Wednesday, July 16, 2014
I can't open a newspaper or read the news online without seeing INCONTROVERTIBLE evidence of real estate bubbles nationwide. In Seattle, it is so obvious I wonder who is making financial decisions at some of these firms, especially on the buying side.
For example, a nice luxury hotel in downtown Seattle called the Hotel 1000 was just sold for $63 million. This works out to be a city record of $525,000 per room.
So let's look at the valuation here.
You can rent a room on Hotels.com for $339 per night at the Hotel 1000.
What is the average gross profit margin on each room? The number is extremely volatile but is now about 26.8%. (During the recession of 2008-2009 the margin was NEGATIVE 8%.)
This means the Hotel 1000 earns about $90.86 per room per night.
What is the average occupancy rate of an urban hotel like the Hotel 1000? About 62.9%.
365 days per year x ,629 is 230 days of occupancy per year.
So the new owners of the Hotel 1000 will earn $90.86 x 230 days per year or $20,897 per year per room.
At this rate they will earn their $525,000 purchase price back in twenty-five years. Or the year 2039.
The average investment yield on these number is a paltry 3.9%.
Of course these are rough estimates based on averages but they are solid numbers. These statistics do not assume room rates will rise over the next quarter century but so will taxes, maintenance and labor costs, and the need to do at least four complete hotel renovations over these same years. Hotels do sell things other than rooms but they usually lose money selling them. A great example is hotel gift shops which exist for the convenience of guests at most places.
You can juice the yields with leverage to raise them a bit but the results are still essentially the same. A high price without leverage is still one with it.
The purchase price here is just too high. You can make more money taking the original $63 million and earn four hundred basis points more by purchasing shares in the average hotel REIT. Current average yield is 4.3%. Plus you don't need to run a hotel and have complete liquidity over your investment to earn a higher yield.
To earn a 4.3% comparable yield on $20,897 per year the owners would need to pay a maximum of $485,976 per room.
In other words, the purchase price viewed from this perspective is $39,024 per room or 7.4% too high.