Making the Investment Decision

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Making the Investment Decision
Mr. Bill Sipple (HVS Capital)
Post Session Assignment

1. What are the three main approaches to value and the pros/cons of each?
The three main approaches to value are the income approach, which is widely used in the hotel valuation process, the sales comparison approach, and the cost approach. The income approach deals with either a Cap Rate or discounted cash flows. This approach is the preferred approach to valuation as it most closely reflects the economic analysis employed by typical buyers and sellers. The sales comparison approach views no sale is the same and too many adjustments to variables need to be made to make the approach reliable. The cost approach basis for valuation does not consider economic factors and numerous adjustments must be made for subjective depreciation estimates.

2. During which phases of the real estate cycle are the income approach and the direct capitalization approach used and why.
The income approach for valuing a hotel can be used at any point of the real estate cycle. What is best to look at is when the discounted cash flow method should be used or when direct capitalization method should be used. If you were in a steady upturn of the real estate cycle its best to use the discounted cash flow method. This method forecast the NOI for 5 or ten years, plus the net sale proceeds at the end are discounted back to the date of value using an appropriate discount rate. So this method is should be used in upturns because you would be predicting higher NOI’s for the future giving your hotel a higher value. The Direct capitalization method looks at the trailing 12 months NOI to determine the cap rate. The higher the cap rate the lower the value of the hotel will be and visa versa. So this method should be used in a downturn, lowering the cap rate thusly improving the value.

3. What is a Cap Rate? If the NOI is $1,000,000 and a cap rate is 10%, what is the value of the hotel?
A...
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