June 26, 2020
By Bram Gallagher


Creating implied values using estimated net operating income (NOI) and cap rates since the Great Financial Crisis (GFC) has been relatively straightforward. Since the hotel market enjoyed nearly a decade of stable, steady growth, the trailing four-quarter estimated NOI could be used as a reliable stabilized aggregate NOI. Cap rate aggregates could include some distressed properties that traded at an abnormally high cap rate, since it was likely that fortunate assets would trade for a premium. The aggregation would smooth out these aberrations and produce a rate that one could reasonably expect a typical property to garner.

Though this method worked well in the past, the recent policies taken to mitigate the terrible human cost of the COVID-19 virus, as well as the fear and uncertainty surrounding the outbreak, has created an unprecedented disturbance in the hotel market, motivating changes to the methods used to estimate hotel values. The difference in the recent downturn compared to previous market downturns is not only one of scale, but also qualitative expectations about the future of lodging. Specifically, the downturn is expected to be acute, not indicative of underlying demand for lodging and attributable to specific policies that can be rescinded when no longer necessary.

NOI Forecasts

Hotel performance metrics were shocked in March and through Q2 2020. CBRE expects national occupancy to reach an average of approximately 20% in Q2 2020. Nonetheless, the anticipated temporary nature of shutdowns that propelled low occupancy has led most hotel operators to plan on reopening even as operating income falls well below conventional market-exit levels. Figure 1 illustrates the dramatic plummet in net operating income, forecast to be negative for two quarters in 2020.

Covid Investment Article_Figure1

Negative NOI stems from hotels maintaining some business presence in the face of partial or even zero capacity usage. Because of numerous fixed costs, compared to revenues, operating expenses are not as responsive to the occupancy decline. This gives rise to the popular term “burn rate,” in which the hotel manager calculates the expenses in excess of revenues incurred every day that partial capacity is maintained. Figure 2 illustrates aggregate annual total revenue and expense. The two approach near parity for 2020, and the market is expected to incur losses during Q2. Because of the slower recovery in group and food and beverage business, total revenue is expected to regain its 2019 level by 2024, approximately one year after rooms revenue.

Covid Investment Article_Figure2

Cap Rate Forecasts

The recent downturn in the lodging capital market has unfolded more quickly and landed more deeply than any in recent memory. Figure 3 illustrates volume of hotel trades. Volume drops 49% in March and 98% in April to approximately $42 million, or less than a third of the lowest recorded volume of the GFC, in April 2009. 

Covid Investment Article_Figure3

The April volume resulted from the sale of eight properties comprising 634 rooms, a relatively small 79 rooms per property average. Clearly, the market essentially paused in April to gather new information. In the weeks that followed, it has emerged that April was the bottom of the crisis in terms of hotel performance and may be the lowest trading volume month as well. However, this trading volume presents some difficulty in presenting aggregated cap rate data or for forecasting the same, as it necessitates delicacy in determining which transactions are impacting these cap rates. Moreover, the series responds more sensitively to outliers when transactions are thin.

 Since the historical series does contain aggregates from the previous downturn with these characteristics, we can think of modeled cap rate forecasts to describe not what economic conditions would imply for the cap rate of each property, but rather the realized cap rate from transactions that are likely to occur in the economic conditions of a major downturn. This purposefully includes distressed properties and liquidity constrained sellers. Additionally, during uncertain times, buyers expect to be compensated for the additional risk of engaging in the lodging market. These two effects create upward pressure on cap rates that peaks at approximately 90 basis points (bps) - the forecast about four quarters after the initial shock of the outbreak, illustrated in Figure 4.

Covid Investment Article_Figure4

Subsequent to the upswing in cap rates, rates quickly fall to, briefly, lower than precrisis rates as pent-up inventories trade again. Then, trading resumes at a stable rate at about the 2011-2019 average.

Value Estimates


Estimates of typical market value combine cap rate and NOI estimates in a fashion that replicates how actual market participants will judge the value of assets. This entails using a theoretical future stabilized cash flow, as well as accounting for the additional risk of carrying lodging assets. During the expansion following the GFC, trailing year NOI was an excellent proxy for stabilized NOI as the market was amid a protracted period of slow but steady growth.

The broad consensus among hotel forecasts is that April and May will be the worst performing months in the lodging industry, and that improvements are forthcoming. Any transaction that occurs after May will not experience the low NOIs seen in those months. This means that the trailing year NOI that includes these months will dramatically understate the realized cash flow that any property would expect for future periods, and thus trailing year NOI will not be an appropriate proxy for stabilized NOI. Because of this, we calculate post-COVID-19 typical valuations from the average of five years of forward NOI. Values thus drop more sharply in Q2 2020 than during the GFC to a shallower loss. Values then increase relatively quickly as NOI recovers and lossy periods are moved from future expectations to historical values, illustrated in Figure 5.

Covid Investment Article_Figure5



As a result of an unprecedented disturbance in the lodging market, CBRE expects that values for typical transacted hotels will experience a sharp drop in the second and third quarters of 2020. The silver lining is that since volumes have also dropped to near-zero, the reduction in value will remain hypothetical for nearly all properties, and recovery is expected to be relatively quick. Enormous financial sector support from the Federal Government may contribute to favorable conditions, and combined with forward-looking expectations of recovering fundamentals for the lodging industry, suggest that values of traded properties recover slightly more quickly than NOI.


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Bram Gallagher is a Senior Economist for CBRE Econometric Advisors.