Asia Pacific Region 4th Quarter 2002 Adjusting Historical Development Costs to The Job Seeker and Arrive at Realistic Current Replacement the Executive Search Costs Consultant he Cost Approach to value Case Study One of the common misconceptions estimates market value by in the hospitality industry is that Let us consider the following case study computing the current cost of an executive search company will work T to arrive at our estimation of replacing a property and subtracting to find a job seeker a job. It does replacement cost for a fictitious hotel any depreciation resulting from happen of course, but in the rare in Singapore that was constructed one or more of the following factors: circumstances when the job seeker just during 1997. physical deterioration, functional happens to match the specifications obsolescence and external (or economic) of a current search. This article will Brief Description of the Hotel obsolescence. The cost approach explain the role of the executive search provides a reliable estimate of value Table 1, below, summarises a brief consultant and focus on recruitment for newly constructed properties; description of the fictitious hotel used from a job seeker’s perspective, it is however, as buildings and other in this case study. not a comprehensive guide to finding forms of premises increase in age a job, but it will highlight some of the and begin to deteriorate, the resultant Table 1 Hotel Description and Historical key aspects of the process. loss in value becomes increasingly Development Cost difficult to quantify accurately. A job seeker is wise to advise a reputable Hotel Name: Sunset View Hotel, Singapore search firm of their career objectives; Our experience with active hotel Location: Orchard Road however they should have realistic purchasers indicates generally that Opening Date: 1997 expectations about what happens when active buyers of hotels generally base Hotel Star-Grading: 5-Star a job seeker contacts the Executive their purchase decisions upon Number of Guestrooms: 350 Search firm. Most executive search economic factors, such as forecast net Total Meeting Space (m2): 3,000 consultants will listen to the job seeker’s income and return on investment. aspirations, they might offer to meet, Number of Food & Beverage Outlets: 8 However, the cost approach to value most will happily receive a resume Site Area (m2): 5,000 provides an estimate of the cost to and the kind ones will also offer some 2 enter the marketplace. Furthermore, Gross Floor Area (m ): 35,000 useful advice. Most times, the job the cost approach to value implies Number of Storeys: 12 seeker’s resume will be added to a that no prudent person is likely to Source: HVS International Estimates database and may be retrieved for pay more for a hotel property than future searches. In the past some firms the amount for which the site can have developed the habit of sending be acquired and the hotel of equal Historical Development Costs the resume of the job seeker to numerous desirability and utility, in comparison companies. Though these introductions to the existing hotels in the market Table 2, overleaf, sets forth the historical are unsolicited, the hope presumably place, can be constructed without undue development cost of the hotel in 1997 is that one of the companies may hire delay. values. the applicant and then pay a recruitment fee. In reality companies receiving Also in this Issue:. Table 2 illustrates that the development unsolicited resumes in such a way • The Job Seeker and the for the hotel equates to US$ 99,000,000, usually bin them. Or in the event that Executive Search Consultant or approximately US$ 300,000 per they do have a suitable vacancy are • Ecotel – Now in Delhi available guestroom in 1997 prices. unwilling to proceed, being unable • Seychelles – An Overview to pay a recruitment fee for that • Special Announcement • Regional Watch - continued on page 2 - continued on page 4 1 HVS International www.hvsinternational.com 18522-HVS Journal 1 12/24/02, 9:49 AM Adjusting Historical Development Costs to Arrive at Realistic Current Replacement Costs. - continued from cover Table 2 Historical Development Cost Table 3 Physical Deterioration The current age of the hotel is approximately four and half years, Cost Component Amount (US$) Estimated Hotel Life 60 years therefore according to the schedule set Land 10,000,000 Chronological Age of Hotel 4.5 years out in Table 4 we would normally Building Estimated Effective Age of Hotel 6.0 years estimate the depreciation of the Construction Contract 65,000,000 Percent to be Depreciated 10.0% Furniture, Fixtures, and Equipment Architectural and Engineering 250,000 by approximately 45%. However, Historical Building Cost (US$) 65,000,000 Insurance 50,000 considering the high annual Phsycial Deterioration (US$) 6,500,000 Permits 750,000 occupancies achieved at the hotel Taxes 50,000 Source: HVS International Estimates since opening we have adjusted the Furniture, Fixtures and Equipment depreciation percentage to 60%. (FF&E) 12,250,000 We consider this upward adjustment Soft Costs is appropriate and furthermore Legal Costs 150,000 Table 3 illustrates that the percentage represents more accurately the actual Financing Fees 100,000 of the estimated life of the hotel that effective age of the quality of the Interest During Construction 400,000 has been used is 10%. Therefore we Furniture, Fixtures, and Equipment at Pre-Opening Costs 250,000 have depreciated the historical the hotel. Table 5, below, sets out Working Capital 150,000 building cost by 10% to arrive at our our calculation for the depreciation of Professional Fees 750,000 –––––––––––––––––––––––––––––––––––––––––– appropriate estimate of physical the Furniture, Fixtures, and Equipment Total Development Cost 90,150,000 deterioration deduction, namely at the hotel. Developers Profit @ 10% 9,015,000 US$ 6,500,000 Total Development Cost (Say) 99,000,000 Table 5 Furniture, Fixtures, and Equipment Development Cost Per Room 300,000 Furniture, Fixtures, and Equipment Depreciation Schedule Source: HVS International Estimates Generally the Furniture, Fixtures, Cost of Furniture, Fixtures and Equipment in a hotel are and Equipment 12,250,000 depreciated at a more rapid rate in Physical Deterioration comparison to the depreciation of Adjusted Depreciation 60% the hotel building, reflecting the Total Depreciation (Say) 7,350,000 As a hotel ages, the physical condition higher usage and wear-and-tear of of the hotel is likely to deteriorate. these items. For the purpose of this Source: HVS International Estimates Therefore, the prudent valuer in study we have assumed a depreciation assessing replacements costs in today’s rate of 10% per annum, which is inline values for existing hotels will make with current accepted accounting As illustrated in Table 5 we consider deductions from the historical costs for practices. that US$ 7,350,000 represents an deterioration. The amount of physical appropriate deduction for physical deterioration for the hotel can be Table 4, below, sets out the depreciation deterioration to the Furniture, Fixtures, quantified using the age-life method. schedule for the Furniture, Fixtures, and and Equipment at the hotel. Equipment at the hotel. The Building Functional Obsolescence The age-life method estimates the Table 4 Assumed Depreciation Schedule, Functional obsolescence results from Furniture, Fixtures, and Equipment amount of depreciation by calculating a defect in the structure, material or the percentage of the useful life of the design of the structure or layout of Year Annual Cumulative hotel in comparison to the amount of the building. In many instances the useful life that has been currently Depreciation Deprecation 1 10% 10% functional obsolescence can be utilised. For the purpose of this case overcome through redesign. 2 10% 20% study we have assumed that the However, when there are cases 3 10% 30% economic life of the hotel is 60 years. As of incurable functional obsolescence the hotel opened in 1997 the age of the 4 10% 40% the prudent valuer should make hotel is approximately four and a half 5 10% 50% an adjustment to the gross floor of years. However, as the hotel has 6 10% 60% the existing hotel to represent those achieved significantly high occupancy 7 10% 70% areas that contain incurable functional levels since opening, we consider the 8 10% 80% obsolescence. We consider the current physical deterioration at the 9 10% 90% items listed below represent areas hotel is higher than typically expected 10 10% 100% of incurable functional obsolescence at a hotel of this age. Therefore, as at the hotel: illustrated in Table 3, we have made an Source: HVS International Estimates • Excessive number of kitchens; upward adjustment to the effective age of the hotel. 2 HVS International www.hvsinternational.com 18522-HVS Journal 2 12/24/02, 9:49 AM Adjusting Historical Development Costs to Arrive at Realistic Current Replacement Costs. - continued from page 2 • Room service pantries on each hotel Table 7 Estimated Replacements Costs After construction costs have declined floor; Reduction for Obsolescence significantly in many markets in Asia • Ineffectively designed housekeeping compared to pre-crisis levels. Based on areas on each floor. Current Gross Floor Area (m2) 35,000 our recent research, we estimate that Original Development Cost 99,000,000 construction costs in for a hotel of this In order to account for functional Original Development Cost Per m2 (Say) 2,800 type in this location in 2002 are likely to obsolescence we have adjusted the gross Adjusted Gross Floor Area (m2) 32,500 be in the region of approximately 20% floor area (square metres) that we Revised Development Cost 91,000,000 less in comparison to 1997 costs. consider appropriate to build a similar Revised Development Cost Per Room 260,000 type of hotel, eliminating the We set out in Table 9, below, our unnecessary areas.