Appraisal Expert Argues Debt Coverage Ratio Offers Clearer Hotel Valuations
Industry veteran Stephen Rushmore contends that evaluating properties through lender-mandated metrics produces more defensible asset values than traditional equity-return assumptions.
A prominent hotel valuation expert is urging industry professionals to reconsider how they determine property worth, advocating for an appraisal method grounded in lending requirements rather than subjective investor assumptions.
Stephen Rushmore, founder of hospitality consulting firm HVS, maintains that real estate transactions rarely involve all-cash purchases, making the interplay between debt and equity capital central to accurate valuations. According to Rushmore, this fundamental reality should drive how owners, asset managers, and advisors assess hotel values.
The traditional mortgage-equity technique blends debt costs with equity costs through what's known as the band-of-investment method. This approach weights a mortgage constant by the loan-to-value ratio and combines it with an equity dividend rate—the investor's required cash-on-cash return. While mathematically sound, Rushmore identifies a weakness: the equity dividend rate remains a subjective input that proves difficult to extract from market data and varies with individual investor preferences.
As an alternative, Rushmore recommends the debt coverage ratio method, which he describes as producing clearer and more defensible valuations. This approach calculates the overall capitalization rate by multiplying three lender-determined parameters: the required debt service coverage ratio, the loan-to-value ratio, and the annual mortgage constant. Each input derives directly from published loan terms rather than estimated investor expectations.
The debt coverage ratio represents net operating income divided by annual debt service—a metric lenders actively use in underwriting decisions. Rushmore suggests this method proves particularly valuable for refinancing transactions, acquisitions, and ground-up development projects where loan parameters play a central role.
The algebraic formulas supporting this methodology were developed by Suzanne Mellen, a partner at HVS, and subsequently became foundational to the firm's hotel valuation framework. Rushmore's advocacy draws on lessons from his mentors—James Gibbons, Charles Akerson, and Leon Ellwood—whose core principle that properties trade with combined debt and equity capital has remained consistent across five decades of industry practice.