Wellness Real Estate Valuation and Finance
As the wellness real estate market continues to accelerate, it seems increasingly clear that wellness and sustainable asset types will become a new class of properties in the market. Whereas these developments have been underway for a while, these assets often have distinct property features that require reconsidering the wide and general framework of conventional financing, valuation methodologies, CAP rate averages, and WACC factors. This article describes an outlook for this new asset class to help identify and unlock wellness and sustainability in hospitality finance.
Traditional Property Developments
Hotel and resort property types vary widely. It is standard practice to sort assets into property class types within various market segments, such as luxury, upper-upscale, upscale, upper-midscale, midscale, extended-stay, and economy lodging categories. These differ in value based on the subject property, country, region, location, market demographics, demand, etc.
While we all know these factors greatly affect occupancy, ADR, RevPAR, and the typical data points, what is yet to be unraveled is the full impact of new and structural changes amongst an expanding set of property norms. In recent news, there has been some interesting movement in the hotel sector amid portfolios and investment funds. While the general feeling remains cautiously optimistic, new data suggest select economic and demographic concerns overall.
What is also changing is the increasing development of wellness-centered hotel and resort assets and wellness real estate development at large. The wellness real estate market continues to accelerate and grow significantly, often running up against conventional valuation methods that no longer serve all property types. Generally, valuation and financial practices are influenced by various current market conditions. However, with the rise of new wellness developments across the hospitality sector, CAP and WACC averages face a combination of dissents, swiftly moving away from conventional thinking. These conditions are breaking new ground not only in real terms but are being greatly affected by longstanding finance and valuation cornerstones.
Realities and Challenges
This presents multiple issues. First, the financing of such properties is often subject to a range of traditional financing frameworks that misunderstand and commonly undervalue select market performance and income expectations. Second, I often see these kinds of projects and properties face capital market options that don’t understand the granularity and, often, large-scale differences in the value of these developments. Third, many of the underpinnings driving these developments include new technological and program innovations that are not widely deployed, in low supply, or new to the market. This thereby makes assembling competitors and similar regional assets further challenging.
These dynamics predominantly impact smaller and independent owners and developers seeking to leverage financing through conventional means. Although larger and midsize facilities are experiencing this, too. This then becomes a two-prong issue: one, it greatly narrows the field of financing opportunities for smaller or capital-light businesses wanting to enter and develop beyond the boundaries of predictable outlooks. Second, it generates an inventory of top-tier, well-funded, equity-backed, and often luxury-class supply, leaving a void in the lesser, upscale, midscale, and independent boutique markets.
While healthy skepticism on performance and value is essential, long-held perspectives can create significant barricades when it comes to valuations and financing. Once commonly viewed as amenities only 20 years ago, in recent years, the global spa, wellness, and sustainability sectors have grown tremendously. Moreover, they continue to contribute heavily to the shifting global demand base within lodging and leisure. So then, why do these assets remain commonly viewed as functions over features? There are a lot of reasons.
Some of the most common issues I see don’t understand or account for the extent of recent market growth. In addition, operational and layout planning often adhere to long-established and outdated model ratios, which, in combination with various space limitations and low engagement metrics, hold conventional use in place without evolving systems within the business. For example, once, a 10,000 square-foot spa facility would have been considered a premium size. Today, this is more likely to be 20,000 to 40,000 square feet or greater.
Changing Market Conditions
An omnipresent shift is occurring in global hospitality dynamics, which is imperative to unpack as emerging market conditions require increasing attention from capital market groups, lenders, appraisers, real estate investors, and developers. Many of these changes are operational, with rapid adaptations being made to a variety of fundamentals and technological integrations, including broad applications in AI but not only. Program and participation preferences are also changing, many of which will further transform performance and outcomes.
Furthermore, a significant revolution in project development has occurred outside of the U.S., European, and Asian markets. The timeless cliche ‘location, location, location,’ has never been more relevant than today as rapid developments across other regions have quickly added new energy to the global market. Table A (above) from the Global Wellness Institute (GWI) Wellness Real Estate Market Growth Report (2024) illustrates the contrast in growth between wellness-oriented real estate compared to standard construction outputs. We are living in a time of huge transition and a changing of the tides. This momentum has been building up for a long time—some might say since 2009. This will cause further waves in financial institutions and investment funds. These factors are also likely to hinder valuation mainstays and the development and planning process itself.
For example, design, architectural planning, and construction processes have already experienced remarkable advancements across a variety of sector-specific systems. As AI and other utilities play a more active role in resources and materials expansion, these mechanisms will significantly improve beyond where they are today. In addition to this, there are increasing concerns related to climate and extreme weather systems, and the prospects of building above ground, in-ground, on coastlines, or on interior land will reveal new preferences and further drive changes in the market.
As the overtone continues to change, adjustments are slowly coming to the fore. International Valuation Standards (IVS) are globally recognized standards embraced by over 100 countries. They establish guidelines for valuing assets and liabilities, including financial instruments. Recent updates in 2024 to the IVS now include a more modern approach to data, models, and traditional inputs. Whereas data accessibility and modeling have all changed vividly in recent years, these revisions are dynamic and well-timed. Other additions include Environmental, Social, and Governance (ESG) criteria, as well as a dedicated appendix that opens new doors to wider, more inclusive social and environmental impact considerations that align with improved government incentive structures.
According to HVS, Kasia Russell, MAI, Hospitality financing is in a season of significant challenge as higher interest rates have significantly impacted debt coverage ratios and performance feasibility. Underwriting has become far more stringent, and in most cases, only the strongest sponsors with long-term relationships and proven track records are getting deals across the finish line. This new real estate class remains limited, causing hesitance and risk adversity. Nonetheless, collaboration between lenders, developers, investors, and industry experts, in concert with the demand for wellness, will address these challenges going forward.
Why This Matters
While wellness assets can continue to be classified into existing property and class sets short-term, they involve numerous diverse distinctions. Like sustainable building practices, these commonly involve elevated mechanical, engineering, and utility infrastructures. They also typically include advanced building methods and materials and significant capital investments, resulting in a higher WACC compared to traditional buildings. These kinds of developments also classically consider land impact, efficiencies, and a range of highest-and-best-use factors focused on inventive guest propositions and a gamut of community and tourism-based targets.
As technical and building standards continue to amend and expand market fundamentals to acknowledge increasing advancements, the likelihood of needing to integrate comprehensive definitions will become further urgent. The Traditional Uniform Standards of Professional Appraisal Practice (USPAP) of valuation standards in the U.S. include five basic rules. These pertain to ethics, record keeping, competency, scope of work, and jurisdictional exceptions. As company cultures, vision, and data metrics continue to evolve, we can expect these attributes to require more agility and more frequent updates. Over time, these are likely to mature into a class of new and enhanced standards that can be curated for select models across the market.
While the trajectory of wellness-minded building and construction appears clear, it’s becoming increasingly evident that the market needs to catch up and be ready to manage and disseminate across wider, more diverse property types. Changes to the IVS are leading in the right direction. Moreover, this is happening worldwide, with more companies, appraisers, and lenders working to close the gaps between traditional and emerging real estate and hospitality factors. See Table B (above).
While hospitality debt advisory firms such as Arriba Capital and others increasingly focus on wellness and spa financing, Tim Valaski at Arriba Capital says, Spa and wellness in hospitality is very much a natural progression for us. We’ve seen an increase in financing requests in established wellness markets and areas ripe for a wellness influence. As more of these projects come to fruition, it will become easier to point at these success stories, and I believe lenders will continue to open the doors to new opportunities.
Analysis Agility and Level of Detail
As this energy increases, what’s important to keep in mind is the depth of understanding performance integration models alongside inputs and data to manage risks accurately. The speed of incoming change also comes with various degrees of unforeseen risks. Meanwhile, the ability to recognize and convey not only value but also confidence in conditions that factor into long-term viability will matter immensely. As these attributes continue to evolve with shifting market conditions, uncommon attention to demographics and details will be evermore important.
Traditional modeling focused solely on EBITDA and NOI may no longer be isolated ways to value investment and performance factors. With fluctuations in rates, inflation, and similar factors, a more modern and incremental approach to model-making is not only necessary but critical. Modeling outcomes with a greater level of detail not only strengthens multi-functional performance but also plays a more visible part in establishing end-to-end value.
In the bigger picture, as this accelerates, we can expect to see greater market opportunities related to commercial real estate at large. In addition to changing standards, the U.S. will see an increased need for commercial rezoning and broader incentives related to asset repositioning. Some properties will be ideal to redevelop and reposition, while others may be best converted for other purposes. Such locations will be prone to unique financial and societal economic challenges.
Final Thoughts...
Essentially, the cycle ahead will drive a chapter of fundamental asset changes through the commercial real estate market. These conditions will reveal unexpected turbulence in locations and markets traditionally viewed as investment-safe, accelerating the need for forward-thinking and innovative solutions. This makes it vital for appraisers, capital market groups, and financial insxtitutions to unpack and explore the unique impact these properties provide to understand the full scope of asset values better.
This article hopes to help raise awareness. It highlights some of the benefits and differences across an increasingly important sector of hospitality. I urge those interested in this topic to become more active advocates and examine how these aspects prompt varying degrees of change within traditional systems.
Reprinted from the Hotel Business Review with permission from http://www.hotelexecutive.com/.
