The Role of Stakeholders’ Perspective on Determination of The Most Appropriate Method(s) for City Hotel Valuation, A Case Study

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Master Facility & Real Estate Management

 

Title Assignment:   “The Role of Stakeholders’ Perspective on Determination of The Most Appropriate Method(s) for City Hotel Valuation, A Case Study”

Name Module/Course Code: Master Thesis / BUIL1230

Name Tutor:    Carla BROUWER

Name Student:    Elif ILERIYE GIRGIN

Full-Time / Part-Time: Full-Time Greenwich Student Number: 001007301 Saxion Student Number: 455910

Academic Year: 2017-2018

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Master Thesis Facility and Real Estate Management

“The Role of Stakeholders’ Perspective on Determination of The Most

Appropriate Method(s) For City Hotel Valuation, A Case Study”

Saxion University of Applied Science University of Applied Sciences Saxion Handelskade 75

7414 DH Deventer &

Greenwich University Old Royal Naval College Park Row 30

SE10 9LS London, United Kingdom

I certify that this assignment is my own work, that it has not been imitated from other persons published or unpublished work and has not been submitted for assessment at the University of Greenwich or elsewhere before. I have read and

understood the policies, procedures and regulations of the Department and the University.

Elif ILERIYE GIRGIN August 2018

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READERS

Tutor

Carla Brouwer

Saxion University of Applied Sciences

2

nd

_Reader

Eric Wagelaar

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Abstract

This thesis is about finding the most appropriate valuation method(s) for city hotel valuation while taking consideration of stakeholders’ perspectives in a case study from Istanbul, Turkey.

In valuation studies, there are 3 parties; the owner of the real estate, the lender, and the appraisal company who prepares the valuation report. The appraisal company prepares the report based on 3 points of view: Cost approach, income capitalization approach, and sale comparison approach. A problem arises because of the different interpretation and expectation of each stakeholder from the report which is related to the applied approaches.

Therefore, the main research questions are;

What is the most suitable approach to provide the most realistic estimate for the city hotel valuation according to stakeholders?

Do different stakeholders have different points of view for city hotel valuation methods in Istanbul?

The research strategy to answer these questions is based on qualitative research in the form of a single case study. In this research, the case study includes a number of city hotel valuation reports to recognize the perspective and acceptance of stakeholders in the valuation process, approving the relevant authority in Istanbul. In addition, interviews and desk research were used in order to collect the data. The outcomes are based on the ten semi-structured interviews with investors, banks, appraisal companies and the results of 21 approved valuation reports.

This research has shown that the most suitable approach for providing the most realistic estimate for city hotel valuation is income capitalization approach (the DCF method) based on the findings of field research, approved valuation reports and literature. However; according to all stakeholders, if sufficient data existed, other approaches can also be used to verify the income capitalization approach. Another important finding is that because of the unstable economic situation of Turkey, all stakeholders want to stay in a safety zone in the valuation process. Because of this reason, conflicts also arise about parameters. The necessity of standardization of approaches and parameters based on valuation purposes is the most important conclusion of this research.

The most important recommendation of this research is that in order to provide agreement between stakeholders, there should be a regulation by government in this field by creating a committee which includes BRSA Turkey (Banking Regulation and Supervision Agency Turkey) authorities, REIT’s (Real Estate Investment Trust), authorities and publicly-traded companies and Turkish Appraisal Association for standardization, both in valuation approaches and their parameters.

For further research, Istanbul should be also compared with cities that have stable economy and similar characteristics in order to see similarities and differences and take their standardization as successful examples.

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Foreword

I would like to thank the people who helped me during my thesis research in this foreword. It would have been almost impossible to do this research without the help these people provided. The persons who I want to thank are illustrated in arbitrary order.

The process of conducting this research was carried out under the auspices of Carla Brouwer, and most importantly, I would like to thank her for her helpful feedback to keep me on track. Moreover, I am very grateful to the respondents who participated in this research. They have given their time to share interviews and thoughts during busy times. The results of this research are greatly based on their knowledge and experience. I would also like to thank are Hester van Sprang, Adrien Eros and Joris Verwijmeren. They did an excellent job during the Academic Skills lectures, which gave me the structure and input of the research process.

I would especially like to thank Ahmet Arslan, my former general manager who taught me everything I know in a professional sense and did not hesitate to support me in writing my thesis.

Furthermore, my great thanks go out to my parents who mentally supported me during to whole period of this academic year.

I would also like to thank Adam Foxwell, who always shows me his hospitality, which gives me the perfect environment to study with his support.

Finally, and most importantly, thanks to my husband Levent Girgin who endured this long process with me, always offering support and love.

I hope you enjoy reading this.

Elif ILERIYE GIRGIN Amsterdam

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1. INTRODUCTION

As tourism and business trips have increased over the last decade, it paved the way for a growth in national, international and global hotel chains. Not only the number of chains is affected by this growth; also, mergers, acquisitions, and takeovers increased. Moreover, the combinations of franchising, management and joint venture agreements appeared, and all these developments caused an increase in the choice and variety of hotel products, which were provided to customers (Langford & Weissenberg, 2017).

The products became more segmented and shaped on the preferences of the target markets, as the brands expanded. If hotel companies continue to increase their global fortification, hotel brands will keep becoming more accessible worldwide, consequently improving awareness and anticipations of their market. These activities doubled the activity of hotel valuation in Istanbul, as a whole. Firstly, in the international hotel industry, the capital has been significantly reallocated, thereby increasing the demand for trustworthy valuations to aid ensuring the transactions. Secondly, transaction volume along with the complexity of the international environment has led to the development of a more industrialized and sophisticated approach to hotel property valuation (Nilsson, Harris, & Kett, 2002).

The aim of a valuation is indeed to appraise the market value in order to determine the selling price at which a property is relied upon when being put on the open market. However, hotel valuation is a more complex form of real estate appraisal (Walsh & Staley, 1993), needing not only a comprehension of the numerous standards and techniques of general valuation but also a detailed insight of the hotel business. Valuers soon realized that hotel facilities are more than land and building. They are retail-oriented, labor-intensive businesses demanding a high level of managerial skill in their operation. In addition, hotels need huge interest in personal property, which has short valuable life and is liable to quick devaluation, and becoming outdated (Rushmore & Rubin, 1984). During the hotel valuation process, all these different features should be taken care of in an appropriate manner to evolve a supportable estimate of market value.

The market value for hotels is a dedicated shape of real estate, which comes from four ingredients: land, improvements, personal property, and the ongoing business. For valuation of hotels for real property appraisement purposes, the appraiser must separate or subdivide general total property value into its singular ingredients where only the current value of the property and renovations are considered. Furthermore, appraisers should have complete understanding of hotel operations and their economic connection to each ingredient of the whole property (Rushmore, 2004).

1.1. Topic Description

Interpreting the valuation report by the involved parties (bank, owner, appraisal companies) is a source of conflict in determining the proper value of the city hotels. However, the ideal report is the one that can convince all parties to a satisfactory level. While it is not realistic to have all parties fully satisfied, it is still

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9 possible to employ the methods for evaluation that is close enough to the expectation of each side of the problem so that with the minimum level compromising, the determined value is acceptable for all. This research aims to find the most suitable valuation approach for city hotel valuation with taking consideration the aspects of stakeholders’ in Istanbul, as a case study. Istanbul is the largest center for tourism in Eastern-Europe, centrally located between two continents as a gateway and the 10th most visited city around the World (Erenhouse, 2017).

1.2. Problem Statement

In every valuation, there are 3 parties; the owner of the real estate, the lender and the appraisal company who prepare valuation reports.

The problem arises when there are different interpretations and expectations of each party from the report. For instance, consider a company which is traded on the stock exchange market, needs to update the value of their assets each year. They ask an appraisal company to prepare the requested report for them. The appraisal company prepares the report based on 3 points of views; cost approach, income capitalization approach, and sale comparison approach. Each of these approaches results in a different value for the asset. The owner may accept the income capitalization approach to decide on the value of its asset, while the bank may accept the cost approach for determining the value of the asset. On the other hand, in the opinion of the appraisal company the income capitalization approach might be the best estimation of the value of the asset. Therefore, a conflict arises for determining the real value of the assets among these parties.

This problem can be solved if the valuation techniques used in the valuation report are modified to provide closer value of the property.

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2. LITERATURE REVIEW

At the beginning of the 1990s, the UK hotel industry was subjected to a number of serious valuation problems. For example, the serious decline in the value of Queens Moat Houses caused significant debate about the basic methodology of hotel valuations as business entities. This led to the publication of a series of guides and recommendations from the Royal Institute of Chartered Surveyors (RICS), the British Association of Accommodation Accountants (BAHA) and expert hospitality valuation companies. However, while superficially basic methodologies are generally similar for various methods, there is considerable debate about the reliability of any single method in practice (Nilsson et al., 2002).

Earlier reviews of hotel valuation methods are relatively limited, especially in the UK. A major effort was focused on the valuation of goods such as retail, industrial and office buildings. Although there are land and building resemblances between hotels and other commercial properties, there are special features that require particular management expertise, such as "single-use" properties (i.e. having little or no alternative use) has an associated value (Butler Jr & Benudiz, 1994; J. D. Fisher & Martin, 1995; Rushmore, 1979, 1990, 1992; Rushmore & Rubin, 1984; Tiltscher, 1983).

This chapter provides theoretical background information and detailed information about occurrences and historical developments in the process of appraisal, especially income valuation theory and concepts, which can be found in Appendix A.

2.1. Important Terms and Conceptual Issues in Valuation

Value can be subjective depending on when, how or for whom the valuation is made. When the valuation is created from a specific person or organization’s point of view. It is referred to as a calculation of worth.

-Present price, capital and income are the three main aspects of definition of value from the viewpoint of

property valuers (Blackledge, 2016).

Present price is what the property worth today. This is crucial for the property valuation and all calculated values are valid at the “valuation date” and only remain the same value for a limited time period after. Its validity depends on the rules of the market. If the market’s prices are changing by large percentages in short timeframes, today’s value will lose its validity after a one or two-month period. The present price should be calculated objectively, without prejudice and influence of a particular person’s point of view. This price type is used often by the valuers and is the main aspect of all valuation theories. Most of the values calculated by property valuers have a definite valuation date.

Capital, is a bulk receipt obtained at one time from the sale or loan of the property.

Income is money that can be received regularly over time. Property income comes from rent or interest payments. Rent is an annually calculated payment made to a landlord by a tenant who uses the property. The payments, which are advanced against the collateral offered by a real estate are interest payments.

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-Valuation, market rent and market value are the three main definitions provided by the RICS’s Red Book

(RICS, 2014). It seems that the words value, price and worth have similar meanings in daily use, but they have different meaning within the context of property valuation (RICS, 1997):

● price - the real discernable exchange price in the open market;

● value - the estimation of the price if the property were to be sold in the open market;

● worth - a perception of the total amount of capital a party is prepared to pay (or accept) by a specific investor based on the flow of benefits expected to be produced by the investment.

-There are different types of value in literature which differ according to the property’s situation. These are:

a) Reservation Price or Investment Value: The minimum price a seller sets or the maximum price a buyer would spend on a property of interest. Investment value is unique to potential buyers or sellers. When the real estate users’ tastes, choices, perception of the risk, wealth and tax conditions are different, the investment value also differs (Miller & Geltner, 2005).

b) Exchange Value: It’s the most possible price that a property is likely to be sold in the open market. This value is appealing to appraisers, when the price arrives at market value by using this technique (Adetiloye & Eke, 2014).

c) Liquidation Value: If a property is likely to be sold for less than normal market price. It is when the property is sold quickly or when it is sold in thinner markets of ready buyers, means the prices would be lower than normal (Adetiloye & Eke, 2014)

d) Market Value: When the buyer and seller are fully informed and acting freely. This is the highest price a willing buyer would pay to a willing seller. According to (Brown & Matysiak, 2000) the true value is the market value of well-functioning market. In this case, if valued in the present, then the following relationship holds true:

Market value = True value = Present value

Both buyers’ and sellers’ expectations of future advantages of ownership require reference to market transactions, as the theory of market value leads (Kummerow, 2003).

e) Going Concern Value or Use Value: It’s the price of a property, which is used by an existing organization occupying the property. It is usually difficult to separate real estate value from the value it has to its occupants. This type of value is used to define the value of hotels, hospitals and some industrial properties (Adetiloye & Eke, 2014).

f) Equilibrium Value: When issue of efficient pricing is involved, that recognizes all available information, this price is usually applied. Real estate markets might not be effective enough in the means of that market value and may not reflect public information; still equilibrium value can be represented by market value.

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12 h) Highest and Best Use: This price describes the expected use and future income of the property. It is defined by the American Institute as "physically and financially feasible, appropriately supported and reasonably probable and legitimate use of vacant land or properties that cause the highest value" as of appraisal date (Miller & Geltner, 2005). It depends on the skills and discernment of the analyst, who must decide what could be the best use of this property if it is vacant.

2.2. Main Purposes of Hotel Valuation

Valuation comprises a basis for all property ownerships and processes. Having a valuation is seen by many businesses as an unnecessary expenditure. However, there are indeed many reasons to carry out the valuation (Dylan Jones AssocRICS, 2014). If the valuation is timed properly and used efficiently it can be favorable for businesses to know their assets and to see their company’s future to make informed decisions about their assets. Besides, the purpose of the valuation may be change of the many reasons about for hotel valuation (Millington, 2013). There are many situations which are subject to the hotel valuation including the following:

If a hotel owner is willing to sell their hotel, a valuer should be asked about its worth and depending on the valuer’s experience and skills, an advice will be given to the client about the hotel’s worth. This is a valuation for sale. Upon being asked for valuing the property (hotel), the valuer must consider the buyers in the current market and estimate property’s worth while a competition grows between many to-be buyers.

On the other hand, hotel investors may request a valuation because they are willing to invest in a specific hotel. The valuation for purchase may be as large as the range of people interested in the property, but valuers should be directed to the needs and financing of an investor. In such cases, the needs and characteristics of the customer may change the entire market decisions.

The investor's subjective requirements may cause a lower value than those valued by others whose aims of the valuation are different. It may cause to a buyer to outbid for a property and while it may be fit to an investor’s requirements perfectly, it may be a huge risk for other potential buyers who expect lower bids. Hotel owners may ask the bank for a loan by offering their hotel as a collateral, which is the assurance of the property by the bank’s side. For the reason that anything about the payments or transactions goes wrong on the client’s side, the bank wants to guarantee before they lend the money to the client. The bank has the right to be able to claim the money lent for the owner’s purchased or will be purchased property, while the loan is rest assured upon the property, which causes lower values on these properties in the market.

When a client wants to rent a hotel, a valuer may be needed to value the hotel for rental purposes. The client must add to the account what he can pay for use of the hotel and this will require an amount of the annual value as opposed to the capital figure. It should be noted if it is appropriate for the client to rent and what has been obtained for a similar property. In doing so, the conditions for granting comparable characteristics within related methods compared to the subject property must be considered carefully by considering all variables of the property.

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13 A hotel valuation needs totally different method when used for insurance purposes. In this case, it should be taken into consideration by the valuer, the bricks, mortar and installations which were used to build the hotel should the building be destroyed, in part or as a whole. To find the value of the hotel for insurance purposes or the replacement costs, the entire building should be measured to calculate its size and equipment / installation costs should be added to the various building works for a replacement.

When a company is about to publish its annual accounts or if there is a redevelopment potential, a hotel valuation for balance sheet purposes would be done.

If the companies in the stock-exchange market are used for business purposes, the value of their assets must be updated and the value of the business including hotel properties should be determined. Moreover, if two companies are going to merge, they need to comprehend how much capital will exist through their assets (Gasparini, 2011). In both situations, the value of the property is reflected in the balance sheet.

In such cases, the valuer must comply with the standards established by the statute or agreed by the professional groups, such as International Assets Valuation Standards Committee (IVSC) ‘s standards, which in many countries comply. If a public authority wants to own a property, compensation for compulsory purchase is required and where local taxing is concerned, a valuation for rating purposes would be necessary (Millington, 2013).

Depending on the reason of the valuation, there may be an array of difference in values of a property, it should be kept in mind that there would only be a single market price, which means when a property is offered for sale in open market, it would change hands.

2.3. Three Approaches to Hotel Valuation 2.3.1. Sale Comparison Approach

The simplest and the most reliable method is the sale comparison approach. Where possible, it is preferred to other 'traditional' methods or it is used together with the investment method, if the final value is not available as a result of comparison. A comparison can be made between a property to be valued and other identical properties that are currently on the market or have been the object of recent processes (Blackledge, 2016). The Sale Comparison Approach used the recent price for a similar property, without taking the replacement costs or profits into consideration.

The three main requirements of the property comparison are: 1. The comparison property is of similar type to the subject; and 2. The comparison property is in a similar location; and

3. The evidence obtained is recent and reflects current market conditions.

The current conditions of the market occurs for this method, however it is crucial to compare two hotel properties regarding to similar category, number of rooms, room pricing and location (Mitchell & Ingram, 2002). Hotel investors do not necessarily use this approach to reach final purchasing decisions while they

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14 are interested in the information contained in the sale comparison approach, which has been also discussed later on the research. Factors such as the lack of recent sales data, the number of unsupported adjustments required, and the overall financial constraints of comparable transactions and the overall inability to identify human motivations make the results of this technique doubtful. To provide a range of values specified by previous sales and set in the creation of an indicator of the pricing momentum, the most effective method is sales comparison approach. However, beyond this wide range of parameters, relying on this method is rarely justified by the quality of the sales data. Market-based capitalization rates used by appraisers are sensitive to the same flaws in the sales comparison approach (Rushmore & DeRoos, 1999).

2.3.2. Cost Approach

The cost approach provides a physically directed value estimate, focusing on changing the asset with less appropriation for cost rebuilding devaluation (Jackson, 2008).

When there is no market, this approach is used on properties. It is also used when there is no direct evidence of the market or that it will generate nil or deficient profits for a potential occupant, thus hindering the use of comparison or profit evaluation methods. These types of properties usually are dependent on their size, design or plan and / or settlement in specific geographical areas for appropriate reason. The cost approach is principally used in asset valuation for the appraisal of uncommon properties such as specially designed industrial and public utility buildings or those used in for rating purposes. While the contractor's work is sometimes known as the past test of the contractor, it is the method that used in rating the valuation (Blackledge, 2016).

In cost method, the market value of the raw land will be determined by the valuer by comparing similar land values, which have proper alternative use. In addition to this value, the cost of rebuilding a new building, which will fulfill the function of the existing build, is added after the existing build has been adjusted in terms of aging and depreciation according to the new hypothetical unit. Accordingly, the three main elements of the cost approach are as follows (TAQEEM Academy, 2016):

a. Land Value: When determining the market value of the raw land, one must consider the restrictions, if any, as determined by the existing improvements or the Existing Usage Value (EUV). (i) If there is a sufficient number of comparable precedents, use market evidence.

(ii) Consider how the local planning agreement might be settled and use the market evidence for the use of planning.

(iii) Consider a site in the same area with similar features.

(iv) Consider the use of the particular area in a different location.

b. Building Value: It is assumed that the building value is the construction cost, contractor’s profit margin, the building’s new or net replacement, which is the cost of building the same building today, and the cost of allowing for restrictions, obsolescence and surplus. Briefly, it means removing the depreciation

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15 from existing construction cost. A cost estimation for a property may be based on an estimate of either rebuild or replacement cost. (See paragraph 2.3.1.1 and 2.3.1.2)

c.

Depreciation (Amortization): If an improvement has a lower value than the cost of replacement or reproduction, depreciation occurs. There are three types of depreciation or obsolescence: physical, functional and economical.

In general, these are the three essential methods of the cost approach (IVSC, 2016).

2.3.1.1. Replacement Cost Method: In general, the replacement cost is the cost associated with determining the price a market participant will pay based on multiplication of the benefit of the asset, not the full physical properties of the asset. Usually the replacement cost is set for physical deterioration and all the related obsolete formats. After these adjustments, this can be called the replacement cost subject to depreciation. The basic steps in the replacement cost method are:

- To calculate all the costs that would be incurred by a typical market participant to create an asset of equivalent benefit,

- Determining whether there is a removal from any use related to physical, functional and external aging related to the subject,

and

- deduction of total depreciation from total costs to achieve the value of the subject asset.

Replacement cost is generally the cost of a modern equivalent property that is constructed using an existing design and available cost-effective materials and techniques that provide similar functionality and equivalent utility to the equivalent asset.

2.3.1.2. Reproduction Cost Method: Reproduction costs are eligible in the following situations:

- When the cost of a modern equivalent is greater than the cost of recreating a copy of that particular asset, or

- When the benefit is offered by the entity. In other words, when the benefit can only be achieved by a multiplicative replication from a modern equivalent.

The only step in the reproduction cost method is to calculate all costs that would be incurred by a typical market participant wanting to make a precise copy of that asset.

2.3.1.3. Summation Method: The summation method is generally used for investment companies or other assets where the value is mainly a factor of the values of the assets. The basic steps in the summation method are:

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16 - Following appropriate valuation approaches and methods for each component asset, which is a part of the subject, and

- Bringing together the value of the component assets to achieve the value of the subject asset.

These methods emphasize the reduction of costs, without reflecting income-related evaluations and overlook the value of the hotel in terms of ownership and operation (Lesser, 1992). Also it is necessary to have a number of subjective and disputable reduction estimates (Sikich, 1995).

Regarding these three cost approach methods:

While it becomes difficult to measure the loss in value precisely as buildings and improvements begin to decay and grow older, the cost approach may grant a convincing estimate of value on newly build properties. Although hotel buyers mostly consider economic factors such as estimated net income and return on investment before buying the property (Rushmore & DeRoos, 1999), it is usually given little weight in the hotel valuation (Lesser, 1992). It is, however, useful in establishing a criterion for procurement decisions and time-relative pricing (Rushmore & DeRoos, 1999).

2.3.3. Income Capitalization Approach

The income capitalization approach helps to make the cost relatively simple by trying to relate the value of the hotel to its wealth creating capacity and goes beyond cost and sales comparison approaches (BODLENDER, 1985).

Transforming the expected future benefits derived from property ownership into a value proposition through an activation process that translates the expected future income and / or returns into an existing value estimate are involved in the income capitalization approach (Reynolds, 2011). In other words, “the present worth of future benefits.” Future benefits of revenue generating properties, such as hotels, are the net estimated by revenue and expense estimates, along with expected revenues for future sales (Rushmore & DeRoos, 1999).

Country-wide experience shows that the procedures used to estimate market value with the income capitalization approach are in fact comparable to those used by market and hotel investors. For this reason, the income capitalization approach yields the most supportable value estimate and is usually given the greatest weight in the hotel valuation process (Rushmore & Rubin, 1984).

Additionally, income capitalization valuation approaches are debatable in terms of maximizing shareholder value, reflecting the behavior of the investor in risk protection (Koller, Goedhart, & Wessels, 2010). The economic substance is always the same for any capital investment from the purchase of a machine to the purchase of a company. In any case, there is a current expenditure foreseeing future cash flows (Eubanks, 1991; Rappaport, 1981). For this reason, income capitalization works by valuing the income or wealth of the hotel (Akalu, 2001).

Therefore, this approach involves procedures comparable to hotel investors in the market (MacDonald, 1998; Sikich, 1995) and is generally considered the most appropriate method for determining hotel

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17 valuations (Human, 1996; MacDonald, 1998; Mellen & Castro, 1994; Menorca, 1993; Rushmore, 1990; Sikich, 1995).

The single capitalization rate methodology (SCR), discounted cash flow analysis (DCF), simultaneous valuation formula (SVF) and band of investment method (BIM) are the four essential methods of the income capitalization approach (Nilsson et al., 2002).

2.3.3.1. Single Capitalization Rate (Direct Capitalization): The SCR is determined using a one-year net income and dividing by the "capitalization rate" (income multiplier) (Sayce, 1995) and it is based on the market, i.e. the capitalization rate of a hotel that has been sold in the recent time (Novelli & Procter, 1992). It is crucial to note that different years’ net incomes can be used, when using the capitalization rate from latest hotel transactions. Certain calculations may use the first-year forecast, the previous year, the previous 12-month record, or the estimated stable year net income; each of which can result in different capitalization rates. For instance, a price can easily reflect a 5 per cent capitalization rate in the net income of the previous year; but 9 per cent predicts net income for the first year (Human, 1996). Moreover, the composite nature of hotels has to be taken into account in order to make appropriate adjustments to differences in age, use, location and occupancy level (Accetta, 1998; Martin, 1993) which has been also discussed later on the research.

2.3.3.2. Discounted Cash Flow: The SCR method is based mainly on current performance, with little or no effect on future net income (except in the determination of the capitalization rate), and DCF analysis is calculated using future net income estimates. This method is calculated on an unfunded basis and generally uses a 10-year projection of net income to be deducted from net present value using a discount rate and a terminal or residual value. Considering the income of the future, the DCF analysis adds accountability, especially if it is likely that the projected profitability of the investment, which is of considerable interest to the investor, will change significantly, especially over the years (Nilsson et al., 2002).

DCF is ideal to use when future projected revenue does not reflect current revenue and is subject to future income variables. This is typical for the hotels, as they are very sensitive to both micro and macroeconomic factors, they often have diverse sources of income. The DCF requires the valuer to make estimates for a predefined period of time, generally between 5 and 10 years, of revenue and expenses. Each year's cash flow is then deducted from the effective date and combined with a final savings value that is free of transaction costs that may arise. Correct application of DCF requires not only a general rate of capitalization for the terminal value of the property, but also an appropriate discount rate based on the investors’ expectations on return on investment and the investment’s riskiness and the amount of transaction costs to be included (Luehrman, 1997; Rushmore, 1992). Industry norms and existing financial information are part of the data analysis needed to accurately predict future income based on room revenues, growth and occupancy rate and other revenues and also expenses such as departmental, undistributed, fixed and short and long term renovation costs with considering sustainable FF&E (fixture, furniture and equipment) and all movements in working capital and tax payments (Jones, 1982; Karadeniz, Kandir, & Önal, 2009; Pike & Neale, 2006; Reynolds, 2011). However, while estimating future projection of revenues, risk factors also should be taken into consideration such as establishment

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18 of rival hotels, separation of successful management team, floating revenues and tourism crisis (Karadeniz et al., 2009).

2.3.3.3. Simultaneous Valuation Formula: The SVF method is, in principle, similar to the DCF analysis approach; this method brings the multi-year net income stream to the assessed market value. However, the biggest difference between the two methods is the reduction of the SVF through a mortgage-equity technique that takes into account factors such as interest rate, depreciation period and debt / value ratio, rather than using a common discounting procedure for presentation (Mellen & Castro, 1994; Rushmore, 1979, 1990; Rushmore & Rubin, 1984). Both of these methods can be called "income-based" methods, while they tend to concentrate on generating future income. In addition, the SVF method emphasizes the market and can therefore be expressed as a "market-derived" method.

2.3.3.4. Band Of Investment Method: The band of investment method is predominantly concerned with the weighted average cost of capital and a one-year stabilized net income (Mellen & Castro, 1994; Rushmore, 1979, 1990, 1992; Rushmore & Rubin, 1984; Sikich, 1995). One-year stable income can be defined as "a stable level of income that will remain stable and extend the economic life of the property" (Rushmore, 1992b,).

Through these methods, single capitalization rate and discounted cash flow (DCF) model are commonly applied on hotel valuation.

2.4. Advantages and Disadvantages of Three Approaches

Besides the advantages and disadvantages of three approaches which mentioned before, they are examined in upper scale as well. The following information, in the table 1, are extracted from (Almy, 2014; AM Corp, 2017; Manitoba REA, 2012; Stephen, 2016; TAQEEM Academy, 2016).

Table 1- Advantages & Disadvantages of Three Valuation Approaches

Advantages Disadvantages Co st Ap pr oa ch

- For new construction uniquely instructive based on contractor’s line item lists of costs for labors and materials and indirect costs.

- Appropriate for use where the subject property is a special use building such as oil refinery, museum or church.

- Easy to comprehend as it separates the land value, building value as well as any improvements or additional works that are available.

- Appropriate to determine minimum value

- Not reflecting the forces of supply and demand - Not appropriate for building with high depreciation

degree

- Assuming building cost equals building value

- Not taking consideration the developer’s profit and risk

- Difficulty of assuming the construction period in specialized buildings – backdating the cost and inconsistent with the date of valuation for the land.

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19 Sa le C om pa ris on A pp ro ac

h - Reflecting market behavior.

- widely used and understood.

- Requiring least adjustment if sufficient data is available.

- With inadequate data impossible to apply.

- Adjustments must be made – no two properties are ever identical.

- Sales are always historical.

- Accuracy of the method depends upon the valuer's ability to recognize differences, and to make the proper adjustments.

- Difficulty of confirmation circumstances surrounding a sale. In co m e A pp ro ac h

- Applicable in estimating the value of income producing or investment properties

- More flexible in addressing assets in different stages of their life-cycle.

- Factoring in varying operating conditions over the projected period.

- Being able to provide to the differing investment or ownership needs of the buyer and seller by measuring risks through its discount and/or capitalization rate

- Simulating a market price even if there is no active market

- Not as subject to market fluctuations – because it’s long term

- Dependency on the assumptions on the forecasts which can be subjective

- Sensitivity to growth, discount and capitalization rate that cause a big change in the estimated value - Difficulty of determination of projection risks, lack of

liquidity risks and other company-specific risks. - Difficulty of assumption the income and operating

expenses.

2.5. Stakeholders’ Perspective

An authorizing party, person, or group of persons, who own a hotel asset are the main stakeholder of a valuation. This can broadly be categorized into two sectors: Private sector which are industrial and commercial companies, property companies, property developers and construction companies, REITs and publicly – traded company; public sector that are local authorities, public authorities, central government departments and agencies & charities. The outcome of the valuation determines the value of the asset for the issuer, and the second stakeholder is the valuer. Valuers are assigned by the buyer or the seller of the hotel property to perform a valuation. However, there is usually a third stakeholder as the lending institutions that banks, factoring companies, leasing companies, asset management companies and financing companies. This stakeholder group bases the financing decision on the valuation of the hotel, usually in financing the buyer. These three groups are the main focus of this work because they represent the main stakeholders of an open market value related to the ownership of a hotel property (Verginis & Stephen Taylor, 2004).

Subjective behavior that leads to a systematic error in the valuation of real estate is of particular importance for real estate investors, managers and lenders. Investors need accurate and objective estimates of market values of real estate portfolios. These are to make appropriate decisions about the balance in general mixed asset portfolios between real estate and securities (such as stocks and bonds). Potential valuation bias is also important for professional real estate investment managers operating revenue-generating real estate funds (or "open-end" commingled real estate fund (CREFs)) where

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20 investors are allowed to "buy" and "cash out" based on their current valuation value of the portfolio. Mortgage Lenders have to know the “true” loan-to-value ratio that supports the loans (Hansz & Diaz III, 2001).

An appraisal is a systematic application of behavioral research in which the appraiser tries to adapt the decisions of market participants and property qualities strives into a market context (Nichiforeanu, 2017). The outcomes of property appraisal are not always accurately reflected the market value of real estate. This is crucial for institutional investors who depend on these periodic valuations for benchmark purposes, annual accounts, fund entry and outflow, and asset sales decision. With changing the valuer on these property portfolio valuations has a serious effect on the assessment of capital value (van der Werf, 2016). Property studies are mostly based on the regular expectations of the prevailing economics: rational decision makers with reliable preferences, excellent competitors, accessible knowledge and homogeneous products. The practices of property professionals are usually based on these expectations (Ohman, Söderberg, & Westerdahl, 2013).

Investors are looking for ways to increase their returns by targeting alternative investment instruments to capitalize on international capital flows in emerging markets. most real estate businesses have limited experience and do not have information about buying or selling real estate. (Worzala, Sirmans, & Zietz, 2000) survey the risk / return assumptions of pension funds and fund managers of large insurance companies on different investment alternatives, including REITs. The survey results show that both investors have low risk / high returns for known asset classes. Both investor classes are less familiar with real estate investments and deliver higher risk / lower expected returns. Behavioral financing documents are negatively associated with experience and over-confidence, so if investors gain more experience, assurance get fewer (Gervais & Odean, 2001).

Debt and equity providers theoretically have limited tolerance for income falling below the required levels of payment, as the use of real estate is not liquid and changes to local and national economic strengths: lenders and equity investors have significant implications for both debtor and investor it has to be found. The risk of payment of an asset discount or accrual received as a measure to characterize the failure of contract conditions or changes in the original investment thesis (Hott, 2011). For this reason, capital availability varies similarly with the demand for the occupation: when demand is high, and supply is low, more lenders are willing to commit capital in larger quantities; when demand is low, and supply is high, more lenders become motivated to quit their real estate loans and assets and retire to other, more liquid investment classes. This capital "faucet" quickly revolves from a high capital asset to a very limited capital asset severely, as the majority of variable demand in the commercial market remains stable during the fluctuating market cycle, and the stability in the stock market can have deteriorating effects. Businesses that need to grow or relocate downstairs are severely constrained by their ability to find sufficient development partners with sufficient capital availability and borrowing capacity (World Economic Forum, 2016).

According to the results, the banking sector may be exposed to an important property market risk, a financial crisis or a sovereign crisis. Regarding the analysis of depreciated real estate markets, another hypothesis suggested that banking sectors were more vulnerable to property price increases than to

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21 property price decreases (Bracke, 2015). Now, lenders do not like to take risks and get assured themselves first. Before deciding on what to do or not to finance your project, they look at you as an individual, your ability to repay the loan, and finally the development itself. In other words, the banks do not lend only on the basis of the security of the project; they also want to establish records of the people behind the development (Yardney, 2018).

(Rushmore, 1993; Smolen & Hambleton, 1997) reported the prevalence of customer pressures. (Roberts & Roberts, 1991) suggested that customer influences could represent the most common cause of valuation judgment variation. (Kinnard, Lenk, & Worzala, 1997) have identified the true evidence of customer influences. In an experiment presented by the survey, expert valuation specialists showed that they were willing to pay the reported value judgments to meet large customers. Through a series of intensive discussions of expert New Zealand valuers, (Levy & Schuck, 1999) stated that expert value decisions were influenced by customers and that the extent of influence changed according to the type of customer and the purpose of valuation.

The main issue is always the value of a property and how it is determined. This determination involves rational and unreasonable behavior, which implies an optimal strategic deviation to try to determine a true valuation. Special attention is paid to irrational behavior in property investment (Aliefendioglu, Tanrivermis, & Sengul, 2017). Given that the real estate market is an important part of the economy, and consumer confidence and spending are important determinants, understanding the key causes of stakeholders in the markets is particularly important (Beracha & Skiba, 2014). Apart from the different acceptance of stakeholders which are related to approaches and parameters, there are also other reasons that cause conflicts between stakeholders found from the field research.

2.6. Conceptual Model

The conceptual model is to define the core concepts and their (sub) aspects. It also shows the relevance of the research topic to the measurable and subject matter based on core concepts. The function of a conceptual model is to determine its relevance, research area and design (Saunders, 2009).

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22 Figure 1 - Conceptual Model (Source Author)

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23

3. OBJECTIVE AND RESEARCH QUESTIONS

To formulate the research objective, questions and sub-questions, literature review and theoretical background in chapter 2 are used as a base. The theoretical background has led to a conceptual model showing the relationship between the core concepts of the main questions. Sub-questions are formed based on these relations.

3.1. Objective

As mentioned previously, there is a conflict between stakeholders, while determining the value of city hotel. Although there are three approaches: sale comparison, cost and income capitalization approach, the aim of this research is determination of the most appropriate approach for city hotel valuation with considering stakeholders’ aspects and comparing city hotels valuation reports in Istanbul.

3.2. Main Research Questions and Sub-questions

Main Research Question 1 (M1) - What is the most suitable approach to provide the most realistic estimate for the city hotel valuation according to stakeholders?

Sub Research Question 1 (S1.1)- What are the requirement/criteria/demands for the most suitable approach?

Sub Research Question 2 (S1.2) – What are the variables to consider when determining the capitalization rate, which is the most important factor in implementing the income approach?

Sub Research Question 3 (S1.3) - What are the advantages and disadvantages of income capitalization approach according to stakeholders?

Main Research Question 2 (M2) - Do different stakeholders have different points of view for city hotel valuation methods in Istanbul?

Sub Research Question 1 (S2.1) – Which valuation methods do different stakeholders prefer?

Sub Research Question 2 (S2.2) - What are the reasons that lenders prefer certain valuation methods? Sub Research Question 3 (S2.3) - What are the reasons that owners prefer certain valuation methods? Sub Research Question 4 (S2.4) - What are the reasons that appraisal companies prefer certain valuation methods?

Sub Research Question 5(S2.5) – What are the other reasons for conflicts between stakeholders?

Figure 2 illustrates the research framework for this research that based on the literature review and the connection between the main questions and sub-questions.

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24 Figure 2 - Research Framework (Source Author)

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25

4. RESEARCH METHODS

This chapter explains in which way data is collected and analyzed during this study. 4.1. Research Strategy

This study is based on qualitative research in the form of a single case study.

Case study research is seen by some commentators as the most appropriate design for the first preliminary research, which is often of a qualitative nature. Case studies are often regarded as valuable to assist in the development of a qualified theory, view and theory for the in-depth examination of a subject in a specific context, but are generally not seen as a means of testing existing theories (Brotherton, 2015). In addition, case studies are often used to answer "why" questions (Baxter & Jack, 2008), because sub-questions of the second main question concern stakeholders in choosing different valuation methods. A case study contains research within one organization, or a group of organizations in which a phenomenon is researched within its real life context (Saunders, 2009). In this research, the case study includes a number of city hotel valuation reports to recognize the viewpoints and acceptance of stakeholders in the valuation process, approving the relevant authority in Istanbul.

There are several classifications in a case study. This study is a case study, which has descriptive qualities and aims to add realism and in-depth examples to other information (Baskarada, 2014). (Dyer Jr and Wilkins, 1991) writes that when a researcher wants to create a high-quality theory, the single case studies are better because it produces such extra and better theories. It also reveals that the researcher has a deeper understanding of a subject that is exploring. Accordingly, it is to be trusted in its representation, but fewer periods of observation, single case studies, may well define the existence of events. According to (Yin, 2003), it is better to conduct a single case study if one wants to work on a researcher or a group of people. In addition, the researcher may question an old theoretical relationship and discover innovations when a single case study is used. This is due to a fact that more careful study is made in accordance with (Dyer Jr & Wilkins, 1991).

In addition, the design phase focuses on describing the analysis unit and probable cases to be studied, cultivating the theory / proposal, identifying the underlying problems of the projected work, defining the case study design (single, multiple, holistic, embedded) and preserving the quality of the case study (Yin, 2009).

(Yin, 2003) also explains that a single case study can be done with entrenched units if the investigator wants to investigate the case through data analysis, between case analysis, and cross-analysis. If the researcher wants to gain the ability to explore subunits within bigger cases, then a single case study with entrenched units may be chosen. In this study, single case study with embedded units was chosen instead of multiple case studies because deeply analysis was needed to examine different valuation methods as a case in approved hotel valuation reports and interviews with different stakeholders in Istanbul, in order to find differences and/or similarities between them.

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26 The method of the case study should be in line with the latent research paradigm; e.g., positivist/post positivist, interpretive, and critical/postmodern (Gephart, 2004). For case study research critical realism has been advocated as the preferred paradigm (Easton, 2010).

Figure 3 - Basic Types of Designs for Case Studies (Source: COSMOS Corporation)

Furthermore, this study was not first that uses case study research in hotel valuation field. Some of them can be found as following;

- (Fu, Sheel, & Lang, 2013) analyzed fourteen randomly selected hotel firms in their paper named “A Reexamination Of Current Hotel Valuation Techniques – Which Approach Is More

Realistic?” by using nine valuation methods.

- (Chen & Kim, 2010) studied seven valuation techniques to appraise Huatian Hotel as a case study in their research “Hotel Valuation in China – A case study of a State-Owned Hotel”.

- (Boldyreva, 2012) studied four valuation methods for the assessment of market value of case study in the thesis named “Hotel Development Project Valuation Techniques: Case study of the Hotel development project”.

Obviously, case study was most suitable research to compare different hotels and apply different hotel valuation methods in same hotel as a case.

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27 4.2. Data Collection Techniques

This study is based upon a multi-method of qualitative researches, i.e., for only qualitative research, more than one data collection technique was used (Saunders, 2009). In a case study, it is prevalent to use multiple data collection techniques and this study includes two kinds of qualitative data collection: desk research and interviews.

Interviews

Information was obtained through semi-structured interviews; this means that the topics of the interview have already been settled, but the order in question is not important. In addition, semi-structured interviews let the participant to add data during the interview. The reason behind choosing the semi-structured interviews are that these type of interviews are more flexible and it allows the investigator to have a better understanding of the perspective of the participants, which is important in a relatively new study (Baskarada, 2014). More detailed information about the selection criteria of participants is in paragraph 4.4.2.

The subjects of the interview were general aspects of city hotel valuation, types of hotel valuation approaches, differences between them and key points for more efficient valuation methods and stakeholders’ aspects about approaches and conflicts between them. The core themes of the interviews are already shown in the interview guide and translated in questions (Appendix B).

Desk Research

This study also contained desk research in the form of different valuation approaches and analyzing different income capitalization methods and other relevant documents and market reports. Examples of these documents were that similar previous researches were analyzed which studied different valuation methods on same hotel property with comparing results according to each method. In addition, approved appraisal reports from different hotel properties, which were prepared for different purposes were analyzed and compared their accepted methods for appraised value with each other as a case study. The desk research was seen as an added value to the information provided by the interviews. Furthermore, literature was used to formulate sub-questions.

4.3. Operationalization

Operationalization can be defined as specifying concrete representations of concepts (Saunders, 2009). For this research, concepts are defined as stakeholders’ point of view and valuation approaches & methods. In order to illustrate the links of the research parts, the research questions and sub-questions are developed, and three tree diagrams are created.

First tree diagram is general concept of valuation in which the real estate types are elaborated until the ‘city hotels’ focus of this study in figure 5.

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28 In figure 6, second tree diagram is illustrated that is related to valuation approach. As mentioned in chapter 2 there are three different valuation approaches which are used in hotel valuation.

In third tree diagram, which is shown in figure 7, stakeholders are more elaborated according to their valuation purpose perspective.

Figure 4 - General Tree Diagram of Real Estate Valuation

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29 Figure 6 – Stakeholders’ Tree Diagram

Under the light of first three tree diagrams, core concepts were determined, and fourth diagram was created which based on literature and field research. According to core concepts which are general aspects of city hotel valuation, valuation approaches and stakeholders’ aspects, not only theoretical perspective of city hotel valuation was analyzed, but also determination of valuation methods according to purpose of valuation, implementation conditions of valuation approaches and their pros and cons in current market situation and stakeholders’ opinion and the reasons of conflicts were scrutinized (Appendix C).

4.4. Sampling

Choosing the right sample in a qualitative research is about collecting certain cases. The goal is to find ways to improve existing knowledge in the literature. In a case study, sampling is often used to provide a deeper understanding of the phenomenon and, therefore, a non-random or unqualified sampling type is often used in case studies. Such an example does not represent the total population but is chosen to be relevant to the research topic. Such an example does not represent the total population, but is chosen to be relevant to the research topic (Ishak & Bakar, 2014; Saunders, 2009).

There are different case selection techniques in this non-random sampling. Purposive sampling technique has been used for this research. Purposive sampling (also known as judgement, selective, or subjective sampling) is a sampling technique based on the researcher's own decision to choose population members to participate in the study. In such a sample, the researcher chooses cases for a specific

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30 purpose (Black, 2009). For this research that specific purpose is finding most suitable valuation methods for city hotels with considering stakeholders’ aspects.

Two kinds of sampling included to this study: the case selection and the participants of the interview selection.

4.4.1. The Case Selection

Istanbul has a great cultural background from the past up to the present. According to analysis of 45 European cities and the fastest growing city in terms of overnight stays and growth in bed capacity, Istanbul city leads the cluster 1 cities (Russo, 2015).

Approximately one-third of Turkey's tourism activities taking place in Istanbul. The greatest city in the country endures the foreign travel market more than almost all other global cities in the world. Expenditures from abroad come from 91.2% of tourism revenues - since mid-2006. The share of travel and tourism in employment is greater than that of Europe's GDP. In contrast, Istanbul's contribution is 2.1% of total city employment - significantly less than its share in GDP. Labor productivity in the travel and tourism sector, in Istanbul and Turkey are higher than for all other sectors.

On the other hand, Turkey’s Travel and Tourism has suffered from political unrest and security concerns, and this is the relative contribution of Travel & Tourism to GDP between 2006 and 2016 the city was also reflected in Istanbul, where it dropped by approx. 3 points. it is predicted that Istanbul will be the fastest growing European city in the next decade at 8.6% (WTTC, 2017).

In this research chosen valuation approaches and methods in city hotel valuation were compared in Istanbul based on the 21 approved city hotel valuation report. Hotels were chosen according to their location, stars/category and number of rooms (bed capacity) that have effect on value of hotel. Then, approved appraisal reports of these hotel properties were analyzed according to their preparation purpose and for whom, compared and determined their valuation method(s) that was used to reach the final market value. Analysis method of these valuation reports is explained in paragraph 4.5.

4.4.2. The Participants of The Interview Selection

Sampling strategy of the participants of the interview was as follows: Since the total population of the experts whose profession is the city hotel valuation is not known by the statistics, it was non-probability sampling. For this reason, depending upon selection criteria, self-selection sampling was used.

The selection criteria of experts, for the interviews were based on some criteria. The first one was the position of the participant and more than five years experiences within the field of city hotel valuation. The participants from lender (bank) and appraisal company side of stakeholders must have the CMBT (Capital Markets Board of Turkey) real estate valuation expertise license and/or RICS membership. It was arranged that three interviews with owner (investor) side, three interviews with lender (bank) side and four interviews with appraisal company side in Istanbul.

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31 4.5. Data Analysis

It is important to make clear the unit of analysis, while analyzing the obtained data. The unit of analysis defines the content of the case, like an event, a process, an individual, a group, or an organization (Baxter & Jack, 2008). In this case, a process, for example city hotel valuation, is analyzed in the appraisal reports.

Two types of analysis methods, open coding and axial coding, were used in the analysis section of this study. Open coding summarizes the interview transcript data and every section of the data gets a unique label, a code that includes short description of the message. Open coding results was gathered in a code book. Axial coding was performed after open coding. The relationships in the code book constitute axial coding. This approach causes the classification of information in the interview transcript (Saunders, 2009) to compare and to find differences or similarities of cases.

To sum up, the analysis of the data contains the following steps (Baxter & Jack, 2008): 1. Making transcripts of the interviews;  

2. Dividing interview transcripts into little fragments;   3. Labeling each fragment with a code;  

4. Grouping codes, resulting in a code book;   5. Looking for relationships;  

6. Compare cases.  

For data analysis, these approaches focused mainly on an interview transcript. However, these approaches were also applied to case study and documents obtained through a desk research.

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5. RESULTS

This chapter shows and analyzes the data gathered in chapter 4 based on the conceptual model and the literature as described in chapter 2. Out of the interviews some new topics were added to main the tree diagram (Appendix C). The outcomes of this research were critically compared with the literature. According to open coding based on desk research, core concepts were created that are general aspects of city hotel valuation, valuation approaches and stakeholders’ aspects. Under these topics, details were discussed according to axial coding of the literature and field research (Appendix D). Additionally, all labels were analyzed vertically according to stakeholders’ answers (Appendix E). Furthermore, approved hotel valuation reports were compared as a case study in Istanbul (Appendix F). Lastly, according to outcomes of the interviews and case study, research questions were answered.

Figure 7- Core Concepts of Research

5.1. General Aspects of City Hotel Valuation

During interviews, questions were asked to acquire data about general aspects of city hotel valuation which includes differences of city hotels from other real estate, purpose of city hotel valuation and determination of valuation methods. The main focus of this topic was to determine whether the valuation method has changed according to the purpose of valuation and property type.