Hotel Valuation Reality Check: Linking STR Dynamics to Industry Fundamentals

“Hotel income is not ‘just rent’—underwrite it like an operating business.”

Hotels are fundamentally different from apartments or office buildings. The nightly rental model means revenue resets every day, and performance swings with demand, seasonality, and management decisions. Traditional commercial real estate (CRE) valuation methods must be adjusted to account for this volatility. In this report, we connect the dots between STR metrics (industry jargon for Smith Travel Research data like occupancy, ADR, and RevPAR) and core CRE principles (NOI, cap rates, risk assessment) to provide a reality check on hotel valuation. The goal: help hospitality consultants, lenders, and investment professionals underwrite hotels as the operating businesses they truly are, not just as static real estate assets.

Market Trends: STR Performance and the Big Picture

After a strong post-pandemic rebound, U.S. hotel performance is entering a more mature phase of the recovery – with growth tapering and signs of softening demand. According to data from our Loan Analysics dataset (based on aggregated STR metrics), RevPAR (revenue per available room) actually dipped slightly in 2025 (on the order of a 0.3% decline year-over-year). This marks the first sustained RevPAR contraction since the depths of the pandemic and is a rare occurrence outside of recessionary periods. The slippage has been driven by a modest drop in occupancy (down roughly 1–2%) coupled with anemic ADR growth (average daily rates up barely ~1%, well below inflation). In short, many markets are seeing flat to falling room revenues in real terms, as hotels struggle to push rates fast enough to offset higher costs and slight demand erosion.

Several factors underlie this plateau. Corporate and group travel remains under pressure – group booking volume has declined for eight consecutive months as companies tighten T&E budgets amid economic uncertainty. Weekday occupancies (a proxy for business travel) have trended downward since spring. Meanwhile, leisure demand, while still relatively solid, is showing signs of fatigue: U.S. travelers face tighter budgets as inflation in essentials crowds out discretionary spending on vacations. Some would-be vacationers are even shifting to alternatives like cruises for better bundled value. International inbound travel to the U.S. also remains soft (down ~3% in 2025), hampered by a strong dollar and other headwinds. The net effect is sluggish demand growth overall – just 1.3% more room-nights sold over the past year according to STR figures, against a supply increase of about 0.7%.

On the supply side, the pipeline of new hotels has dramatically slowed. As of late 2025, only around 140,000 hotel rooms are under active construction in the entire U.S., a notable drop after several years of stability. This slowdown is no accident: financing costs for development have spiked (construction loans often demand rates of SOFR + 650–750 bps, meaning interest in the 10%+ range) making many projects infeasible. Additionally, labor shortages – especially of foreign-born hospitality workers – and elevated construction costs are putting further drag on new developments. The result is that new supply growth sits well below the historical average (roughly 0.7% vs. a 1.6% long-term norm). In the Top 25 markets, new supply is even more constrained (around 0.5% growth). This limited new competition is a silver lining for existing hotels: in theory it should bolster pricing power long-term. However, in the near term softening demand is eroding that advantage – occupancy declines are undercutting the ability to raise rates despite the supply lull.

Crucially, performance trends now vary widely by chain scale and segment. The recovery has become “K-shaped,” with higher-end hotels doing relatively better while the economy segment struggles. Luxury and upper-upscale properties (think Marriott, Hilton, Hyatt Regency, etc.) have managed to post RevPAR gains of ~3% this year, driven entirely by ADR increases (wealthier leisure and group guests are tolerating rate hikes). In contrast, midscale and economy hotels (e.g. Best Western, Comfort Inn, Motel 6) are experiencing an outright decline – RevPAR is down more than 4% year-to-date in the economy tier. These budget hotels have seen occupancies slip by a few percentage points and even slight rate drops, especially in markets that had a temporary boost in 2024 (e.g. hurricane-related demand spikes that didn’t repeat). This divergence underscores that not all hotels are equal: higher-end urban and resort hotels are leveraging rate growth (even if occupancy is flat), while price-sensitive segments are cutting rates to chase demand, often unsuccessfully. Geography plays a role as well. Certain destination markets are bucking the trend – for example, San Francisco’s beleaguered hotel sector is finally rebounding with RevPAR up roughly 12% year-to-date as travelers return to cities, while markets like Las Vegas or Houston saw declines due to tough year-over-year event comparisons. Broadly, however, the message is that the easy gains of the early recovery have given way to a more competitive, uneven environment.

Asset-Level Underwriting Challenges: Inflation, Labor and Franchise Constraints

Translating these market trends to the asset level, hotel underwriters face a trifecta of challenges: inflationary cost pressures, labor challenges, and brand mandate constraints. Unlike a simple rental property where higher expenses might be passed through to tenants or offset by fixed leases, hotels must continuously adjust rates and manage operations to defend their margins. This is where “underwriting it like an operating business” becomes critical.

Inflation and Margin Compression: Persistent inflation in the broader economy is hitting hotels from both sides. On the revenue side, as noted, ADR growth has been modest – raising room rates too aggressively can hurt occupancy when guests become price-sensitive. Yet on the cost side, expenses have climbed significantly, eating into profits. Everything from laundry services to utilities to the cost of food for hotel restaurants is more expensive. Most significantly, labor costs have surged, often outpacing revenue growth. In 2024, rising wages and benefits drove a noticeable drop in hotel profit margins. Even in 2025 as revenues plateaued, cost inflation prevented meaningful margin improvement – industry net profit is expected to hover around only ~11% of revenue (a low figure by real estate standards). Major operators confirm that GOP margins and EBITDA profits are running below last year’s levels due to inflationary pressures. In practical underwriting terms, this means NOI forecasts should assume higher operating cost ratios (or slower margin expansion) than in pre-pandemic years. One cannot simply take historical expense percentages for granted; many hotels are experiencing 200–300 bps of margin compression compared to 2019, and underwriting models need to build in adequate expense growth assumptions to reflect that reality.

Labor Shortages and Productivity: Hand-in-hand with inflation is the labor shortage dragging on the industry. Hotels are fundamentally service businesses – from front desk staff to housekeepers to food & beverage teams – and the pandemic drove many workers to other industries. Today, unemployment in hospitality is low, and hotels report acute difficulty filling positions, especially in certain markets. The shortage of foreign-born workers (historically a key labor pool in U.S. hospitality) is an added strain. The result is higher labor costs (wages, overtime, third-party contract labor) and in some cases reduced service levels (e.g. only cleaning rooms every three days) which can impact guest satisfaction. Underwriters must account for labor as both a cost and an operational risk: if a hotel can’t staff properly, it might not achieve the service quality needed for its rate category, which in turn could pressure ADR or occupancy. Moreover, new labor contracts and minimum wage laws in some states are pushing wages up. In markets like California and New York, unionized hotel labor agreements are resulting in significant pay increases phased over a few years – these will raise the expense baseline for those assets. An effective underwriting approach is to build in conservative payroll growth (e.g. 4–5% annually near-term) and test scenarios of continued staffing shortfalls (which could mean higher use of temp staffing agencies or paying above-market rates). The bottom line is that labor is not a fixed cost – it’s volatile, and in today’s market it’s a source of downside risk to NOI if not diligently managed.

Franchise and Brand Constraints (PIPs and Fees): Most hotels operate under franchise flags or management agreements with major brands (Marriott, Hilton, IHG, Best Western, etc.). These affiliations bring marketing power and guest loyalty, but they also come with strings attached that impact financial performance. One major consideration is the Property Improvement Plan (PIP) cycle. Every 6–10 years (or upon a change in ownership), branded hotels must invest in upgrades to meet the latest brand standards. This could mean anything from soft goods replacement (carpets, bedding, furniture) to full bathroom remodels or lobby renovations mandated by the franchisor. PIPs are capital expenditures, but they directly factor into underwriting because a buyer of a hotel knows that a costly PIP might be due soon – which effectively raises the true acquisition cost or erodes near-term cash flow (if you buy a Hilton and immediately must spend $5–10 million on renovations, that’s part of your investment). Indeed, in the current transaction market, costly PIPs are hindering deals and widening bid-ask spreads, as buyers demand price discounts to offset required renovations. Beyond PIPs, franchises impose ongoing royalty and marketing fees (often ~10–15% of room revenue for a Marriott/Hilton tier brand), which significantly reduce net income. There are also brand standards that limit how operations are run – for example, a brand might require a certain guest amenity that raises costs, or restrict cost-cutting measures that could undermine quality. All of this means underwriting a franchised hotel requires careful attention to franchise costs and requirements. Underwriters should model the fee structure in detail and maintain a reserve for PIP expenditures (some investors allocate a reserve of 4–5% of revenue for capital replacements, which in hotels partly covers PIPs). Failing to account for these can lead to a valuation gap, since the hotel’s true cash flow to the owner is lower than a naive analysis might assume. In short, hotel owners don’t get to keep every dollar of RevPAR increase – a chunk goes to Marriott or Hilton and another chunk will be reinvested in the property every few yearsto stay in the system.

Transaction Market Context: Deals, Distress and Capital Constraints

The current investment market for hotels reflects these operational headwinds and the broader capital markets environment. Transaction volume has cooled significantly from the post-pandemic buying spree. In the first half of 2025 there were glimmers of optimism – Q1 hotel deal volume was actually up ~23% year-over-year according to JLL, as some investors anticipated a rebound. However, by Q3 2025, reality set in: quarterly hotel transaction volume dropped to about $5.7 billion, down roughly 10% from $6.4B a year earlier. Year-to-date through Q3, only ~$15 billion of hotel assets changed hands, trailing prior years by a wide margin. The reasons boil down to a mismatch in expectations between buyers and sellers, compounded by tight debt markets. Sellers – especially those who recapitalized or bought in 2021 at low cap rates – are reluctant to slash prices to today’s levels. Buyers, on the other hand, face higher financing costs and softer NOI outlooks, so they require lower prices (higher cap rates) to achieve target returns. This bid-ask spread has been persistent and is cited by brokers as the single biggest obstacle to deal flow. In addition, the cost of capital remains a hurdle: where hotel mortgages could be had at ~4% interest a couple years ago, now rates are often 7–8%+ for well-performing assets, and higher for riskier deals. Many investors simply can’t make the math work at prevailing seller price expectations.

Despite the slowdown, deals are happening – especially for high-quality assets and in distress situations. Trophy resort and luxury hotels still command premium valuations when they come to market. For example, in mid-2025 Ryman Hospitality Properties paid roughly $865 million for the JW Marriott Desert Ridge Resort in Phoenix, a record-setting price reflecting the property’s irreplaceable resort scale. (This equated to well over $900k per key, showing that buyers will pony up for marquee assets with strong long-term demand). At the opposite end, we are seeing some distressed saleswhere values have corrected sharply downward. A headline case was the Hilton San Francisco Union Square & Parc 55 deal – these two large urban Hiltons were appraised north of $1.4 billion pre-pandemic, but in 2023-2024 they became distressed, and ultimately sold to a new investor for only ~$400 million, more than $1 billion below the prior appraised value. That sort of deep discount (over 70% off) underscores how severely values can fall when cash flows decline and financing dries up. While that San Francisco scenario was an outlier (hit by unique local market woes), it put the market on notice that opportunistic capital is lurking for deeply discounted assets in major markets.

Capital market constraints are a big part of the story. Commercial Mortgage-Backed Securities (CMBS) lending for hotels has slowed to a trickle – only about $9.5 billion in U.S. hotel CMBS issuance through the first nine months of 2025, which is well below historical norms. Traditional lenders like banks have also pulled back on hotel lending due to recession fears and higher interest rates. The few lenders active are demanding more conservative terms (lower leverage, higher debt yields). Even liquidity within real estate private equity funds is under strain – many closed-end debt and equity funds that invested in hotels are now facing investor redemption pressures or nearing end-of-fund-life, forcing them to consider asset sales in a tough market. This situation creates a paradox: some owners need to sell or refinance, but the pool of buyers who can secure financing is limited, and those with cash or low leverage requirements demand bargain pricing. All of this has led to a stalemate of sorts in 2025: volume is down, and many marketed deals don’t transact as the bid-ask gap persists. It’s also led to creative deal-making – we see more seller financing, joint ventures, or mez financing fills to bridge valuation disagreements.

One more factor weighing on transactions is the capex burden. Investors today are laser-focused on upcoming capex needs – not just PIPs (as discussed) but also deferred maintenance and sustainability upgrades. If a hotel requires a significant outlay in the near term, buyers factor that in and effectively subtract it from what they’ll pay. Sellers, naturally, resist that deduction if they’ve been riding high on the recent strong EBITDA. The result: fewer deals until either sellers capitulate on price or performance improves enough to narrow the gap. As we head into 2026, distressed transactions may tick up, especially if loan maturities force the hand of owners who can’t refinance without injecting more equity. In contrast, well-capitalized owners of high-performing hotels are more likely to hold onto them, waiting for a more favorable market. This bifurcation in the transaction market mirrors the bifurcation in hotel operations – the strong will survive (or even expand), while weaker assets trade at discounts.

Strategic Implications for Investors: Bridging Operations and Value

What do these dynamics mean for hospitality investors and lenders formulating strategy? The current environment presents a mix of caution and opportunity. Here are a few key implications:

• Mind the Valuation Gap: Hotel valuations today can diverge widely depending on which lens you use. Income-based approaches (capitalizing current or near-term NOI) might yield a substantially lower value than the owner’s asking price or the replacement cost. This is because NOIs have been suppressed by higher expenses and only modest revenue growth, while cap rates have expanded with rising interest rates. For context, hotel cap rates in 2024 were estimated to be ~170 bps higher than pre-pandemic levels, which mathematically implies roughly an 15–20% drop in values if NOI was flat. Many owners are still anchoring to pre-2022 valuations, creating a gap. As an investor, it’s critical to stick to fundamental valuations – if the cash flow only supports a $100 million price at an 8% cap, paying $130 million (a sub-6% cap) in hopes of a rebound is a risky bet. On the flip side, if you encounter an asset priced well below replacement cost and below historical averages (e.g. buying at $80k per key when it would cost $150k/key to build new), that could signal a valuation cushion – the asset might be undervalued if you have patience for the cycle to turn. Savvy investors will do both an income approach and a per-key/replacement cost sanity check (see Appendix) to identify such mispriced opportunities or to avoid overpaying.

• Underwriting Assumptions: Prepare for Pain and Gain: In underwriting models, it’s time to get realistic (or even pessimistic) on near-term assumptions. That might mean assuming minimal RevPAR growth for the next year or two – indeed, industry forecasts for 2026 RevPAR growth are under 1%, essentially flat. Expense growth, conversely, could easily run 3–5% given labor agreements and inflation inertia. Incorporating these trends may result in lower projected NOI in the early years of your pro forma, which will affect how much debt the asset can support and what price makes sense. Also, be careful with rate versus occupancy trade-offs – for example, if you assume you can hike ADR 5% annually, consider whether occupancy might decline if the market is price sensitive. It’s often safer to underwrite a more conservative 2–3% ADR growth and moderate occupancy gains, especially for economy and midscale hotels where the demand pool is price-conscious. Stress-testing the pro forma for a mild recession scenario (e.g. a 5% RevPAR drop in one year) is wise given the possibility of economic slowdown. On the positive side, low new supply growth could set the stage for out-sized performance later in the cycle if demand accelerates – but it may be 2–3 years out. Underwriting should perhaps delay the return to robust growth until the economy clearly picks up or new demand generators (like a large convention or event) come online. In sum, prudence in underwriting now will pay off; it’s easier to justify a higher price later when trends actually improve than to regret over-optimistic projections.

• Hold vs. Sell Decisions: For existing owners, the question of whether to hold through the current slump or sell at a discount is tricky. The answer often lies in capital structure and asset quality. If you have low-interest debt locked in and a property that’s still performing decently, holding might be the best course – you can ride out the turbulence, benefit from the limited new competition, and potentially refinance or sell when the cycle turns up. Especially for owners of well-located hotels in markets with big events on the horizon (e.g. cities hosting the 2026 World Cup or 2028 Olympics), there’s reason to hang on and capture that upside. On the other hand, if your hotel is struggling (e.g. an older asset needing a PIP, or in a market secularly declining) and you’re facing a loan maturity, a strategic sale or bringing in a partner now could salvage equity before it erodes further. The presence of opportunistic buyers with ample cash (including PE funds and high-net-worth investors looking for bargains) means there is liquidity for deals – but only at the “new normal” pricing. Some owners are choosing to sell one or two weaker assets to delever and shore up their balance sheets, then refocus on their core performers. Lenders, meanwhile, are looking at borrower business plans closely – if an owner doesn’t have a clear path to improve an underperforming asset (through renovation, rebranding, or cost restructuring), refinancing that loan will be tough. This dynamic itself is a signal: if you can’t present a convincing three-year pro forma to your lender, it might be a sign to consider selling and redeploying capital elsewhere.

• Operational Improvements and Asset Management: In this environment, investors should also think like operators. Small changes can yield big benefits. For instance, if labor is tight, investing in technology (like mobile check-in or service optimization software) can reduce staffing needs. Energy efficiency upgrades can cut utility costs – some brands’ PIPs now encourage installing modern HVAC or solar panels to lower operating expenses long-term. These operational moves might not be as exciting as chasing a new deal, but they can improve NOI and thus value. Additionally, consider repositioning or rebranding strategies. Could an underperforming full-service hotel be converted to a smaller upscale boutique with fewer F&B outlets, thus reducing expenses? Or might switching from one franchise to another yield better market penetration or lower franchise fees? We are seeing owners and asset managers get creative, working within franchise rules to maximize returns (for example, negotiating with the brand to delay a PIP in exchange for some other concession, or rolling out fees for amenities). The key strategic mindset is: in a low-growth environment, value will come from operational excellence and disciplined capital allocation.

In summary, the hospitality real estate sector is going through a valuation reality check. The heady days of rapid RevPAR recovery and cheap debt are behind us; now both cash flows and cap rates are normalizing. For investors and lenders, this is the time to sharpen the pencil: dig into the STR dynamics that drive hotel income and ensure your underwriting marries those with sound industry fundamentals. Hotels should indeed be valued like the operating businesses they are – with all the complexity that entails. Those who do their homework on market trends, anticipate expense pressures, and remain disciplined on price will be best positioned to capitalize on the opportunities (and avoid pitfalls) in this evolving landscape.

Glossary of Key Hotel Finance Terms

• Occupancy Rate: The percentage of available rooms that are occupied by guests over a given period. For example, a 70% occupancy means 70% of all hotel rooms are filled on average. Higher occupancy generally indicates stronger demand and can enable higher room rates.

• ADR (Average Daily Rate): The average room revenue earned per occupied room, per day. This is essentially the average price guests pay for a night’s stay in a hotel room. It is calculated as total rooms revenue divided by number of rooms sold. For instance, if a hotel sold 100 room-nights and earned $12,000 in room revenue, the ADR would be $120.

• RevPAR (Revenue per Available Room): A key performance metric that combines occupancy and rate – effectively ADR multiplied by the occupancy rate. RevPAR represents the average revenue generated per available room (occupied or not). It can also be calculated as total room revenue divided by all rooms in the hotel (including empty rooms). RevPAR is useful for gauging how well a hotel is filling rooms and at what rate. If RevPAR is growing, it means either occupancy, ADR, or both are improving.

• GOP (Gross Operating Profit): The hotel’s operating profit after subtracting all operating expenses from total revenue, but before fixed costs like property taxes, insurance, or debt service. It essentially measures the profitability of core hotel operations (rooms, F&B, other departments). For example, if a hotel generates $10 million in revenue and has $7 million in departmental and operating expenses, the GOP is $3 million. GOP is a common metric for comparing operating efficiency, since it excludes the impact of capital structure. (Related metric GOP Margin = GOP divided by total revenue, expressed as a percentage).

• NOI (Net Operating Income): In real estate terms, NOI is the annual income from the property after all operating expenses and fixed expenses are paid, but before debt service and income taxes. For hotels, NOI is typically calculated after deducting operating expenses, franchise fees, management fees, and an asset management or reserve allowance. It is slightly different from GOP in that NOI is net of more expenses (e.g. administrative costs, fixed fees). Lenders and investors often use NOI as the basis for valuation (via cap rates) and debt coverage. If a hotel’s NOI is $1 million and market cap rates are 8%, the rough indicated value would be $1M / 0.08 = $12.5 million.

• Cap Rate (Capitalization Rate): A yield metric used to value income-producing real estate. The cap rate is defined as NOI divided by the property value (or conversely, NOI = cap rate × value). It represents the unlevered return on the asset. For example, a hotel purchased for a 10% cap rate means the buyer expects a $10 NOI annually for every $100 paid in purchase price. High cap rates (e.g. 10%+) generally indicate higher perceived risk or lower growth prospects (thus a lower price relative to income), whereas low cap rates (e.g. 5–6%) indicate higher values placed on the income (often due to strong growth expectations or lower risk). Cap rates move with interest rates and investor sentiment – as interest rates rise or risk increases, cap rates tend to increase (and values decline).

• PIP (Property Improvement Plan): A mandated renovation program for a hotel, required by the brand (franchisor) to uphold brand standards. PIPs typically occur every 6–10 years or upon a change in ownership. They outline specific upgrades and improvements the hotel must make – for example, updating room furnishings, lobby decor, technology systems, etc. While PIPs help maintain a consistent guest experience across the brand, they can be expensive for owners. A hotel under a major franchise will usually negotiate the scope and timing of the PIP with the brand, but ultimately must complete the required improvements or risk losing the flag. In valuation, the cost of an imminent PIP is often treated as a deduction from the price (since the new owner will have to bear that cost).

• CMBS (Commercial Mortgage-Backed Securities): A type of financing where commercial real estate loans (including hotel mortgages) are pooled together and sold as bonds to investors. In the context of hotels, CMBS loans are a source of debt capital. When we say “CMBS liquidity is constrained,” it means fewer new hotel loans are being securitized, often leading to a tighter availability of credit for hotel owners. CMBS loans can offer fixed-rate debt but come with rigid terms. The health of the CMBS market is a barometer of investor appetite for real estate debt; in downturns, CMBS issuance often dries up, making refinancing harder for hotel owners.

• NOI Margin / Profit Margin: The percentage of total revenue that is retained as NOI or profit. For hotels, profit margins are generally much lower than other real estate asset classes because operating expenses are high. An NOI margin of 25–30% is common for a well-run hotel (meaning 70–75% of revenue goes to expenses), though it varies by segment (limited-service hotels tend to have higher margins than full-service resorts with lots of amenities). Understanding a hotel’s current and potential profit margin is crucial for valuation – small changes in margin can significantly alter NOI and thus value.

(Additional industry terms: TRevPAR – Total Revenue per Available Room, includes all revenue sources; GOPPAR – GOP per available room; FF&E Reserve – Furniture, Fixtures & Equipment reserve, a fund for replacing worn items; EBITDA – Earnings before Interest, Taxes, Depreciation, Amortization, essentially similar to NOI + some adjustments in hotels.)

Sample Underwriting Pro Forma (Base Year vs. Stabilized Year)

To illustrate how underwriters project hotel performance, below is a simplified pro forma for a hypothetical 100-room hotel. We show key line items for the first year (base year) and a stabilized Year 3, reflecting expected ramp-up and normalization of performance. (All figures are annual and in millions of dollars except ADR, which is daily rate, and percentages.)

• Occupancy: 60% in Year 1 → 68% in Stabilized Year 3

• ADR (Average Daily Rate): $120 → $130

• RevPAR: $72 → $88 (RevPAR grows as occupancy and ADR increase)

• Total Revenue: $3.1 million → $3.8 million (includes rooms revenue of ~$2.6M → $3.2M, plus other income like F&B, etc.)

• Operating Expenses: $2.2 million → $2.6 million (rising with inflation and higher occupancy, but some efficiency at scale)

• GOP (Gross Operating Profit): $0.9 million → $1.2 million (GOP margin improves from about 30% to 32%)

• Fixed Costs: $0.4 million → $0.45 million (includes management fees, property taxes, insurance, etc., slightly higher in Year 3)

• NOI (Net Operating Income): $0.5 million → $0.75 million (NOI margin improves from ~16% in Year 1 to ~20% by Year 3 as the hotel stabilizes)

In this example, the hotel ramps up occupancy after opening or renovation, and pushes modest ADR growth each year. The combination yields a higher RevPAR and better expense absorption by Year 3, expanding the profit margin. An investor might then apply a cap rate (say 8%) to the stabilized NOI of $0.75M, indicating a valuation around $9.4 million for the hotel. Underwriting involves examining if these assumptions are reasonable (is 68% occupancy attainable in that market? Are expenses realistic? etc.) and assessing the risks (for instance, what if the occupancy only reaches 65% or wage growth is higher than expected). The pro forma provides a roadmap for the hotel’s financial trajectory and is the basis for both valuation and obtaining financing.

Appendix: Valuation Methodology for Hotels

Income-Based Approach: The primary valuation method for hotels is the income approach, akin to how other income properties are valued but with extra nuance. Investors typically use a discounted cash flow (DCF) analysis or direct capitalization of a stabilized NOI. A DCF will project the hotel’s annual cash flows over, say, 10 years, including a terminal value from a sale in the final year. These cash flows are then discounted to present value at a required rate of return (which captures the hotel’s risk). Key to this approach is determining a realistic stabilized NOI. Since hotels can have volatile earnings, one often normalizes the NOI to an economic “steady state” (e.g., average expected performance over a full business cycle, excluding one-time events). Once a stabilized NOI is determined, applying a capitalization rate gives a value indication. For example, if after stabilization a hotel can sustainably generate $1 million NOI and appropriate cap rates for that asset class in that market are 8%, the indicated value by direct cap is $12.5 million. The choice of cap rate is critical – it should reflect current market return requirements for hotels, which in turn incorporate growth prospects. Because hotels’ income can grow (or shrink) faster than inflation, often a cap rate spread vs. other property types is used. In practice, investors might derive cap rates from comparable sales or surveys (e.g., midscale limited-service hotels might trade around an 8–9% cap today, whereas luxury full-service resorts might trade at 6–7% cap due to higher growth potential). The income approach, especially via DCF, allows the underwriter to model specific assumptions (RevPAR growth, cost inflation, capital improvements, etc.) and see their impact on value. This approach directly ties to the “operate like a business” mindset – you’re valuing the cash flow generation of the hotel.

Sales Comparison and Per-Room (PPR) Cross-Check: Because hotels are unique (each one has different location, brand, condition), the sales comparison approach is used more as a cross-check than a primary method. A common metric is Price Per Room (or Per Key). Investors will look at recent sales of similar hotels and note, for example, “Hotel X sold for $200,000 per key; our target hotel has 100 keys, so at that unit price it’d be $20 million.” They then compare that with the income-based value. If the income approach says $15 million and comps suggest $20 million, one needs to investigate why – is the target hotel underperforming its peers (making the income approach lower)? Or were those comps in superior markets with higher ADRs? Replacement cost is another useful benchmark: estimate what it would cost to build a similar hotel today (including land). If a hotel is trading far below replacement cost, it might indicate a bargain – you’re buying for less than it would cost to develop new, assuming demand is steady. Conversely, if values are above replacement, it could entice new development eventually (though the current high construction costs have pushed replacement costs up significantly). In the current climate, many hotels are in fact selling at or below replacement cost in certain markets, reflecting the income struggles. A prudent valuation approach will align the income approach with these per-room metrics. For instance, you might conclude a hotel’s stabilized NOI supports a $150k/key value, and that happens to align with both recent sales in that area and is still below the ~$180k/key it would cost to build new – giving confidence that the valuation is grounded and perhaps offering upside if performance improves.

Putting It Together: An investor will usually do all the above – run DCF scenarios, look at cap rate valuations, and check per-key prices and replacement cost. They might weight the approaches or simply use the range to negotiate a price. Given the uncertainties in hotel forecasting, it’s wise to err on the side of caution. As we’ve emphasized, hotels are operating businesses: their value is not just in bricks and mortar, but in the income stream generated by effectively selling thousands of “room-nights” per year. Thus, any valuation must critically examine the assumptions behind that income stream. By linking STR dynamics (occupancy, ADR, RevPAR trends) to underwriting inputs, and by cross-validating against what the market is paying per room and what it costs to build, one can arrive at a well-supported valuation. This comprehensive approach helps ensure you’re not overpaying in exuberant times, nor underselling in times of distress – it grounds the number in both cash flow reality and market sentiment, which is exactly where sound hotel investment decisions should be made.