Calculate Cap Rates Using Regression Analysis

(4-minute read)

Author: James Cornell

This article is based upon decades of work accomplished by Steve Rushmore, academics, and renowned hospitality appraisers (see endnotes for details).

Industry Magazines Frequently Publish Out-of-Date Cap Rates

Published Cap Rates (otherwise known as Capitalization Rates) are frequently outdated and incorrect because the cost of capital changes rapidly due to factors such as politics, fluctuating economic trends, and buyer/seller sentiment, among other determinants of capital costs. Recent sales activity provides a basis for calculating the Cap Rate, taking into account geographic location, class segments, and other relevant factors.

The primary reason overall property yield rates are frequently incorrect is that lender and investor yields are not factored into Cap Rate computations. Cap Rates must satisfy the expectations of both the lender and the investor.

Appraisers and brokers are often taught to calculate overall property yield without factoring in the returns lenders and investors require. Valuations computed with overall property yield rates are calculated as if the property were purchased “all cash.” The property yield model lends itself to substantial guesswork when computing a discount rate (Cap Rate) for income streams.

A Better Way to Calculate Cap Rates – Regression Analysis

Most appraisers and brokers rely on published Cap Rates from trade journals and hotel magazines. However, there is a more precise and reliable method for calculating Cap Rates. It is essential to include the weighted cost of capital in the Cap Rate calculation, as it accounts for both required investor and lender returns on investment. Calculating Cap Rates using the weighted cost of capital and algebraic regression analysis yields more credible results. This method for calculating Cap Rates is not new; it was formulated by academic researchers and hotel appraisers decades ago. However, few in the hotel industry have adopted this method for calculating market-adjusted Cap Rates.

As with Net Operating Income (NOI), the correct Cap Rate is critical to properly valuing a hotel. Incorrect Cap Rate calculations can indicate that a hotel is underpriced or overpriced. An underpriced hotel may sell quickly, but an overpriced hotel will languish in the marketplace.

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Attributions & Endnotes

Stephen Rushmore, MAI, CHA, has built a name and reputation that is well recognized in the hospitality industry. Rushmore (HVS) has appraised thousands of hotels worldwide. He is a renowned teacher and author who has been published in numerous industry magazines and academic journals. The Rushmore method accurately computes Cap Rates by weighting Lender and Investor required returns on investment capital. The weighted cost of capital result is then factored into a regression analysis formulation to provide the most up-to-date and valid Cap Rate, which is used to calculate a verifiable and credible hotel price valuation.

Steve Rushmore teaches an excellent method for computing Cap Rates as described in his article titled “How to Value a Hotel, A Complete Guide to the Hotel Valuation Methodology.”

  1. Appraisal Institute, The Appraisal of Real Estate, 14th ed. (Chicago: Appraisal Institute, 2013), 495.
  2. Steve Rushmore & Suzanne Mellen, Let’s Revisit the Mortgage-Equity Analysis
  3. Stephen Rushmore, MAI, CHA, How to Value a Hotel, A Complete Guide to the Hotel Valuation Methodology. Valuation Procedures. https://howtovalueahotel.com/valuation-procedures