An excerpt taken from ADR The Rule of Thumb – validity and Suggestions for it’s Application By John W. O’Neill
For the full article please follow the link – http://www.personal.psu.edu/jwo3/Hotel%20Average%20Daily%20Rate%20(ADR)%20Rule-of-Thumb%20Article.pdf
Rules of thumb have been used in real-estate appraisal, general real estate, and general business for many years. More accurate and up-todate value indexes are needed, however, particularly for commercial real estate. As already noted, hotels’ ADR rule of thumb, which has been used for decades, is that a hotel should generate one dollar in average daily rate per every thousand dollars in value per guest room. In other words, a 100-room hotel developed or purchased for $12,000,000 would be valued at $120,000 per guest room. Based on the ADR rule of thumb, this property should generate a $120 average daily rate.
A more recent corollary to the ADR rule of thumb has been a room-rate multiplier technique for valuing hotels. In this reverse calculation, a hotel may be valued at 1,000 times its average daily rate on a per-room basis. For example, a 100-room hotel with a $120 average daily rate would be valued as follows:
1,000 × 100 × $120 = $12,000,000
This technique may be used in addition to the three traditional real-estate valuation approaches of income capitalization, sales comparison, and cost. Despite the fact that more sophisticated real-estate-valuation-techniques exist than just the room-rate-multiplier technique, executives, investors, and even real-estate appraisers
frequently use rules of thumb. Hotel executives use the ADR rule of thumb to aid them with decision-making regarding new hotel development, and to some extent, with establishing room rates and with valuing existing hotels. Recent literature suggests, however, that perhaps the ADR rule of thumb needs to be revised for
certain property types.
The purpose of this article is to present research that undertakes that revision for hotels both in the aggregate and by types of hotels.
Another interesting read concerning hotel valuation was found at https://pdfs.semanticscholar.org/3eb4/8eb9938a492e543c7b6937fc9941e49cd5e9.pdf
Please follow that link to read the full article quoted below.
The ADR Rule of Thumb as Predictor of Lodging Property Values
By – John B. Corgel and Jan A. de Roos
In this paper, we compare value estimates from the ADR rule-of-thumb model to value estimates from an economic fundamentals model. The economic fundamentals model is a hedonic pricing model that has been customized for lodging property valuation. In the aggregate, the ADR rule-of-thumb model yields estimates of lodging property values that only differ slightly from hedonic estimates. When the property sample is disaggregated, using physical characteristics and financial performance characteristics as the cross-¬sections, many statistically significant differences in the estimates from the two models are found. These results suggest that care must be taken when interpreting results from aggregate comparative analyses of the hotel and motel values.
The balance of the paper is organized into three sections. The next section presents the background of rule-of-thumb valuation models and specifically the ADR rule. The section that follows describes the development of the economic fundamentals model and how the comparative analysis was performed. The findings and conclusions from the study are contained in the final section…….
As in other industries, rules-of-thumb are part of the heritage of the lodging industry. An often expressed industry standard, for example, is that the number of employees needed in a full service lodging operation is equal to the number of available rooms. * Room rates are equated to property development costs and values in similar ways by traditional standard. The rule that $1 of ADR equals $1000 of development costs is evidenced through examples found in several early hotel management (Podd and Lesure, 1964) and marketing (Coffman, 1970) texts. In their 1991 text, Vallen and Vallen refer to the rule as the ‘building cost method’ for evaluating room rates. Use of the rule is characterized as analogous to an old cookbook direction—‘flavor to taste’. Yet, they note that the rule is still applied
directly on the theory that rising construction costs are matched by rising room rates. Advocates of the rule also may argue that it works more effectively for economy hotels. Kasavana and Brooks (1991), in another recent hotel management text, recom¬mend that the rule be restructured as a relationship between ADR and the replacement cost of the hotel to adjust for inflation.
Rushmore’s (1990a, 1990b) writings legitimize the ADR rule-of-thumb as an alternative model for valuing new and existing lodging properties. Yet, he makes it clear that the reliability of the model for general usage is questionable. In Rushmore (1990b), an existing property’s value is estimated consistently with the room rate multiplier and six other valuation models. (Room rate multiplier is ADR x 1000 x R.) In Rushmore (1990a), the rule is presented along with cautionary notes. Implicit in the rule are assumptions about occupancy, ratio of food and beverage revenue to rooms revenue, and other costs and expenses. The multiplier, therefore, should be adjusted if the subject property’s operating characteristics vary from those assumed for direct use of the rule. This model should be used to ‘establish broad
parameters for room rates and project value’ (pp. 11-17).
The advantages of applying the ADR rule-of-thumb model for valuation are clearer than the disadvantages. In exchange for ease and expedition, many assumptions must be made implicitly, and a high degree of subjectivity is introduced to reach value conclusions from the ADR model.