Hotel Appraisers & Advisors, LLC
12/23/2016
Client Report
CONFUSING CONSUMER SURPLUS WITH
MARKET VALUE IN HOTEL APPRAISALS
Why Some Appraisers Confuse Consumer Surplus with
Property Value in Hotel Appraisals
Introduction
Consumer surplus is a valuable concept that can help
appraisers understand what is and is not property
value in hotels. Readers can think of consumer surplus
as the difference between what a buyer is willing to
pay for an item and that item’s market price. If you
are willing to pay $5.00 for a gallon of milk, but the
local supermarket price is only $3.49, then you can
enjoy a consumer surplus of $1.51 by purchasing the
gallon of milk.
which something would trade in a competitive
marketplace.
Graphic Representation of Consumer Surplus
Graphically, consumer surplus represents the area
between a demand curve and the market price of
whatever is being traded. The following figure shows
the consumer surplus in the shaded area, below the
demand curve, above the market price P1.
Figure 1 - Consumer Surplus
In this example, the market price, or market value, of
a gallon of milk is $3.49, even though at least one
buyer would be willing to pay more. The market value
of an item can be higher or lower than the price
various individuals are willing to pay.
The Appraisal Institute 1 provides the following
definition of market value:
The most probable price, as of a specified date,
in cash, or in terms equivalent to cash, or in
other precisely revealed terms, for which the
specified property rights should sell after
reasonable exposure in a competitive market
under all conditions requisite to a fair sale, with
the buyer and seller each acting prudently,
knowledgeably, and for self-interest, and
assuming that neither is under undue duress.
There are many definitions of market value. In general,
these definitions focus on determining the price at
The Appraisal Institute, The Appraisal of Real Estate, 13 th
Edition (Chicago: The Appraisal Institute, 2008), 22-23.
1
In the graph, the blue line represents a supply curve
and the green line represents a demand curve, for an
item actively bought and sold in a market. P1
represents the market price at which supply and
demand are in equilibrium, at a given time, for this
item. Q1 represents the quantity of the item that will
be supplied by vendors, given the market price.
If your demand for the item lies somewhere on the left
half of the green demand curve, then you will happily
pay the market price for the item. The amount of
consumer surplus you will enjoy depends on how far
above P1 you are located on the demand curve. On
the other hand, if your demand lies somewhere on the
right half of the green demand curve, below P1, then
you will not purchase the item because its market price
exceeds what it is worth to you.
Hotel Example
Now let’s assume you are developing a hotel instead
of purchasing a gallon of milk. To develop a
functional hotel, you will need to purchase beds, and
various other furniture, fixtures, and equipment items.
These items collectively make up a hotel’s tangible
personal property.
In this example, let’s assume you need to purchase 100
beds for your new hotel. There are many sellers and
buyers of new hotel beds, creating an active and
competitive market. There are multiple suppliers that
meet all the specifications and brand standards you
are seeking. After comparing various suppliers, you
determine that the market price for the particular type
of bed you want is $800 per bed, or $80,000 for
100 beds.
Regardless of how much you are willing to pay for the
beds, the market price is $800 per bed. Even if the
beds are worth more than this to you, you do not need
to pay more than the market price. Imagine a vendor
offering to sell you the beds for $1,000 each, because
that is how much they may be worth to you. Even if
they are worth this much to you, it still would not make
sense to pay this amount, as you could obtain the same
beds from another vendor for $800 each.
Contributory Value vs. Market Value
In a property tax case involving a hotel I recently
appraised, the hotel owner’s attorney argued that the
hotel’s tangible personal property was worth
significantly more than its replacement cost. This
seemed unlikely. So, I asked whether she believed the
used furniture in the owner’s hotel really was worth
Assuming the conditions apply that are required to meet
the definition of market value.
2
more than it would cost to buy the same items brand
new?
She answered no. But she then went on to argue that
the “contributory value” of the furniture was much
higher than the cost of the furniture because without
beds nobody would stay at the hotel and the whole
operation would go out of business.
It may be true that a hotel’s furniture is worth more to
a hotel owner than the cost of the furniture, just as a
gallon of milk may be worth more than its market price
to some consumers. But this does not mean its market
value is greater than its cost. The market cost, or
market price, of the furniture represents its market
value.2 Any difference between its market value and
its value to an owner represents consumer surplus.
Conclusion
When valuing hotels, appraisers may recognize these
properties include various components, such as land,
improvements, and tangible personal property.
Appraisers may also recognize that all of these
components are needed, and must work together, to
achieve the highest and best use of such properties.
However, just because tangible personal property is
necessary to achieve a hotel’s highest and best use
does not mean an owner will be forced to pay the
maximum amount the owner is willing to pay. This
would require suppliers to practice perfect price
discrimination. A detailed discussion of the conditions
necessary for perfect price discrimination is beyond
the scope of this article. But suppliers in such a
competitive market as hotel furniture are not likely to
achieve much price discrimination, if any.
So, if an appraiser estimates how much value the
tangible personal property of a hotel contributes to its
owner, then the appraiser is probably not estimating
market value. Instead, the appraiser is really
estimating the sum of its market value plus the owner’s
consumer surplus.
This article is for discussion purposes only and is not
intended to be construed as investment advice.
Hans Detlefsen, MPP, MAI is president of Hotel Appraisers & Advisors,
LLC, an advisory firm specializing in the hotel industry. Mr. Detlefsen is
a designated member of the Appraisal Institute. Prior to forming Hotel
Appraisers & Advisors, Hans was owner and Managing Director of the
Chicago office of HVS, a global hospitality consulting firm. He received
his B.A. from the University of Notre Dame and his M.P.P. from the
University of Chicago. Hans is a frequent speaker at industry
conferences and has been cited in numerous business journals and trade
publications.
Contact: [email protected]