(14-03-2015, 10:37 AM)johnnydash Wrote: [ -> ]The context is important. If I am a buyer, I can use a cap rate and noi any way I like as long as the method reflects my willingness to pay for something. Like I said if you use your non conventional type of noi to arrive at a figure of about 200 plus million, that is what you are willing to pay for the hotel. But then, thats a very strange way to determine how much you are willing to pay for a hotel. I can assure you that there are other ways in which investors use to determine how much they should pay for a hotel to get their required rate of return.
If you want market value, you must know the basis on which the cap rate was derived. Cap rate is an estimation of the yield/required return that investors on the whole demand on an asset class. So transactions were done (in which buyers have their own financial models), and post-transactions, analysts impute NOI, and transaction value to calculate the cap rate, which is an estimation of the required return of investors. The analysts may then use the derived cap rate, and NOI of a comparable hotel, to estimate what is the likely price at which this hotel will sell for in the market: - the market value.
Now the derived cap rate was based on a certain methodology(formula for NOI). So he cant use any other form of NOI that he wants in the subsequent calculations. The formula of the NOI used must be the same as that from the derived cap rate.
In general agreement with your latter points but the basis must be that there must be an open mind, a receptivity to ideas and a willingness to change one's mind when faced with new information. And perhaps underlying all this is an unbiased basis on which to form judgement.
We are here to learn, but we strive towards the truth, or correctness, and distinguish between right or wrong. Some things are fundamentally wrong, some things fall within the grey area. For instance what is fundamentally wrong will be an analyst who use his own unique iteration of NOI to calculate market value of a property. What is grey area is an analyst who decide to use a higher than industry cap rate to estimate market value of a particular hotel because he thinks that this particular hotel suffers from some shortcomings that will result in the hotel being less attractive than the "average" industry hotels to potential buyers.
When in doubt, it is always a good idea to go back to the basic - and this is how I understand it from the basic principle.
Assume:
H1 = Hotel 1
H2 = Hotel 2
H1 and H2 are comparable hotels in the same vicinity.
H1 was recently sold for a sales price of k
Cap Rate (H1) = NOI(H1) / k => representative of market cap rate of comparable properties
MV(H2) = Market Value of Hotel 2
MCR (H2) = Market Cap rate of H2 = market cap rate = Cap Rate (H1), assumed so, since both are comparable properties
MV(H2) = NOI (H2) / Market Cap Rate (H1) = k x NOI(H2) / NOI(H1)
Value is a concept.
Cap Rate is conceptualized to measure Market Value (MV) and not Target Value (TV) or Target Price (TP)
If we try to make a market value estimate of hotel 2 using market cap rate derived from the transaction of hotel 1, it can be seen that basically
MV(H2) = K x NOI(H2) / NOI(H1)
Essentially, the market only provided k (the actual transaction price - a constant) – meaning, market value estimate actually boils down to NOI estimate – hence, the accuracy of market value estimate is entirely dependent on the accuracy of NOI estimate.
In reality, NOI may not be readily available - analysts, appraisers, investors may have to derive it from the financial statements of the sellers - hence different analysts may end up with different NOI estimate.
Since there are different definition or version of NOI (such as before or after adjustment for maintenance capex; trailing or future NOI; projected stabilized NOI etc), one would get different cap rate estimate and hence different market value estimate based on different version of NOI inputs.
Hence, we could have
NOI(A) = NOI after maintenance capex has been deducted => Method A
NOI(B) = NOI before maintenance capex has been deducted => method B
NOI© =……………………………etc
Regardless of which definition/version of NOI is being used, IMO, all are conceptually correct - the key is consistency in its application and no mismatching of different version of NOI
Who knows as to which version of NOI or method is more robust and would give a better and reliable market cap rate estimate (and hence market value estimate) – but as the number of comparable transaction increases, and the number of analysts increases, a range of estimate would be resulted from them.
The fact that two analysts (using same or different method) could arrive at estimates which could differ significantly doesn’t mean that the analyst with the lower estimate is trying to do a target price estimate instead – in fact both are trying to measure market value.
Target value or target price estimate is a totally different ball game all together, when financing, tax, investment holding period, expected return, risk appetite - all of which are unique to each investor are taken into consideration.
Direct Capitalization of NOI is one of the many tools for performing market value estimate and should not be used as the only sole tool.
Yes, cap rate could be used to compare return on investment (cash on cash return) between different asset class but which method (A or B) offers a better measure? Method-a, IMO.
My estimate of 200 over million may be on the low end of the range but it was never meant to be a target value estimate - it is not my final estimate - until further value estimate with other method has been carried out - it only remains as a rough estimate.
I don’t think there is anything magical about cap rate computation – the basic building block is still centred on the fundamental relationship of cap rate = NOI / Value
Can one deviate from it?
(not vested)