What Cap Rates Aren’t Telling You About Hotel Valuations
Cap rates (capitalization rates) have long been a go-to metric in real estate valuation. In many asset classes, they offer a quick, apples-to-apples way to compare value relative to income. But in hospitality, the story is much more complex.
If you’re relying solely on cap rates to value a hotel asset, you’re missing critical pieces of the puzzle.
This article explores the limitations of cap rates in hospitality real estate, and what investors should consider instead to accurately assess value in today’s market.
The Basics: What Cap Rates Measure
A cap rate is typically calculated as:
Cap Rate = Net Operating Income (NOI) / Purchase Price
In theory, the lower the cap rate, the more expensive the asset (and the lower the yield); the higher the cap rate, the better the return on investment. But that assumes NOI is stable, and in hotels, that’s rarely the case.
Why Cap Rates Fall Short in Hospitality
1. NOI Volatility
Hotel income statements fluctuate week to week, season to season, and year to year. Unlike multifamily or office, where leases are fixed and predictable, hospitality operates on daily pricing and occupancy swings.
A property with a RevPAR of $120 in 2022 could see $95 in 2023 due to regional demand shifts or brand changes, completely altering the “cap rate.”
2. CapEx Distortions
Cap rates don’t account for deferred capital expenditures. A 7% cap rate might look attractive until you realize the hotel needs a $6M renovation to meet brand standards.
Example: In 2024, average PIP (Property Improvement Plan) costs ranged from $18K–$25K per key for branded select-service hotels (CBRE Hotels).
3. Brand & Management Complexity
Franchise fees, management agreements, loyalty program costs, and PIP timelines all impact net income, but they don’t show up directly in a simple cap rate.
A hotel with a 7% cap may have brand fees eating 13%+ of top-line revenue, drastically altering actual returns.
4. Misleading Comparisons Across Markets
Cap rates often get benchmarked between urban, suburban, and tertiary markets—but market demand drivers, labor costs, and rate compression differ widely.
In Q1 2025, secondary market deals averaged 6.8%–7.5% cap rates, while coastal gateway cities saw cap rates in the 5.0%–6.2% range (JLL, 2025). But higher cap rates didn’t always mean better deals - often, they signaled operational or demand risk.
What to Look at Instead of Cap Rate
Stabilized NOI Projections
Evaluate the 3–5 year stabilized NOI, not just the trailing twelve months (T12). Especially important for value-add deals or recent rebrands.
Flow-Through & Operating Leverage
Understand how incremental revenue impacts the bottom line. Hotels with high flow-through potential may be undervalued by a flat cap rate comparison.
Typical flow-through: 40%–60% for select-service, up to 70%+ for extended stay (STR Benchmarking 2025).
CapEx Reserves & Remaining Useful Life
Always adjust value based on needed renovation spend and remaining useful life of FF&E and systems (HVAC, elevators, roofs).
Brand & Operator Synergy
Evaluate the strength of the flag, brand contribution to RevPAR Index, and operator capability. A low-cap deal with the right team can outperform a “high cap” deal with weak execution.
Adjusted Return Metrics
Use a full-stack view:
IRR (Internal Rate of Return)
Equity Multiple
10-year DCF modeling
Exit cap assumptions
Best practice: Build a base case, downside, and upside scenario. Investors who underwrote downside RevPAR drops of 10–15% in 2020 recovered faster and performed stronger post-COVID.
Cap Rates in Today’s Market: Misleading or Useful?
In the current environment, marked by elevated interest rates, cautious lending, and motivated sellers, cap rates are a lagging indicator at best. They don’t account for debt service, operational recovery timelines, or brand-driven upside.
In fact, buyers relying on cap rates alone risk mispricing assets, either overpaying for stabilized income that’s unsustainable, or passing on deals with hidden upside.
Know the Story Behind the Number
Cap rates can still play a role in hotel investing, but they should be the starting point, not the final decision driver.
Savvy investors dig deeper, into management quality, asset lifecycle, debt structure, and market trends. Because in hospitality, value lives in the margins, in the operations, and in the execution.
In a complex operating business like hospitality, the real cap rate is how well you run the hotel.
Sources:
CBRE Hotels Cap Rate Survey (Q1 2025)
JLL Global Hotel Investment Outlook 2025
STR & HotStats Performance Benchmarking
PwC: “Hospitality Trends and Performance Outlook”