Editor’s Note: M.

Lance Coyle, MAI, SRA, is the 2015 president of the Appraisal Institute
Future of Valuation
By M. Lance Coyle, MAI, SRA

Saying that the valuation profession – and, indeed, the real estate industry as whole – has withstood a
seismic shift over the last several years would be stating the obvious. When the behemoth that is the U.S.
housing market collapsed, new rules and regulations were put in place to prop it up again … and their
effects on the valuation profession are still in question. However, rather than take a wait-and-see
approach to this new phase, the Appraisal Institute is proactively looking at the valuation profession and
examining the challenges and opportunities of the future.

Fewer Appraisers

The decreasing number of appraisers is a major challenge for the long-term health of the valuation
profession. The number has steadily declined; as of June 30, 2015, there were approximately 78,800 real
estate appraisers currently practicing (not retired) in the U.S., down from 98,450 in 2007, or a cumulative
decline of 20 percent.

It’s anticipated that over the next five to 10 years, the number of U.S. appraisers will decrease sharply
with retirements playing a major role.

The reasons for fewer people in the profession are complex, and involve demographics, the recession,
changes in appraisers’ business models, clients using alternative valuation products, and new complex
regulations that discourage new entrants into the field.

An Appraisal Institute survey determined that the average U.S. valuation professional is a white male
between the ages of 51 to 65, with 11 percent age 66 and over. Women comprise 26 percent of the field.

As experienced appraisers retire, it is essential to attract new people to replace them in order for the
profession to thrive. However, statistics indicate that fewer early- and mid-career aged professionals are
now active appraisers. The Appraisal Institute survey shows that 12 percent of U.S. appraisers are ages
36 to 50, with one percent age 25 or less.

Starting in 2015, a bachelor’s degree is the minimum education requirement to become an appraiser.
Currently, 58 percent of appraisers hold bachelor’s degrees. Approximately 19 percent of appraisers with
active licenses have master’s degrees. But for some, the cost of the degrees and all the additional
education that it takes to become an appraiser isn’t justified by the profession’s financial return. Forty-one
percent of appraisers earn annual incomes of $50,000 to $99,000, and another 20 percent earn less than
$50,000 per year.

Commoditization
Appraiser incomes and their business models have been affected by the process of commoditization.
Commoditization is the process by which goods and services that have economic value and are
distinguishable in terms of attributes (uniqueness or brand) end up becoming simple commodities in the
eyes of the market or consumers. The key effect of commoditization is that the pricing power of the
business owner is weakened: when products become more similar from the buyers’ points of view, they
will tend to buy the cheapest. This has clearly happened in the residential mortgage lending appraisal
space. Although appraisers understand that the quality of analysis can differ, appraisals prepared on
forms generally look alike to buyers of the product. Even the words and codes are now uniform, adding to
the process of commoditization. Appraisers working in the highly-regulated mortgage lending environment
must consider how to adapt their business models to the effects of commoditization.
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Regulatory Environment

While the declining number of appraisers continues to be a challenge for the valuation profession, so too
is the current regulatory environment.

Financial Institutions Reform, Recovery, and Enforcement Act

In 1990, five regulatory agencies issued a final rule implementing FIRREA, which included a provision
requiring appraiser independence. By 1994, the Interagency Appraisal and Evaluation Guidelines stated
the lending institutions could expect bank examinations. However, federal banking regulatory agencies
cut staff, reducing supervision of these functions. Lending institutions folded appraisal functions into their
loan departments, leaving mortgage brokers in control of order processing.
Appraisal Subcommittee
The ASC provides federal oversight of state appraiser regulatory programs. States have been issuing
licenses to appraisers for 20 years; by contrast, mortgage originators have had licensing for about half a
decade.
GSEs
The Appraisal Institute has expressed concerns with the government-sponsored enterprises that
Collateral Underwriter ratings could become a set of rules used by lenders. This was true for the Selling
Guide in the past, but it should not happen to CU. Fannie Mae has learned a great deal over the last
number of years and it is emphasizing appraisals in a positive manner. However, an ongoing concern is
the continued allowances for the staffs of untrained loan sellers to review appraisals.
Dodd-Frank
The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed by Congress in 2010, has
released a tidal wave of change on the valuation profession. Many of these changes impact smaller,
niche areas such as higher-risk loans and manufactured housing. Others, however, are much more
significant, affecting the Real Estate Settlement Procedures Act, Equal Credit Opportunity Act, Customary
and Reasonable Fees and appraiser independence. The profession is still seeing a shake-out and we
expect more to come, particularly concerning demographics.
When appraisers think about changes to the valuation profession, they needn’t look further than big data
and technology to see just how rapidly things evolve and how crucial it is to remain up-to-date on current
best practices.

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Big Data and Technology
The history of the valuation profession can be broken down into four categories, all measured on how
data is used.
The Data Rummage Era, which spanned the 1920s–1970s, focused on data collection, with appraisers
“owning” the data.

The Market Analysis Era (1980s–1990s), brought in the availability of data in competitive market
segments, and the use of three to six comps.

The Data Discarding Era (1990s–2000s) provided large electronic data sets. Along with useful
information, there was also miss-used data and “junk” science. Using three to six comps remained the
norm.

Finally, the Data Optimization Era (2010s–present) focuses on optimal sets of large datasets, and the
analysis of all the data– not just sampling.

Appraisers used to focus on the collection and verification of data; those who were the best at this were
often well rewarded. But today data is widely available, so appraisers must focus on the analysis of that
data to bring value to their services. While automated valuation models are unlikely to completely replace
a human appraiser, they will nevertheless continue to evolve into an alternate form of valuation that
competes with traditional appraisal services. Appraisers will increasingly be expected now and into the
future to adopt big data analytical techniques into their product.

Stale and Limited Product

As key participants in residential and commercial real estate transactions, appraisers have been subject
to certain negative feedback. However, as always, the role of the appraiser is simply to provide a credible
opinion of value as an independent, third-party expert.

Who among us has not heard one of these complaints?

• “Over-valuation by appraisers was a key reason for the housing crisis.”

• “Low appraisals are holding back the housing market.”
• “Appraisals are too high.”
• “Appraisals are too low.”
• “What good are appraisals if they don’t protect us from market cycles?”
While some of these complaints are unfounded, the Appraisal Institute hears the concerns and is
responding by further developing its body of knowledge. Is an appraisal that only provides an estimate of
value on one date still adequate for today’s needs, or has it become stale and limited in its usefulness?

The Appraisal Institute’s “Guide Note 12: Analyzing Market Trends” addresses to what extent appraisers
are responsible for recognizing changes in market conditions, and what steps appraisers must take to
ensure due diligence is done regarding the analysis of market trends.

The Guide Note states, “Analyzing current and anticipated market conditions is more complicated – and
more critical – when a market is rapidly changing, either upward or downward.” Adequate market analysis
must be completed before highest and best use analysis, and the determination of highest and best use
is critical to an appraisal assignment when market value is the objective, according to the Guide Note.

The Uniform Standards of Professional Appraisal Practice (USPAP) include rules that address the steps
appraisers must take to ensure due diligence is done regarding the analysis of market trends. According
to the Guide Note, “Reconciliation is an important step in the valuation process, especially when market
conditions are such that good quality, current data is lacking.”

Signs of a changing market are symptoms, as opposed to causes, according to the Guide Note. An
appraiser observes the symptoms, but must understand the underlying cause or causes in order to
properly analyze market trends. For appraisers and market participants, a “bust” market is usually
relatively obvious. However, it can be difficult to spot a “bubble” market when in the midst of one. Further,
it can be difficult to tell when a bust market has started to turn and improve, or when a bubble market has
begun to decline.

Future Trends
While no one has a crystal ball, there are certain things that can reasonably be expected to impact the
valuation profession in the coming months and years, including:
• More commoditization;
• Consolidation and valuation firms;
• Specialization and true expertise;
• Alternate valuation products;
• A growing divide between commodity appraisal and consulting appraisal; and
• The principle of change.

Obsolete Business Model

In the world of rapidly changing technology, adaptability is a key to viability. Clinging to obsolete business
models can spell doom to companies and entire industries. Kodak was sunk by the “creative destruction”
of the digital camera. However, Apple rose on the wave of change and evolved from the maker of small
personal computers to the iPod and ultimately to mobile devices like the iPhone.
Changes in demographics, regulations and technology all present challenges to the valuation profession.
However, an improving housing market and increasing business and growth opportunities have
appraisers feeling optimistic about their futures and that of the profession. The Appraisal Institute is
dedicated to assisting appraisers in adapting to these changes, and to the future viability of the valuation
profession.
Persistent Problems Webinar (this October!)
Dates: October 15th and 22nd
Identifying & Correcting Persistent Appraisal Failures: Quality, Condition, & CU – by: Richard
Hagar, SRA
CU Version 3.0 is coming this September, promising “improvements” and enhancements that will
undoubtedly affect how appraisers interact with their lender and AMC clients going forward. Be prepared!
CU continues to flag appraisers for unsupported adjustments and erroneous Q&C ratings. In this
upcoming two-part webinar, Richard Hagar, SRA shows appraisers, step by step, how to avoid the most
common appraisal failures and “get it right” with Q&C ratings. Sign Up Now!

Fall Webinar Schedule

• Fannie Mae and Q&C Ratings – Richard Hagar, SRA (Oct. 2 parts)
• Appraisal Adjustments – Solving Common Problems – Richard Hagar, SRA (Nov. 2 parts)
• How to Create a Proper Reconciliation – Tim Andersen, MAI (available now)
• Claims, Complaints, and E&O Insurance – David Brauner (available now)

Season Ticket: $129 (Save 35% on all six webinars)

Save $78: Get the Season Ticket

About the Author

Lance Coyle, MAI, SRA, of Dallas, is the 2015 president of the Appraisal Institute, a global professional
association of real estate appraisers, with nearly 21,000 professionals in almost 60 countries throughout
the world. He has been involved in the real estate appraisal profession for 30 years. He is principal of
Coyle Realty Advisors, a Dallas-based real estate services firm engaged in fee-based investment
property valuation, analysis, research, expert witness testimony and counseling. He currently
concentrates on providing support in real estate litigation cases, and has been a guest lecturer and author
for several eminent domain conferences.

n Investment Driven Breakeven Analysis

for Hotels - ID.RevPAR & ID.GOPPAR:
the Investment Driven RevPAR and
GOPPAR - by By Elie Younes and Russell
Kett - HVS International
9 min
Hotel managers, analysts and asset managers typically use the traditional operating and/or interest

payment breakeven analysis to assess the potential profit of their hotel properties, or before setting the

strategic positioning of a hotel.

In an increasingly competitive hotel market, and with more demanding hotel owners, this method, if used

alone, might lead to a conflict of interest between the asset manager, the operator and the hotel investor, as it

ignores the investment requirements of the shareholder in the asset.

This article elaborates on the traditional operating and interest payment breakeven analysis and illustrates

the advantages of using investment driven breakeven analysis.

Operating Breakeven Analysis

The operating breakeven point is defined as the threshold where total operating costs are equal to total

revenues - where operating costs are a combination of both fixed and variable expenses.

Hotel expenses have one component that is fixed and another that varies directly with occupancy or facility

usage. The fixed component typically varies with inflation, while the variable component is adjusted for the

percentage change between the occupancy and the facility usage that produced the known level of revenue or

expense. The concept of identifying the cost structure of a hotel property is easier said than done, and

requires proper statistical analysis, or comparable operating performance analysis. We briefly discuss each

type of hotel expense item.

 The following items are typically considered to be largely fixed costs: administrative and general

expenses (though a small portion is variable), marketing, property taxes, and insurance;

 The following items are typically considered to be variable costs: rooms expenses, direct expenses

for food and beverage, allowance for bad debt expenses, management fees, and reserve for

replacement (fixed expense - but not fixed!);

 The following items are typically considered to be semi-fixed expenses, including both a fixed portion

and a variable portion: energy costs, payroll, and property operation and maintenance expenses
.
Let us assume that a 100-room mid-market hotel, Hotel A, has the following cost structure.

 Fixed Costs = £1,000,000 per year

 Variable Costs = 40% of total revenues

Let us assume too that 75% of the total revenues of the hotel are generated from the rooms department and

that 25% are generated from the other operating departments (food and beverage, telephone, and so forth).

Therefore the operating breakeven of Hotel A can be computed by the following formula.

 Operating Breakeven Revenues = Operating Fixed Costs + (Variable Costs % x Operating Breakeven

Revenue)

 Then

 Operating Breakeven Revenues = Operating Fixed Costs / (1 - Variable Costs, or Gross Margin).

As illustrated in Table 1 and Figure 1, Hotel A requires a RevPAR (rooms revenue per available room) of

approximately £35 per day in order to achieve an operating breakeven. It is, then, the market characteristics

and positioning of the property that dictate the optimal trade off between occupancy and average daily rate

that will achieve this RevPAR threshold.

This analysis allows managers and analysts to determine the hurdle point above which the property will

show a positive EBITDA (earnings before interest, tax, depreciation and amortisation). Moreover, it enables

line managers (in each department) to better assess the cost structure and profitability of their departments.

Table 1 - Operating Breakeven Analysis - Hotel A (£)

Figure 1 - Operating Breakeven Analysis - Hotel A (£)
On the other hand, such an analysis neglects the cash required by both lenders and owners to provide the

necessary return on their respective investment.

Interest Payment Breakeven Analysis

This analysis takes into account the cost of debt of a hotel property, and determines the threshold above

which a hotel is unlikely to default on its interest payment. Typically, lenders use this analysis in order to

assess the default risk safety margins of a hotel property. In other words, this threshold is set when EBITDA

equals the interest payment of a hotel property.

Table 2 and Figure 2 illustrate our assumptions that the development cost for Hotel A is approximately

£150,000 per room and that it is financed with 60% loan finance (60% loan, 40% equity). To simplify the

exercise, let us consider that the hotel has a 15-year mortgage, with yearly interest-only payments and that

the principal is repaid as a 'bullet/balloon' at the end of the lending period. Let us also assume that the annual

interest rate on the loan is fixed at 7.0% (Libor + 350 points). Consequently, the hotel will need to pay

£630,000 per year to cover its interest expenses. For the purpose of this exercise, we will also assume that the

hotel will be refinanced at the end of the loan term.

According to Table 2, Hotel A requires total revenue of approximately £2.7 million in order to meet its

operating and financing obligations. This figure equates to a RevPAR of approximately £56, compared to £35

to achieve the operating breakeven point. If the hotel is financed via a mortgage, whereby both a principal

and an interest amount are paid in annuity for, say, 15 years, then the debt service breakeven point will be

skewed upwards. In this case, the required RevPAR and GOPPAR would be around £80 and £50, respectively

(but this is from a net cash flow standpoint). Alternatively, one can amortise the loan in order to identify the

yearly interest expense.

It is also useful to use the gross operating profit (GOP) or GOPPAR (GOP per available room) as the hurdle

operating level. The GOP threshold can then be computed by adding the non-operating fixed expenses - those

between GOP and EBITDA (property taxes, insurance, incentive fees, and any other fixed charges, which in

some hotels might include 'rent') - to the interest payment. As shown in Table 2, Hotel A requires GOPPAR of

approximately £25 in order to achieve the interest payment breakeven point.

Table 2 - Debt Service Breakeven Analysis - Hotel A (£)
This analysis takes into account the total cash expenses of a hotel operation and reflects the threshold above

which a hotel property is likely to start generating profits for its owner; however, it assumes that there is no

cost of equity for the investment. In other words, it does not take into consideration the required returns on

the £6 million of equity used to finance the development.

Investment Driven Breakeven Analysis

The investment driven breakeven point is the threshold of revenues and operating performance (RevPAR and

GOPPAR) required to cover the operating costs, the financing (interest) costs and the required equity return

of a hotel operation and investment. In other words, it is the level of operating performance above which

asset managers and general managers will meet the required investment returns to the owner, which is likely

to have a positive effect on the asset value. Below this level of operating performance the owner would need

to take action, as the property's equity value might be eroding.

The investor would expect a risk-adjusted return on investment, taking into consideration the systematic and

non-systematic risk that is borne by the hotel asset. Typically, return on equity requirements for hotel

investments range from 12% to 20%. For the purpose of this exercise, we have assumed a required equity

return of 15% per annum on the £6 million equity investment in Hotel A.

Therefore, the investment driven breakeven point is computed using the following formula.

 Investment Driven Breakeven Point (or Required Investment Driven Revenues) = (Fixed Expenses) /

(1 - Variable Costs, or Gross Margin)

 Or, in this case,

 Investment Driven Breakeven Point = (Fixed Operating Expenses + Annual Interest Payments +

Equity Investment x Equity Yield) / (1 - Variable Costs, or Gross Margin)

Operationally, there are two key measures to monitor for achieving the investment driven threshold: RevPAR

and GOPPAR.

ID.RevPAR, or Investment Driven RevPAR, is the threshold level of RevPAR a hotel operation would need to

meet its operating expenses and interest payments, and to achieve the required investment return to the

hotel investor. In other words, it is the minimum RevPAR that the operator or general manager should

achieve in order to meet all operating, financing and investment requirements.

Similarly, ID.GOPPAR, or Investment Driven GOPPAR, is the threshold level of GOPPAR a hotel operation

would need to meet its operating expenses and interest payments, and the required investment returns to the

hotel investor. In other words, it is the minimum GOPPAR that the operator or general manager should

achieve in order to meet all operating, financing and investment requirements.

The investment driven breakeven point is therefore translated into ID.RevPAR using the following formula.

 ID.RevPAR = (Required ID. revenues x rooms revenue percentage of total revenue) / (Number of

available rooms x 365)

 ID.GOPPAR is calculated using the following formula.

 ID.GOPPAR = (Property taxes + insurance + incentive fee + other fixed charges + interest payment +

equity requirement) / (Number of available rooms per day x 365)

ID.RevPAR and ID.GOPPAR represent the actual financial breakeven point of a hotel investment (assuming a

broadly similar return from cash flows and property appreciation. Alternatively one might reduce, and adjust,

the required equity yield in a buoyant transaction market where property appreciation represents between

65% and 70% of total returns).

Table 3 - Investment Driven Breakeven Analysis - Hotel A (£)

Figure 3 - Investment Driven Breakeven Analysis - Hotel A (£)

We note from Table 3 that Hotel A requires an ID.RevPAR of approximately £90 in order to meet its operating,

lending, and owners' obligations. This figure translates into an ID.GOPPAR of approximately £55. Should the

actual operating performance of the hotel drop below these levels, then the asset manager and investor

should consider altering the strategy of the hotel or the return expectations associated with the investment in

the property.

Synthesis and Conclusion

While one might consider that a hotel operation can 'easily' achieve an operating breakeven point, it is crucial

to note that it requires a significant level of incremental performance to meet the financial and investment

requirements of a hotel development. This is when a renowned and well-established operator (and asset

manager) could potentially add value to the shareholder(s) in a hotel property. On the other hand, this

somewhat reflects the usual conflict of interest between the hotel operator and the investor, and, potentially,

the asset manager.

Figure 4 - Summary

The investment driven breakeven analysis has the following advantages.

 It serves as a basis for a 'quick and dirty' hotel investment appraisal. For example, if a hotel

investment is being assessed and the range of 'investment driven - ID.RevPAR and ID.GOPPAR'

operating performances is considerably higher than that achieved by the market (or could potentially

be achieved by the property), then the investor(s) should consider altering its/their anticipated

return requirements, the capital structure (loan to value - or to cost - ratio) of the property, or decide

not to invest in the property (considering no other stimulus for the investment exists);

 It enables a more 'financially sound' incentive fee to be set for the operator, asset manager, and/or

general manager;

 It enables asset managers to better assess and compare the operating performances of their hotel

properties, regardless of their market positioning. In other words, it enables a comparable

assessment of different types and classifications of hotels to be made. For example, let us assume that
 Hotel A (a five-star property) achieves RevPAR and GOPPAR of £100 and £50, respectively, and that

the hotel's ID.RevPAR and ID.GOPPAR are £110 and £60, respectively. Therefore, the operator of

Hotel A is considered to be eroding the value of the equity investment in the hotel, and action needs

to be taken. On the other hand, let us assume that Hotel B (a mid-market property) achieves RevPAR

and GOPPAR of £80 and £45, respectively, and that the hotel's ID.RevPAR and ID.GOPPAR are £75

and £42, respectively. While Hotel B has a lower operating performance than Hotel A, it has a better

effect on its equity investment than Hotel A;

 It enables investors and asset managers to better assess the impact of both the operating and the

financial strategy on the overall investment returns, and helps them analyse the reasonableness of

their return requirements;

 It enables development and acquisition managers to sense check the EBITDA multiples (yields) on

any potential acquisition;

 It enables general managers to better understand the investment perspective and requirement of the

hotel operation and structure the optimal strategy that best fits such requirements. It is also a useful

tool that could be used when preparing hotel budgets.

The investment driven breakeven analysis provides all main stakeholders - the operator, the investor and the

asset manager - with a very useful tool to ensure that return requirements to the owner become much more

transparent. It helps the operator to devise future revenue strategies and allows the asset manager to enforce

a suitable operating strategy to help ensure the owner's returns. Furthermore, it is a useful tool for 'quick and

dirty' hotel investment appraisals.

Elie Younes is an Associate with HVS International's London Office, specialising in

hotel valuations and feasibility studies. He joined HVS International in August 2001

after completing his MBA in International Hospitality Management at IMHI, a joint

programme co-administered by Cornell University (USA) and the Essec Graduate

Business School in Paris. Elie has four years of experience in the hospitality industry

in the Middle East and benefits from a diverse multicultural background as he is

fluent in Arabic, English, and French. Since joining HVS International, he has worked

on several valuations and consultancy assignments in the Middle East, Africa and Europe.
Russell Kett is the Managing Director of the London office of HVS International, the

worldwide specialist hotel real estate consulting firm. He specialises in hotel

valuations and feasibility studies for hotels, resorts and time-share developments,

but also advises on investment strategies, management and lease contracts, and

profitability improvement. Prior to his 25-year career in hotel consultancy, he

worked with one of the UK's leading international hotel companies. He speaks

frequently at hotel sector conferences and lectures regularly at leading hotel schools

around the world.