As the cash flows of many resorts around Asia have been affected by the recent global events stemming from the terrorist attacks in the US, many resort owners are wondering about the value of their resorts. Historically, resort values in Asia have been estimated on the basis of replacement cost, comparable sales transactions or various direct capitalisation approaches. Although these approaches are widely accepted throughout Asia by banks, investors and developers, they often completely ignore the future earning potential of resorts, the current and future condition of the markets in which the resorts operate and the current shortfall of debt capital and high return requirements of active equity investors in Asia.
 

WHAT IS DIFFERENT ABOUT RESORT
HOTELS?

As resort hotels differ from urban hotels in many ways, a good understanding of the factors that could impact the future earning potential of a resort is especially important when valuing a resort in Asia.
 

Infrastructure

Many developed resort destinations have good infrastructure, such as a good road network, an educated work force and water and power supplies. Less developed destinations, however, usually do not have such infrastructure in place. This impacts the future development and competitive level of such destinations in comparison to more developed destinations within the region.
 

Accessibility

Resort destinations such as Phuket and Bali have become popular global tourist destinations due to their excellent accessibility – they provide a network of direct international flights from various key feeder markets. Resort destinations with limited accessibility, on the other hand, find it difficult to compete with such destinations. As a consequence, they generally rely on domestic and highly discounted wholesale demand.
 

Guestroom Inventory

A large proportion of the resort hotels in Asia were developed prior to the 1990s and only a few resort owners have carried out necessary works to maintain their resorts at an international standard. Therefore, there is a relatively limited inventory of well-maintained international standard resort guestrooms in the region, which is likely to negatively impact the positioning and level of competitiveness of the resorts.
 

Seasonality










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Furthermore, many resort destinations are affected by strong monthly seasonality cycles. During high season months, many resorts achieve occupancy levels in excess of 80%. However, during low season months, the same resorts may only achieve an occupancy level of say 50%. However, destinations with good accessibility and a good inventory of guestrooms have more opportunities and available market segments to attract demand during shoulder and low season months.

All the above factors cause cash flows and profitability levels to fluctuate. Consequently, both lenders and investors perceive resort investments in Asia as risky, which can result in rapidly changing interest rates and reasonably high investment yield requirements.
 

APPROACHES TO
VALUE

In evaluating a property to assess its open market value, the professional valuer has three approaches from which to select: the cost, sales comparison and income capitalisation approaches. These approaches to value and the valuation methodology set out hereafter may be applied to the valuation of both existing and proposed resorts.
 

Cost Approach

The Cost Approach estimates market value of a resort by computing the current cost of replacing the property and subtracting any depreciation resulting from one or more of the following factors: physical deterioration, functional obsolescence and external (or economic) obsolescence. The value of the land, as though it were vacant and available, is then added to the depreciated value of the premises in order to produce a total value estimate.

Whilst the cost approach may provide a reliable estimate of value for newly constructed resorts, it is not the case for older properties. As assets age and begin to deteriorate, the resultant loss in value becomes increasingly difficult to quantify accurately. Many resort destinations in Asia were developed ten to fifteen years ago and at highly inflated prices. As such, many resort construction costs lack transparency or are incomplete and should be analysed with caution. However, a prudent valuer should also take the cost approach into consideration so as to gain an indication of the cost likely to be incurred upon entry into the marketplace.
 

Sales Comparison
Approach

The Sales Comparison Approach estimates the value of a resort by comparing it to similar properties recently sold on the open market. To obtain a supportable value estimate, the sales price of a comparable property should be adjusted to reflect any dissimilarity between the comparable resort and the subject resort. However, this approach to value has limited usage in Asia due to the lack of recent resort hotel transactions in the region.
 

The Income Capitalisation
Approach




















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Knowledgeable buyers of hotels generally base their purchase decisions upon economic factors, such as forecast net income and return on investment. The cost and the sales comparison approaches are therefore given minimal weight in the hotel valuation process, apart from providing, when applicable, an estimate of the cost to enter the marketplace either through newly constructed properties or acquisitions.

The income capitalisation approach takes a resort’s forecast net income before debt and allocates these future benefits to the mortgage and equity components based on market rates of return and loan-to-value ratios. Through a discounted cash flow and income capitalization approach, the value of each component is calculated. The total of the mortgage component and the equity component equals the value of the property.

Although historically applied only on a limited scale in Asia, our experience with active potential hotel buyers and sellers in Asia indicates that the income capitalisation approach is now becoming more widely accepted in the regional marketplace. Furthermore, through the accurate build-up of cash flows and the application of realistic investment parameters, the value derived through the income capitalisation approach is reflective of what a likely buyer is willing to pay for the resort asset. For this reason, the income capitalization approach produces the most supportable value estimate and is generally given the greatest weight in the hotel valuation process.
 

THE PROCESS

In arriving at the value of a resort using the income capitalization approach,
the following steps are included to support the cash flow projections and
the investment parameters applied:

	Step One Fieldwork and Analysis;
	Step Two Projection of Resort Occupancy and Average Rate;
	Step Three Ten-Year Projection of Income and Expense;
	Step Four Simultaneous Valuation Technique;
	Step Six Capital Expenditure Deduction.

Step One: Fieldwork
and Analysis

Due to the somewhat unique characteristics of resort markets, it is necessary to carry out detailed market research to support the cash flow projections of a resort. Fieldwork is undertaken to gain a thorough understanding of the market area and the demand and supply dynamics in which the resort operates.

The following areas are thoroughly researched and analysed during Step One:
 

Country and Market
Area Overview

The macro- and micro climate in which a resort operates is an important consideration in forecasting resort demand and cash flow potential. This overview analyses the political, economic and social environment in which the resort operates to ascertain whether the market area is likely to experience future growth or decline.
 

Accessibility

With many international investors and hotel operators seeking resort development opportunities throughout the region, competition is likely to increase. Resort destinations with good accessibility, such as Phuket and Bali, are likely to continue to benefit from having an extensive international network of flights from key feeder markets in Europe and Asia. In the case of an emerging resort destination, its level of accessibility is likely to have a serious impact on its future growth potential. It is therefore vital that a comprehensive analysis of future developments that could impact a destination’s accessibility be undertaken.
 

Level of Development /
Hotel Supply

As resort destinations in Asia were largely developed 10 to 15 ago, the level of development in many instances is limited and the hotel inventory of a poor quality. Better accessibility is likely to lead to the development of more upmarket and international standard resorts, which is likely to enable a destination to reposition itself from a reasonably low-end or budget destination to a mid- or higher market destination. However, the level of new resort development and infrastructure development, such as airports, roads, power and water supply lines, is likely to have a long-term impact on the overall positioning and development potential of the destination.
 

Tourism / Hotel Market

A comprehensive study is done of the historic tourism and hotel market performance in order to assess the historic growth / development of the destination. Information pertaining to visitor numbers, seasonality trends, average length of stay, key feeder markets and historic levels of hotel supply and demand is analysed.

The purpose of the research set out in Step One is to establish the current characteristics of the market area. Following this, a conclusion is drawn on how the market area is likely to develop in the future.
 

Step Two: Projection of Occupancy and Average Room Rate

The occupancy and average room rate projections for the resort comprise the basis of the ten year forecast of income and expense.

 

Occupancy Projection

The methodology employed first quantifies the base level of demand in the competitive group of resorts and then forecasts the changes in supply and demand throughout the projection period to arrive at a projection of market-wide occupancy.

The projection of market-wide occupancy considers base demand growth and latent demand, including unaccommodated and induced demand. The projection of base demand growth considers the points set out in Step One. However, to support future demand growth analysis, interviews should be undertaken with prominent airlines and tour operators to ascertain the likely future development of air capacity and tour operator interest in the destination. Unaccommodated demand is a form of excess demand and refers to individuals who are unable to secure accommodation in the market area. For many resort destinations, unaccommodated demand exists in the high season months, when many resorts operate at high occupancy levels. Induced demand refers to the additional room nights created through the introduction of a new demand generator in the market area. As resorts themselves in many instances are the main demand generators in the market area, the opening of a new resort is likely to induce demand to the market area.
 

Subject Resort
Occupancy Projection

Following the projections, a penetration analysis is undertaken to project how the subject resort will be positioned within the market in terms of both occupancy and average room rate. A penetration analysis by market segment is used to project the future occupancy performance of the subject resort against the market. The penetration factor is calculated by dividing a resort’s fair share by its actual share. A resort with a penetration of 110% is performing above its fair market share. This exercise requires an in-depth understanding of the economic factors that influence each segment of demand, including seasonality constraints, maximum monthly occupancy levels, average length of stay, and the economic outlook for each key feeder market. In addition, to forecast the operational positioning of each resort within the competitive market, an in-depth understanding of the current and future levels of competitive supply, including an assessment of the likely impact of brand strengths, competitive facilities and location on the performance of resorts, is required. In the case of undeveloped or emerging resort destinations, such as Krabi and Nha Trang, where there is limited base demand, comparable regional and international resort destinations are used as benchmarks. Adjustments are then made for the subject market area, which reflect the resort’s accessibility, hotel supply and other market specifics.
 

Subject Resort
Average Rate Projection









































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In order to take into consideration the changes in market mix and seasonality in many resort markets, the subject resort’s weighted average room rate is projected following an analysis of the resort’s seasonal average room rate by market segment. Resorts in the region are typically characterised by the following market segments: FIT (full independent traveller), MICE (Meeting, incentive, conference and exhibition) and Wholesale (tour operator business).

The average room rates of most resorts in the region vary significantly depending upon the following criteria:

Seasonality;

Accessibility;

Brand Strength;

Star rating / quality of facilities.

During high season months, resorts capitalise on their popularity and maximise their average room rate potential within the Wholesale and FIT segments. During shoulder and low season months, on the other hand, resorts focus on attracting MICE demand and offer promotional discounts to maintain business in the FIT and Wholesale segments.

Resorts located in destinations with good accessibility from either long- or short-haul markets are able to attract higher paying FIT and MICE segments whilst destinations with poor accessibility tend to attract lower paying Wholesale demand. Therefore, the average room rates achieved are generally higher in better-connected resort destinations.

Resorts with strong brand recognition in key feeder markets and a global reservation system are likely to be able to attract higher paying demand. Furthermore, such resorts are likely to be able to capitalise on global loyalty or reward programmes.

The quality and mix of facilities at a resort significantly impacts the average room rate potential of a resort. Resorts with good international standard facilities, in terms of guestrooms, food and beverage outlets and recreational activities are likely to be able to achieve a rate premium over resorts with inferior facilities. Newly opened resorts or recently refurbished resorts are likely to capitalise on such premiums.
 

Step Three: Ten-Year Projection of Net Income

Based on the occupancy and average room rate projections of a resort, as well as the anticipated market positioning of its food and beverage outlets and other departments, such as the spa and conference and meeting facilities, a ten-year projection of income and expense is prepared. Using actual operating data from the subject resort, or in the instance of a resort feasibility study, from comparable resort facilities, expense estimates corresponding to the projected level of activity and the overall quality of the hotel are developed. In forecasting revenues and expenses for a hotel, a fixed and variable component model should be used. The methodology of such a model is based on the premise that hotel revenues and expenses have one component that is fixed and another that varies directly with occupancy or facility usage. A projection can be made, by taking a known level of revenue or expense and calculating the fixed and variable components. The fixed component is adjusted only for inflation, whilst the variable component is also adjusted for the percentage change between the projected occupancy and facility usage that produced the known level of revenue or expense. The ten-year forecast of income and expense is expressed in inflated currency as of the date of each projection year. Finally, trends in local revenue and expense factors, such as food and beverage revenues, spa revenues, labour expenses, food and beverage costs, energy rates and property taxes should be researched.
 

Ten Year Forecast of Income and Expense (US$) '000S 
Click here to view the Table
 

Step Four:
Simultaneous Valuation Technique

The conversion of the forecast income stream into an estimate of value is accomplished by using a Discounted Cash Flow procedure. In general, many valuers tend to use an overall discount rate, which is meant to represent both the cost of debt and equity capital explicitly.

However, the methodology employed by HVS estimates the value by using the individual discount rates that are specifically required by debt and equity components. To accomplish this task, members of HVS International have developed a valuation formula referred to as The Simultaneous Valuation Formula (SVF). The formula uses a ten-year projection of income and expense. The net income is then discounted through a mortgage-equity procedure that allocates the anticipated net income and reversion to the mortgage and equity components based on market rates of return and loan-to-value ratios. The total of the mortgage component and the equity component equals the value of the property.

The following four steps detail this process:

1. Data pertaining to the terms of typical resort financing are set out, including interest rate, amortisation term and loan-to-value ratio. Such information is gathered from analysing the prevailing interest rates offered in the marketplace coupled with interviews with hotel investors, banks and other investment institutions;
    

2. An equity yield rate of return is then established. Knowledgeable resort buyers are likely to base their equity investments on a tenyear equity yield rate projection that takes into account the benefits of the ownership. The following areas should be borne in mind when considering an equity yield rate for a resort investment: historic levels of trading (if applicable), the covenant of the management company, periodic cash flow distributions resulting from strong seasonality and or accessibility constraints, threat of new supply, residual sale or refinancing distributions that return any property appreciation, as well as mortgage amortisation, income tax benefits and non-financial considerations such as status and prestige. All the above factors contribute to the level of risk associated with the financial projections / investment and for this reason, it is imperative that the person responsible for selecting the appropriate equity yield for a particular investment is the same person responsible for preparing the financial projections;
    

3. The value of the equity is calculated by first deducting the yearly debt service from the forecast net income before debt service, leaving the net income to equity for each forecast year. The net income as of the eleventh year is capitalised into a reversionary value. After deducting the mortgage balance as at the end of the tenth year, together with typical selling and legal costs, the equity residual is discounted to the date of value at the equity yield rate. The net income to equity for each of the ten projection years also undergoes a similar discounting process. The sum of these discounted values equates to the value of the equity component. Adding the equity component to the initial mortgage balance yields the overall property value. (Although the amounts of the mortgage and debt service are unknown, the preceding calculation can be solved either by an iterative process on a computer or through an algebraic equation that computes the total property value as the loan-to-value-ratio has been determined in Step On);
    

4. The proof of value is performed by allocating the total property value between the mortgage and equity components and verifying that the rates of return set out in steps one and two can be precisely met from the forecast net income. Beginning with a ten-year forecast of income and expense for a typical five-star resort in Thailand, the HVS International income capitalization approach to value will now be demonstrated. This income and expense forecast (Table 1) was developed in the fashion described above. Solving for Value using the Simultaneous Valuation Formula, the following known variables pertaining to the subject property have been determined:

However, the annual debt service and result to equity cannot be calculated without knowing the property's total value, the very unknown that we are attempting to calculate. In essence, the property's value must be estimated by using an iterative process to calculate the mortgage amount that the net income is capable of supporting as the assumed interest rate and the specified loan-to-value ratio.

Using our computerised mortgage-equity model (the SVF) to perform the necessary calculations produces the following estimate of value for the subject hotel:

The Total Property Value as indicated by the Income Capitalisation Approach is (SAY) US$75,600,000.
 

Proof of Value

Calculating the yields for the mortgage and equity components during the projection period proves the value. If the mortgagee achieves a 8.50% yield and the equity yield is 20.0%, then $75,600,000 is the correct value by the income capitalisation approach, which amounts to approximately US$220,000 per room. Using the assumed financial structure set forth in the previous calculations, value can be allocated between the debt and equity as follows:

Mortgage Component (50%) 37,800,000
Equity Component    (50%) 37,800,000
Total           75,600,000

The annual debt service is calculated by multiplying the mortgage component by the mortgage constant.

Mortgage Component 37,800,000
Mortgage Constant 0.120420
Annual Debt Service 4,551,893

The cash flow to equity is calculated by deducting the debt service from the projected net income before debt service. The equity residual at the end of the 10th year is calculated by taking the 11th year's net income and capitalising it with the terminal capitalisation rate to arrive at the gross sales proceeds. Subtracted from this figure are the outstanding mortgage balance plus brokerage and legal fees to arrive at the net sales proceeds. The overall property yields (unleveraged), the yield to the lender and the yield to the equity position have been calculated, with the results shown in Table 3, below.
 

Tables 4 to 6, overleaf, demonstrate that each of the capital components actually receive their anticipated yields, proving that the US$75,600,000 estimate is correct, based on assumptions adopted in this approach.
 

Step Five: Capital Expenditure Deductions

In the instance of an acquisition or refinancing exercise of an existing resort, it is likely that a new buyer or lender would deduct a capital expenditure amount to represent the cost required in order to either:

Maintain the market position of the resort in the competitive market;

Or reflect a refurbishment programme that is required in order to refurbish and reposition the resort within the competitive market.

A prudent valuer would deduct any capital expenditure amounts, as considered necessary, from the value to arrive at the likely purchase price that a potential buyer would pay in light of any necessary capital improvements. However, for this case study, we have not made any capital expenditure deductions.
 

CONCLUSION

Resort values in Asia have historically been estimated based on replacement cost, comparable sales transactions or various direct capitalisation approaches. In view of the volatile nature of resorts’ cash flows, the valuer can employ the Discounted Cash Flow approach, which reduces the risk associated with resort investments. As extensive market research is conducted and comparable evidence gathered via this approach, the valuer is able to accurately reflect the future earning potential of the resort and the market rates of return of active equity investors and debt providers. Furthermore, the Discounted Cash Flow approach reflects the investment thinking of active knowledgeable buyers and sellers of resorts in Asia.
 

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