Hotels: Viens' research found that mid-scale hotel cap rates ran from a low of 5.5 percent to a high of 16 percent, and averaged 11.3 percent. In 2001, cap rates tracked by Viens ranged between 6.8 percent and 15 percent, with an average of 11.3 percent.
Viens cautions that the low, high and average cap rates in both 2001 and 2002 were based on an unusually low number of transactions due to the economic climate. "In 2001, we tracked 105 sales," she says.
"During 2002, the average cap rate was based on 100 sales." This compares to annual sales of 150 in 2000; 128 transactions in 1999; and 241 sales in 1998.
The small number of transactions in 2001 and 2002 may have thrown the averages off. "Cap rates on the transactions we've followed are lower than these averages," says Greg Larson, senior vice president, investor relations with Host Marriott Corporation.
Larson believes that investors are accepting lower hotel cap rates or returns as they position themselves for future growth. "Five years from now, if the economy has rebounded, today's investors may see enhanced returns along with higher prices," he says.
