Hotel Ownership Accounting: Cash Flow from Operations. And Real-Estate Value.

[Laxputs]

1. When valuing a company that owns a series of hotels, can one consider the OCF to closely equal FCF? If the useful life of the asset, the hotel, is several decades (greater than 60 years?), can depreciation be seen as a non-maintenance capex item? And given that general upkeep is already expensed, OCF equals FCF?

 

I noticed that for a shipping company this was the case if the asset, the ships, were to be seen as being run until they couldn't be used anymore and then not replaced. Seems like if an asset has an extremely long useful life (hotel has a longer life than a ship), one could just disregard depreciation on the Income Statement?

 

2. Is the land on the balance sheet where a hotel resides, valued on the generation of its cash flows (i.e. if the hotel is earning a pittance as compared to the value of the land, the land could be a hidden asset)? Or is the land valued based on current market value of the real-estate given location and similar values, etc.?

 

TIA

[Laxputs]

3 hours later.. going to go ahead and answer my questions... correct me if I'm wrong.

 

1. Seems like hotel companies report non-GAAP figures like FFO (funds from operations) (and adjusted funds from operations). The main difference between these figures and Net Income is the lack of building depreciation. This suggests to me that a person could look at cash flow from operations as nearly FCF.

 

2. This was in the 10-K of a company I've been looking at:

 

"The useful life of each property is evaluated annually based on certain factors including construction materials used,

location, condition of the property and the particular capital maintenance program and requirements of the property.

The only exception is land which has an unlimited useful life; therefore, it is not depreciated."

 

So it seems like land is always being reappraised but that the asset could still be "hidden" if it is small enough in relation to total assets and the cash flows derived from that property are under performing a reasonable capitalized rate.

 

I could be off on these.

 

 

 

[peter1234]

It might be helpful to read up on Guy Gottfried as he understands real estate.

 

He talks about hotel valuation in the latest Graham and Dooodsville.

 

Also discussed the same stock at the Sep 2014 Value Investors Congress.

 

;)

[bizaro86]

In the medium term I think depreciation can be ignored for cash flow, but it eventually catches up with an asset. If you were taking a very long view (which may not be necessary) you should include some sort of estimate, as large building wide renovations probably end up getting capitalized, even though they're necessary to keep the asset productive.

 

As an example, KingSett and Innvest just bought the Fairmont Royal York in Toronto. The property is in the midst of a $100 MM upgrade, and the new owners are planning on doing an additional $50MM upgrade. The property has ~1300 rooms, so they are doing about $115k per room in renos, which is signicant. Granted the hotel is extremely old.

 

On the other hand, the implied valuation of the hotel from the deal is only $186 million AFTER the previous owner put in a $100MM reno. And the hotel sits on extremely valuable land right across the street from Union Station. So the renovation is an extremely large portion of the value of the hotel building, suggesting that depreciating the previous building to very close to zero would have been economically accurate.

 

http://www.thestar.com/business/2014/10/28/royal_york_sells_for_186_million.html

[tede02]

I always understood that some real estate was carried on the balance sheet of corporations at cost.  I recall Seth Klarman talking about this as something that investors need to understand because of the potential for an asset that may be far understated on the balance sheet.  I'm trying to remember the context of the discussion.  I think the classic cases are where companies have owned large tracks of land for decades. 

 

There were a few instances here in Minnesota that may be good case studies.  Back in 2008, the state purchased several thousand acres from US Steel in northern Minnesota to turn into a state park.  I believe the company had owned the land for many years.  Also, a Ford plant that had been in operation since the  1920s was closed in 2011.  The plant was right in a nice area of St. Paul along the Mississippi River.  I believe its now mostly been leveled and is being redeveloped.  Both of these properties surely had dramatically appreciated in value since they were purchased.  Not sure how they were carried on each respective company's balance sheet. 

[bizaro86]

I always understood that some real estate was carried on the balance sheet of corporations at cost.  I recall Seth Klarman talking about this as something that investors need to understand because of the potential for an asset that may be far understated on the balance sheet.  I'm trying to remember the context of the discussion.  I think the classic cases are where companies have owned large tracks of land for decades. 

 

There were a few instances here in Minnesota that may be good case studies.  Back in 2008, the state purchased several thousand acres from US Steel in northern Minnesota to turn into a state park.  I believe the company had owned the land for many years.  Also, a Ford plant that had been in operation since the  1920s was closed in 2011.  The plant was right in a nice area of St. Paul along the Mississippi River.  I believe its now mostly been leveled and is being redeveloped.  Both of these properties surely had dramatically appreciated in value since they were purchased.  Not sure how they were carried on each respective company's balance sheet.

 

Depends on the accounting standard used. For instance, Canadian REITs (and hotel companies) usually mark their real estate to fair value every year, as we switched over to IFRS from GAAP a few years ago.

[Tim Eriksen]

3 hours later.. going to go ahead and answer my questions... correct me if I'm wrong.

 

1. Seems like hotel companies report non-GAAP figures like FFO (funds from operations) (and adjusted funds from operations). The main difference between these figures and Net Income is the lack of building depreciation. This suggests to me that a person could look at cash flow from operations as nearly FCF.

 

2. This was in the 10-K of a company I've been looking at:

 

"The useful life of each property is evaluated annually based on certain factors including construction materials used,

location, condition of the property and the particular capital maintenance program and requirements of the property.

The only exception is land which has an unlimited useful life; therefore, it is not depreciated."

 

So it seems like land is always being reappraised but that the asset could still be "hidden" if it is small enough in relation to total assets and the cash flows derived from that property are under performing a reasonable capitalized rate.

 

I could be off on these.

 

1. Just because they report a certain way does not mean that OCF is equal to FCF.  On a given year it may be, but eventually major improvements (roof, room upgrades) will occur and will be capitalized.  When they do have major upgrades FCF is below OCF.  My view is more conservative than most and why I rarely buy a REIT, hotel company, or apartment owner. Returns are too low.

 

2. In the US the acquisition price is allocated between land and buildings at the time of purchase.  The land portion does not change over time.  The building portion is depreciated.  Thus over many years the asset may have a book value materially below market price.  I would be careful if the value is in the land as that is much more difficult to unlock. 

 

[Mephistopheles]

I always understood that some real estate was carried on the balance sheet of corporations at cost.  I recall Seth Klarman talking about this as something that investors need to understand because of the potential for an asset that may be far understated on the balance sheet.  I'm trying to remember the context of the discussion.  I think the classic cases are where companies have owned large tracks of land for decades. 

 

There were a few instances here in Minnesota that may be good case studies.  Back in 2008, the state purchased several thousand acres from US Steel in northern Minnesota to turn into a state park.  I believe the company had owned the land for many years.  Also, a Ford plant that had been in operation since the  1920s was closed in 2011.  The plant was right in a nice area of St. Paul along the Mississippi River.  I believe its now mostly been leveled and is being redeveloped.  Both of these properties surely had dramatically appreciated in value since they were purchased.  Not sure how they were carried on each respective company's balance sheet.

 

Depends on the accounting standard used. For instance, Canadian REITs (and hotel companies) usually mark their real estate to fair value every year, as we switched over to IFRS from GAAP a few years ago.

 

Did not know that. So when U.S. corporations finally adopt, a company like SHLD will have to mark their RE at FV? Interesting.

[Laxputs]

Is there a reasonable method to account for major hotel property investments that are not expensed but rather capitalized (roof repairs, major upgrades) when they occur, in relation to the Company's revenue or FFO?

 

I know AFFO account for cap-ex required to keep the earnings power of the asset, but it would be nice to have a method to calculate it on one's own.

[Laxputs]

And it seems to me AFFO does not equal FCF or Owners Earnings because it does not take into account major property expenditures like roof repairs or large scale renovations? Rather, it just takes into account "a reserve for replacement of FF&E". And I understand roof repairs, major renos do not fall under FF&E, correct?