Buying high and selling low in the lodging-property market: the prices of lodging properties are influenced by the motivations a

Originally published in 1994, this is an analysis of more than 1,300 hotel transactions recorded between 1985 and 1992. The study revealed a pattern of consistent overpayment by some types of buyers and underselling by certain classes of sellers. Further comparisons of specific hotel-property types with various combinations of buyers and sellers showed that sale prices are frequently affected by certain combinations of property characteristics with the attributes of buyers and sellers. Individual buyers, for example, regularly overpaid for the properties they bought and were particularly influenced by average daily rate. On the other hand, the Resolution Trust Corporation created considerable market distortion by regularly discounting hotels it sold, because it undervalued its properties' proximity to city centers and their ADRs.

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Each year ownership of hundreds of U.S. lodging properties is transferred in the real-estate market. In theory, the mutually agreed upon sale price for a property is based on the buyer's and the seller's financial goals, their investment outlook, and their knowledge of the property's characteristics. That price is strongly influenced by the physical characteristics of the property (e.g., number of rooms, restaurants, pools, etc.), its location relative to other land uses, and the economic conditions of the market in which it is located. Physical, locational, and economic factors cumulatively generate income or loss and cause value changes over time.

Property prices relate directly to property fundamentals. The analysis of those fundamentals underlies both traditional and currently applied approaches to property valuation in the real-estate-appraisal profession. (1) Because the physical, locational, and economic aspects of a mid-market hotel, for example, are observable and the cash flows from operations and future sales may be estimated by the buyer and seller using standard financial-analysis techniques, the buyer should be able to avoid overpaying for a hotel and the seller should be able to avoid selling a hotel too cheaply. Extending this theoretical argument to the general case of all lodging-property sales, neither a buyer's nor a seller's wealth should be abnormally enhanced or reduced as the result of any transaction.

But not all buyers and sellers are equal. Some buyers are better informed than others about the local economic conditions that affect property prices. Some sellers are not as adept at negotiation as others. Some parties in transactions are more motivated than others to complete transactions in a timely manner and may pay more or accept less for expediency. Japanese hotel buyers during the late 1980s, for example, are thought to have overpaid for properties, perhaps because of their strong motivation to place money in the U.S. real-estate market when it was booming, perhaps because they wished to obtain trophy properties, or perhaps because they made purchase decisions without good information about key property and market fundamentals. (2) The Resolution Trust Corporation (RTC) is another example. Some believe that political pressure from Congress pushed the RTC into selling property from its portfolio quickly and cheaply instead of waiting until the real-estate market recovered.

To show that a particular type of buyer overpaid or that a seller undersold in the lodging-property market, however, is far too general a finding to be useful to market participants. If some buyers pay premiums and some sellers offer discounts, do these outcomes persist in all transactions in which a specific type of participant is involved? Suppose buyer premiums and seller discounts are the result of mistakes. The root causes of such "errors" should be of interest to market participants who want to fill information gaps and exploit inefficiencies. Some foreign buyers, for example, are known for their careful examination of the physical characteristics of properties, but because of their foreign residency, they may not astutely evaluate how local market economics affect real-estate prices or they may unduly weight such factors as residual property value much more heavily than do sellers based in the United States. Armed with the knowledge of how mistakes are made, brokers and consultants may be of better service to these buyers by providing detailed local marker information.

In this article we explore the idea that the transaction price may be different for a given lodging property in the case of one buyer and seller pair relative to another. The findings reported here are from a statistical exploration that is made possible by a large database of lodging-property transactions that occurred throughout the United States during the late 1980s and early 1990s. We begin with a discussion of previous research on the influence of buyers and sellers on property prices, then we present the findings from our study and their implications.

What We Already Know

Property-rights theory suggests that private contracts do not influence real-estate prices in competitive markets unless the contracts affect the underlying property rights. Private contracts including leases, management agreements, franchise agreements, and contracts for sale are outside the realm of rent and price formation unless they restrict the use of the property. For example, a contract for sale accompanied by a deed that restricts owners' rights to use a property only as a hotel would diminish value because of the options it destroys.

Only recently has serious testing begun on the effect of private contracts on value. Sirmans and Sirmans present some evidence that professional management has a positive effect on monthly apartment rent. (3) Shilling, Sirmans, Turnbull, and Benjamin provide somewhat stronger evidence that contingency clauses in contracts for sale lead to significant increases in the prices of houses (such clauses often involve the ability to obtain financing and the sale of the currently owned property). (4) However, Hanson was unable to find differences between the ratios of operating income to replacement costs for hotels affiliating with a chain and engaging a management company versus independent hotels. (5) Corgel also could not establish that the franchise affiliations of hotels had a statistically significant effect on hotel-sale prices. (6)

Each contract for sale represents the agreement on price and terms reached by a specific buyer and seller combination. The idea that the price of a lodging property may be different in the case of one buyer and seller combination compared to another is rooted in the belief that buyer and seller characteristics influence price formation even though property rights have not been disturbed. In theory, a given buyer behaves differently from other buyers and a given seller behaves differently from other sellers for three reasons. (7) First, each buyer and seller is capable of pricing errors because neither buyer nor seller has all the information about every property in the market that is necessary to set a perfect price for any single property. Second, buyers and sellers are not equally patient. Some sellers, for example, are overly eager to sell and thus sell at low prices while other sellers are willing to wait for their price. Finally, there are strategic reasons why market participants may be willing to transact for the same property at different prices. A hotel company, for instance, may value a property higher than an individual because of the competitive edge the property provides to the brand.

The corporate-finance literature is rich with evidence that the values of securities are affected by the presence of investors driven by tax and leverage clienteles. Maris and Elayan review this literature and find in their study a tax-induced clientele that is willing to pay more for equity REITs. (8) We know of only one study that addresses these issues in the market for real estate that does not involve securities. During the 1980s some real-estate-market observers believed that limited-partnership syndications overpaid for properties to gain maximum tax subsidies for limited partners. Holding other factors constant, Beaton and Sirmans accept the null hypothesis that the prices paid for apartments by different types of buyer organizations are equal. (9) In other words, their data indicate that the form of the buyer's organization is unrelated to the price paid.

Lodging-property-transaction data

Our statistical study of the effects of buyers and sellers on lodging-property sale prices relies on a large database of hotel and motel transactions. For this purpose, a property is defined as a hotel if it includes at least 150 rooms, meeting and banquet space, and restaurant facilities. The data are national in scope and include a large proportion of the lodging-property transactions that occurred during the period beginning in the first quarter of 1985 and ending in the last quarter of 1992. The data are detailed with respect to property characteristics, location, and local economic information. Buyers and sellers in the transactions are identified so that they may be classified (see Exhibit 1).

The primary source of transaction information is the database of the Hospitality Market Data Exchange (HMDE) maintained by Hospitality Valuation Services (HVS). The HMDE contains the sale price, number of rooms, date of sale, and general-location information for several thousand properties. Some information about the characteristics of the properties, such as average room rate, age, amenities, and the conditions of the sales (e.g., financing terms and the organization forms of buyers and sellers) were obtained during visits to the HVS office. Other data were gathered from the following sources:

* Hotel & Travel Index, the AH&MA Hotel and Motel Redbook, and Mobil Travel Guides;