What Is Your Inn Worth?

David Caples
Reprinted with permission by
Virgo Publishing 1998
Bed & Breakfast, The Business of Innkeeping

It has been five years since you opened your bed-and-breakfast, and your seven-room inn is finally starting to produce the way you had anticipated. In fact, you have even mused about "moving on up." There's a 12-room inn further south that needs your care and you need its climate.

Hmmm...the mental questions start:

• I wonder what this inn is worth?
• Have we built up enough equity to make a new deal work?
• Will buyers be interested?
• Will they think it's worth our asking price?

You asked the same questions when you bought the inn originally:
Is it worth this price?

Potential buyers are going to ask the same question, but today they are better prepared. They come fresh from aspiring innkeeper courses and valuation seminars at national meetings. They have lodging industry and B&B studies and often a consultant or buyer advocate to help them review the numbers.
In today's world, the transfer of an inn property is best accomplished if both the seller and the buyer are well prepared. For both parties, this will take some pre-planning and investment of time and money to be sure it's accomplished correctly.

Advantages to the seller:

• You will get the full value of the "sweat" and investment you have put into shaping the inn into a business.
• The inn will sell within the time frame that is important to your future plan.
• It is not uncommon that you will have to participate in financing some of the acquisition, and the more equitable the deal is, the less likely you will have to take it back.

Advantages to the buyer:

• Well-organized operating data will be available from the seller to provide a profile of the investment.
• The financing process will be accelerated and is often more successful when a strong business plan is presented with documented historical data and well-thought-out pro-formas.

Sellers Checklist

Back to our seven-room inn. What do you need to get your inn ready for sale? Let's look at the checklist:

þ Document your operating statistics.

In our opinion, you have to be ready to sell your inn the day after you buy it. Whether the inn was a lifestyle, economic or combined decision, it's still an investment when it's time to sell. And you can't always predict when you will have to sell, such as if you were to become ill or disabled.
Just like your personal money-market-account balance, daily stock prices and monthly rental income statement from that apartment investment, your daily, weekly and monthly inn statistics should always be at your fingertips. Those numbers should be treated with as much or more care as any other investment.

þ  Clean up your operating statement.

The real value of an inn-setting aside the (non-economic) lifestyle component-is its ability to generate cash flow. Our sample inn should produce about $59,926 in net income before debt (38 percent of gross). But the innkeepers have operated the inn in a manner that fits their personal objectives and family needs. Additional staff and other expenses have accrued. The actual net is $47,310.

This reduced net income could have the effect of undervaluing the inn by $115,000 (see Income Capitalization). As you can see, it's important to clean up the operating statement before having the inn valued or listed for sale. It can take two to three years to create clean statements reflecting a historical trend that a prospective buyer can rely on. So some pre-planning is essential.

þ Estimate the value of the inn yourself.

Utilize the three methods described below. Use them in concert with one another to give you perspective. Never use one by itself. As an example, the term "Price Per Room" can be misleading if used by itself. This number most often represents an average price of inn rooms in a geographical area or of a particular size. It really doesn't consider the situational nature of an individual inn, its operating season, revenue steam or real firepower—the ability to put income to the bottom line. If you are serious about the sale of your inn, value the inn from the perspective of a buyer and ask yourself: If they pay my price, will the inn be able to pay for itself?

þ Have the inn valued by a professional.

We look at more than 100 inns a year, and our observation is that the majority suffer from overstated and/or unsubstantiated asking prices. Equally distressing are situations in which the innkeeper has underestimated the value of the inn. This is money left on the table from which the seller should have benefited.
In either case, an appraisal and/or a valuation by an outside, independent professional would probably have established a realistic asking price, supported and documented the data and accelerated the transfer process.

þ Appraisal

Look for a state-certified appraiser that has demonstrated experience with appraising inns. There aren't many, but those who have the experience usually list this as a specialty. Initiate a "competitive" search and request a bid. Quoted prices can vary substantially. A reasonable range might be between $1,500 and $3,000. Make sure the appraiser understands that the objective is to determine a fair market price for an anticipated transfer.
Note:An MAI (Member Appraisal Institute) designation attached to an appraiser's name indicates that the individual has satisfied educational requirements and testing, not unlike a certified public accountant designation for accountants.

þ Valuation

There are approximately a dozen consultants nationally that have significant experience valuing small inns. Three or four criteria are used to determine market value of the inn. The consultant should be able to look beyond the valuation at hand and assist you with a strategic plan to effect a transfer. This could include a review of the inn product, its operating performance data and recommendations regarding improving the bottom line.

þ Prepare a profile package.

Subsequent to determining your asking price and concurrent with making a commitment to sell the inn, you should be prepared to "open up your chest" to all queries. This is no time to be shy or have "proprietary withdrawal."
Qualification is a two-way process. The seller wants to be sure the prospective purchaser is capable of affecting a transfer. The buyer doesn't want to waste time with an inn that doesn't meet his objectives. But more importantly, the buyer can't make a reasonable offer without seeing the operating performance data. Anyone who has bought or sold a business knows this is the case.
At the get-go, you or your representative should prepare a short profile package that will fulfill most of the initial tire-kicking criteria, including:

1. A description of the inn and a historical background
2. Location and land description
3. Zoning and licensing status
4. A brief building and furniture/ fixtures description
5. An explanation of the main sources of revenue
6. Up to a five-year history of occupancy, gross revenue, room nights sold and ADR.

þ Work to the end.

Smart innkeeper sellers never break stride. From the operating statement/clean-up period through the sales/marketing process, the seller should be diligent in the endeavor to improve the net income-generating ability of the inn. This can include additional marketing tactics, continued product improvement, room expansion and/or creation of new sources of revenue. Each additional $1,000 brought to the bottom line (net before debt) could add up to $10,000 to the final sales price.

Valuation Techniques for Buyers and Sellers

There are three calculations for valuing inns. When used in aggregate, they will be reliable in assisting you in determining a fair market value for the inn in question.

1. Price per guest room.

This is the most often quoted statistic on inn sales, and the most unreliable when used by itself. This number is most often an average of final inn transaction prices over a period of time, by geographical area or by the size of the inns surveyed.

If a seller were to use this number by itself in determining a potential asking price, the outcome could easily be understated or overstated. One example might go like this: "The Franklins' got $105,000 per room for their inn. Wow! Ours has to be worth $115,000." The fallacy in this approach is that the cost per room does not reveal some of the background issues that may have affected the price. Was the sale arm's length? Were there special terms that encouraged the buyer? Does the inn have expansion potential? Is there a separate owner's cottage? Is the inn profitable?

2. Gross Revenue Multiplier (GRM).

This is a more reliable calculation that looks at the inn's ability to create a revenue stream as a factor of its value.
In setting the price of an inn, a "multiplier" value must be applied. After researching sales nationally and subsequently completing "proof calculations," we have found that (4) is most often a multiplier that creates a fair price for both seller and buyer.
We find the window for most transactions is the three-to-five range. There certainly may be factors that would encourage a seller or buyer to exceed this range, including recent past performance of the inn, historical significance of the property, additional vacant land or buildings for expansion and/or an unusual furniture inventory. For the informed buyer, exceeding the three-to-five multiplier will often raise a flag of caution and will require further explanation from the seller.

3. Income Capitalization.

Definition: Income capitalization is based on the principle that the present worth of a future income stream is the real value of a going concern. The calculation of value focuses on the Net Before Debt (NBD). This is the amount left after deducting all expenses from revenue, excluding depreciation, debt service and owner draws. The NBD is then divided by a cap rate. The cap rate is a reasonable rate of interest one would expect to earn on an investment at a certain level of risk.
Nothing beats this index as the acid test of inn valuation. Income capitalization focuses on the fire-power of an inn—its ability to put income to the bottom line to service debt and generate profit. In essence, will the inn pay for itself and generate the desired profit for the owners?

Our observation of consultant valuations and formal appraisals puts the cap rate for inns between 9% and 12%. Lodging Resources Workshops finds most of its valuations calculated with a cap of 10-11% PKF's 1997 Hospitality Investment Survey reflects the cap rate for lodging "to hover around the 11% mark" since 1986.

The innkeeper of our seven-room inn now has a reasonable valuation window. The potential seller can determine if the time is right to sell, relative to the values developed by the three approaches. Asking price strategy and negotiation limits can now be established.

The decision to put your inn up for sale, in the best of worlds, should be a long-term, choreographed "dance" in which the outcome is predictable. It is the near-perfect timing of matching your personal and financial objectives. It is the product of continuous shaping and attention to detail. The result is a transfer price that is fair to the buyer as well as the seller, but meets the seller's investment objectives.

David Caples is president and partner with Helen Cook of Lodging Resources Workshops. Based on Amelia Island, Fla., this consulting and seminar training company provides feasibility, operational and marketing consulting. The company also hosts seminars for aspiring innkeepers at the 25-room The Elizabeth Pointe Lodge. For more information, call (904) 321-2210. Mr. Caples and Ms. Cook are also the creators of Bed and Breakfast For Sale.com, a one-stop internet resource for buying and selling B&B's, country inns and other small lodging properties.