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Hotel investors use the ADR rule of thumb because it's simple-a hotel should generate one dollar in ADR per every $1,000 in value per guest room; but that rule is not without its problems.
Most hotel-industry observers are familiar with the commonly used valuation rule of thumb that hotels should generate $1 in ADR per $ 1,000 in value per room. That technique is also referred to as the $1-per$1,000 method,1 the building-cost-rate formula,2 the general rule-of-thumb method for determining room rates,3 and the ADR rule-of-thumb approach. I have seen no empirical evidence, however, that this rule-of-thumb's validity has been tested in at least ten years,4 even though it continues to be taught to hospitality managers as a valid method for establishing hotel rates.5 Further, previous research regarding this rule has not sought to provide hospitality managers with information regarding how to apply effectively this particular ratio. This article presents research that both tests the validity of the ADR rule of thumb and provides guidance to managers regarding how to apply it.
The Rule of Thumb
Rules of thumb have been used in real-estate appraisal,6 general real estate,7 and general business for many years.8 More accurate and up-to-date value indexes are needed, however, particularly for commercial real estate.9 As already noted, hotels' ADR rule of thumb, which has been used for decades,10 is that a hotel should generate one dollar in average daily rate per every thousand dollars in value per guest room. In other words, a 100-room hotel developed or purchased for $12,000,000 would be valued at $120,000 per guest room. Based on the ADR rule of thumb, this property should generate a $120 average daily rate.
A more recent corollary to the ADR rule of thumb has been a room-rate multiplier technique for valuing hotels.11 In this reverse calculation, a hotel may be valued at 1,000 times its average daily rate on a per-room basis. For example, a 100-room hotel with a $120 average daily rate would be valued as follows:
1,000 x 100 x $120 = $12,000,000
This technique may be used in addition to the three traditional real-estate valuation approaches of income capitalization, sales comparison, and cost.12 Despite the fact that more-sophisticated real-estate-valuation-techniques exist than just the room-rate-multiplier technique,...