Real Estate Finance

1
Real Estate Finance

• Financial management
• Beyond the corporate finance textbooks, into the
  real estates investment analysis
• Tad Hara
• Rosen College of Hospitality Management

2
Hotel Valuation

• There are basically three approaches (P73)
• Income Capitalization Approach
• Sales Comparison Approach
• Cost Approach

3
Income Capitalization Approach

• Valuation Technique 1 (P77 of RR)
• Band of Investment Using One Stabilized Year
• WACC of Mortgage Return Equity Return

NOI in the case is given as 4,107,000 Divide NOI
by the cap rate Capitalized value of the Flow
Value 36,935,000
4
Income Capitalization Approach

• Valuation Technique 2 (Room Rate Multi) (p78)
• Value Average Daily Rate x rooms x 1000
• 171.64 x 250 x 1000 42,910,000
• Valuation Technique 3 (Coke Can Multi) (p79)
• Value Coke price x rooms x 100,000
  37,500,000

5
Income Capitalization Approach

• Valuation Technique 4 10 year Discounted Cash
  Flow Using Mortgage and Equity Rate of Return
• F x M x V Debt Service ( In Excel you do PMT(
  ))
• NI debt service de (annual CF available to
  equity)
• NI 11/Rr sales price (reversionary value)
• b Brokerage and Legal Costs
• (f i)/(fp i) P (f annual DS constant, fp
  annual DS constant required to amortize the
  entire loan, i mortgage interest rate) P
  fraction of the loan paid-off
• (1 P) x M x V Ending Mortgage Balance
• (NI11/Rr) (b x (NI11/Rr)) ((1 P) x M x V)
  dr (Residual Equity Value)
• Annual CF to Equity NI1 (f x M x V) de1 .
• Present value of CF to equity (de1 x 1/S1) (de2
  x 1/S2) .PV of equity!
• Combining the Equations Annual CF to Equity and
  Discounting CF to Equity to the PV All
  combined (1- M) x V, then solve for V

6
Income Capitalization Approach

• Valuation Technique 4 10 year Discounted Cash
  Flow Using Mortgage and Equity Rate of Return
  (p82)
• Combining the Equations Annual CF to Equity and
  Discounting CF to Equity to the PV
• ((NI1 (f x M x V)) x 1/S1)
• ((NI2 (f x M x V)) x 1/S2)
• ((NI10 (f x M x V)) x 1/S10) (1 M) x V
• Because the only unknown in this equation is the
  propertys value, you can solve for it.

7
Income Capitalization Approach

• Valuation Technique 4a 10 year Disocunted CF
  Using Mortgage Equity Model and Debt Coverage
  Ratio (DCR)
• You use DCR and others are similar to 4.
• Valuation Technique 5 After Tax Investment Model
  
• I will explain on the blackboard

8
Valuation Technique 6 Economic Value Added (P92)

• EVA After-Tax Earnings (WACC x Property
  Investment)
• Property Investment AT Earning / WACC

Economic Value Added (EVA) A measure of a
company's financial performance based on the
residual wealth calculated by deducting cost of
capital from its operating profit (adjusted for
taxes on a cash basis). (Also referred to as
"economic profit".)The formula for calculating
EVA is as follows Net Operating Profit After
Taxes (NOPAT) - (Capital Cost of Capital)
http//www.investopedia.com/terms/e/eva.asp
9
Valuation Technique 7 Sales Comparison Approach
10
Valuation Technique 8 Market-Derived
Capitalization Rate (P95)
11
Valuation Technique 9 Cost Approach Age-life
Method
12
Income Capitalization Approach

• Lets see some examples
• http//www.buyincomeproperties.com/MonthlyListings
  /Florida3.html
• Hotel Investments-Live data?!
• http//www.vancerealty.com/orlando-commercial-prop
  erty.htm

13
Types of Hotel Operating Options

• This presentation is based on a Book and articles
  of Professor James Eyster, SHA, Cornell
  University
• Financial management
• Beyond the corporate finance textbooks, into the
  real estates investment analysis
• Tad Hara
• Rosen College of Hospitality Management

14
Types of Hotel Operating forms

• Independent
• Owner Operated
• Operated by Independent Management Co.
• Chain (Marriott, Hilton etc)
• Company Owned Managed
• Franchised
• Owner operated
• Operated by Independent Management Co.
• Chain Company Operates for Owner
• Referrals (Best Western etc)
• Greens are by management contract

Source Materials made by Professor James Eyster,
School of Hotel Administration, Cornell University
15
Three parties with different interests

• Owner
• Annual Operating Cash Flow
• Capital Appreciation
• Hope to retain Influence on Management and
  Operations
• Flexibility to Sell or Refinance
• Hotel Operator
• Management Fees
• Market Presence Market Share
• High Quality Hotel
• Maximum Discretion in Management Decisions
• Long-term Stability
• Owners Ability to Provide Cash/Investment
• Source Materials made by Professor James Eyster,
  School of Hotel Administration, Cornell University

16
Three parties with different interests

• 3. Lender (Banks)
• Annual Debt Service Coverage
• Adequate Overall Return on Investment
• Quality Competitive Hotel
• Influence on and Protection of Investment
• Flexibility in Difficult Times
• Three parties interest do not crash when there
  is enough cash flow. If not.?

Source Materials made by Professor James Eyster,
School of Hotel Administration, Cornell University
17
Choices for Owner/Manager

• Independent ?No Other Relationship
• Individuality of Property
• Complete Owner Control
• No National Marketing/ Reservation System
• No Additional Cost
• Referral Association of Member Owners
• Individuality of Property
• Some Requirements on Owner Systems, Signage,
  Inspections
• National Marketing and Reservation System
• Group Purchasing Benefits
• COST Initial Fee, Royalty Fee 23 of Room
  Revenue Marketing, Reservations, System Charges

18
Choices for Owner/Manager

• Franchise Franchisor-Franchisee Relationship
• Higher Uniformity and Standardization of Property
• More Requirements on Owner
• National Marketing and Sales/Reservation System
• Group Purchasing Benefits
• Extra Access to Loan Financing
• COST Initial Fee, Royalty Fee 26 of Room
  Revenue, Marketing, Reservations, System Charges
• Holiday Inn, Hampton Inn, Courtyard by Marriott,
  Sheraton, Ramada, Choice Hotels etc.

Source Materials made by Professor James Eyster,
School of Hotel Administration, Cornell University
19
Franchise Conflict of Interests

• Franchisee
• What Business
• Leasing hotel rooms
• Who are the main guests
• Travelers
• How to make profit
• Frequency of renting rooms and the rate, in
  relative to costs
• Build up Real Estate Values

• Franchisor
• What Business
• Leasing a Brand Name to Operating Hotels in
  exchange for Fee ( of revenues)
• Who are the main guests
• Hotel Owners
• How to make profits
• Number of hotels that carry its brands, and the
  success of those hotels

Source P104 of Hotel Investments by R R
20
Franchise Agreement

• AAHOA (Asian American Hotel Owners Association)
• Performance
• A hotel bran should perform at a minimum of
  occupancy or franchisee can exit the agreement
  w/o liquidation damages
• Impact
• A fair formula should be established to protect a
  franchisees assets
• Buyout/Voluntary Termination
• Liquidated damaged should be negotiated based on
  a reasonable time for the franchisor to replace
  the revenues

21
Franchise Agreement

• AAHOA (Asian American Hotel Owners Asso)
• 4. Vendor Exclusivity
• Freedom to choose vendor outside of designated
  ones
• 5. Dispute Resolution
• Fair process to be established beforhand
• 6. Venue
• Where the franchisees property is located
• Transferability
• Minimize the Transfer Fees
• Database Information
• Database information should not be used for
  cross-brand selling by the franchisor
  Franchisees should share proprietary rights to
  the database

22
Franchise Agreement

• AAHOA (Asian American Hotel Owners Asso)
• 9. Sale of Franchise Company
• If a franchisor wants to sell the brand to
  another entity, and the new owner want to change
  system requirements, the franchisee should have
  the option of leaving the system or remaining and
  making the requested changes.
• 10. Disclosure
• There must be greater franchisor accountability
  for marketing and reservation fees.
• 11. Quality Assurance Inspection
• Franchisors should permit an independent quality
  inspection in the event of a dispute
• 12. Franchise Sales Ethics/Practices
• Franchisors should mandate good faith and fair
  dealing practices among their sales agents.

23
Choices for Owner Not to manage

• Management Contract Agency Agreement with Owner
  as Principal and Operator as Agent
• Professional management for Owner
• Minimum Owner Influence or Involvement
• Financial Risk ? Owners
• Chain Operator provides National marketing,
  sales, Reservation system (Independent operator
  does not)
• COST Basic Fee 2-3 of Gross Revenues,
  Incentive Fee 1040 of CFADS, System Reimburse
  Expense, Accounting, Training etc.
• Lease Agreement Lessor/Landlord VS Tenant
  (Operator) Relationship
• No owner influence or Involvement
• Financial Risk ? Operators
• Owner Receives Lease Revenue (Rent) Fixed
  and/or of Gross Revenue and/or of IBFC

Source Materials made by Professor James Eyster,
School of Hotel Administration, Cornell University
24
Choices for Owner Not to manage

• Where is the Risk (fluctuations of NI)?
• Owners Return
• Lease ?stable (no matter how the hotel performs,
  the same amount of fixed rent receipt)
• Management Contract ?Hotels performance is
  directly linked to the return up and down

Source Materials made by Professor James Eyster,
School of Hotel Administration, Cornell University
25
Choices for Owner Not to manage

• Where is the Risk (fluctuations of NI)?
• Hotel Operators Return
• Lease ?Your Revenue Net Income is totally up
  to your performance (pay the rent and the rest is
  all yours)
• Management Contract ?You will receive fees from
  revenues and maybe bonus from incentive fees. But
  you do NOT take the bottom line risk ( rewards).
  

Source Materials made by Professor James Eyster,
School of Hotel Administration, Cornell University
26
Relative Image of Self-operation, Management
Contract and Lease