U.S. Hotel Cap Rates in 2025: Trends, Drivers, and Segment Analysis

MMCG
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Introduction

Hotel capitalization rates (cap rates) are a crucial metric for investors, signaling the expected annual return on a hotel investment relative to its price. In 2025, U.S. hotel cap rates have risen to their highest levels in recent years, reflecting shifts in the economic environment and industry-specific challenges. This comprehensive analysis explains what cap rates are, how they’re calculated, and examines how macroeconomic conditions and hotel-sector dynamics are shaping cap rates across different hotel segments – Luxury & Upper Upscale, Upscale & Upper Midscale, and Midscale & Economy. We also review historical trends, recent data (as of August 2025) from the MMCG/CoStar database, and provide forecasts for cap rate movement. Key performance indicators like occupancy, Average Daily Rate (ADR), Revenue per Available Room (RevPAR), and EBITDA margins are incorporated to highlight the operational economics behind these valuation trends. Investors will gain insight into how factors such as interest rates, labor and insurance costs, tariffs, construction pipelines, and transaction activity influence hotel cap rates and asset pricing in today’s market.

What Are Hotel Cap Rates?

A capitalization rate is essentially the yield of a property – calculated as a hotel’s annual net operating income (NOI) divided by its current market value or purchase price. In formula form:

Cap Rate = NOI / Property Value, expressed as a percentage.

For example, if a hotel produces $5 million in NOI and is valued at $100 million, its cap rate is 5%. Cap rates help investors quickly compare returns on different investments and gauge the pricing of an asset relative to its income. A higher cap rate indicates a higher potential return (but often also higher perceived risk or lower growth prospects), whereas a lower cap rate suggests a more expensive asset relative to its income (often reflecting strong growth expectations or lower risk). Essentially, cap rates are a shorthand for a property’s expected yield in one year, not accounting for future growth or depreciation.

In the hotel sector, cap rates tend to be higher than in many other real estate categories (like apartments or industrial properties) because hotels are operating businesses with nightly leases. They have more volatile income streams and higher operational intensity, which elevates risk. For instance, hotel cap rates averaged ~8% in Q3 2023, significantly above multifamily or office cap rates During periods of uncertainty, the spread between hotel cap rates and other property types can widen as investors demand extra return for hotel-specific risks. Notably, in the aftermath of the pandemic, the risk premium for hotels spiked – hotel cap rates in 2020 were on average 4.44% higher than the average for other commercial real estate, though this spread normalized to about 2.44% by early 2024 as the industry recovered. In short, hotels generally trade at higher cap rates (higher yields) to compensate for their greater income variability and operational demands.

How cap rates are used: Investors and appraisers use cap rates to estimate value: Value = NOI / Cap Rate. Small changes in cap rates can have a big impact on valuations. For example, a 50 basis point (0.5%) increase in cap rate implies a notable drop in value if NOI is unchanged. Cap rates are influenced by numerous factors – some broad (like interest rates) and some specific to the hotel or market (like its earnings growth or condition). The next sections delve into these factors.

Key Factors Affecting Hotel Cap Rates

Interest Rates and Capital Markets

Perhaps the most significant macro driver of cap rates is the prevailing interest rate environment. Cap rates often move in relation to benchmark interest rates and the cost of debt financing. When interest rates rise, borrowing becomes more expensive and investors typically require higher cap rates (i.e. lower prices) to achieve acceptable returns. Since hotels are often purchased with a mix of debt and equity, the mortgage rate directly feeds into cap rate expectations as part of the weighted return required by debt and equity holders. In 2022–2023, the U.S. Federal Reserve’s aggressive rate hikes (a strategy to curb inflation) drove financing costs sharply upward. By early 2024 the average federal funds rate was over 500 basis points (5%) higher than its mid-pandemic lows, translating to much higher hotel loan interest rates. In effect, “debt costs tend to be the leading indicator for cap rate metrics”, and the spike in debt costs has put upward pressure on hotel cap rates.

Evidence of this appeared in the transaction market: hotel cap rates rose by roughly 100–150 bps in the past two yearsfor many asset types, erasing the historically low cap rates seen in 2019–2021. A recent study showed that using pre-pandemic vs. post-pandemic debt assumptions (higher mortgage constants and lower leverage), the implied cap rate for a typical hotel would be about 170 bps higher, corresponding to an ~18% drop in value if NOI stayed constant. In practice, actual values haven’t fallen quite that dramatically because some equity investors lowered their return targets in hopes of refinancing later at lower rates. Nonetheless, persistently high interest rates in 2023–2025 have clearly cooled investment activity and lifted cap rates. The MMCG data confirms that the “current interest rate environment has suppressed both construction and transaction activity”, with fewer new developments and a decline in hotel sales volume. Total U.S. hotel transaction volume in 2024 was about $21 billion, down from $25+ billion in 2023 – a second consecutive yearly decline as buyers and sellers struggled to agree on pricing in a higher-rate environment. Brokers report a wide bid-ask spread in many deals, as owners anchored to yesterday’s prices resist the higher cap rates (lower values) that today’s financing climate dictates.

It’s worth noting that in late 2023, hotel cap rates (avg ~8.0%) nearly caught up to or even exceeded borrowing rates(avg hotel mortgage rates ~8.4% for CMBS loans). This unusual inversion – where the cost of debt equals or tops the asset yield – is not sustainable long-term, since it implies negative leverage (borrowing at a higher rate than the property’s yield). This dynamic further stalled transactions and pressured sponsors to inject more equity or find creative financing. Some relief is expected ahead: with inflation easing from its 2022 peak and economic growth slowing, many expect the Fed to begin modest rate cuts by late 2024 or 2025. Any such interest rate reductions could eventually lower borrowing costs and potentially allow cap rates to compress again (i.e. asset values to rise), but the consensus is that hotel cap rates will remain above pre-pandemic norms for the foreseeable future. In other words, we may have passed the era of ultra-cheap money that fueled sub-7% hotel cap rates, and higher-yield expectations are the “new reality” for now.

Economic Growth, Inflation, and Sentiment

Broader economic conditions also shape hotel cap rates. A thriving economy with rising travel demand and income growth tends to boost hotel NOI (through higher occupancy and ADR), which can make investors accept lower cap rates (pay more) based on strong future outlook. Conversely, fears of recession or actual declines in RevPAR can drive cap rates up as buyers grow cautious. In mid-2025, the U.S. economy presents a mixed picture: consumer spending has been slowing, especially among middle- and lower-income households facing high credit costs. Business investment is under pressure from uncertainties like tariffs and geopolitical tensions. While GDP saw a boost in Q2 2025 after a weak Q1, forward-looking indicators (e.g. purchasing manager indices hovering around 50, slower job growth) suggest an ongoing economic slowdown. Inflation, although down from 2022’s highs, is still above the Federal Reserve’s 2% target (core PCE ~2.9% as of mid-2025). The Fed’s stance remains cautious due to “fears of entering a stagflationary environment” if inflation stays elevated while growth decelerates.

For hotel investors, this macro backdrop means tempered expectations. CoStar’s data notes “ongoing macroeconomic uncertainty” in 2025, with weaker demand in Q2 revealing underlying industry fragility once one-off boosts faded. If investors anticipate a mild recession or sluggish travel demand ahead, they may seek higher cap rates to buffer against potential NOI declines. Indeed, investor sentiment is pivotal – JLL’s forecast for 2025 hotel deal volume being flat hinged on sentiment, indicating that confidence (or lack thereof) can swing market activity. In periods of uncertainty, many owners choose to hold assets (if they can) rather than sell at a high cap rate. Correspondingly, liquidity drops and cap rates can move erratically due to limited data points. Thus, even as cap rate spreads (risk premiums) for hotels normalized by early 2024, the overall caution in the market has kept pricing conservative.

One interesting factor in recent years is competition from alternative accommodations. The rise of short-term rentals (Airbnb, etc.) and even luxury cruises has introduced new competitive pressures. The CoStar report highlights that Airbnb posted strong Q2 2025 results, indicating leisure travelers are increasingly opting for alternatives. This can cap ADR growth for hotels and weighs on investor outlook, especially in certain markets. In fact, CBRE noted that by 2019 the perceived threat of short-term rentals had been one reason hotel cap rates were inching up relative to other real estate classes. While the long-term impact of these alternatives is complex, investors do factor in their effect on demand, particularly for leisure travel segments.

In summary, a slower-growth, higher-inflation environment in 2025 has generally put upward pressure on cap rates. Investors are pricing in more uncertainty and requiring a cushion for risk. At the same time, if economic news turns more positive (e.g. a rebound in travel or successful large events like the 2026 World Cup bolstering demand), we could see sentiment improve and cap rate compression for hotels with strong income growth prospects. But for now, caution prevails.

Operating Costs: Labor, Insurance, and Tariffs

Cap rates are not only about revenue and interest rates – they also reflect profitability, which can be eroded by rising operating costs. In 2024–2025, U.S. hotels have faced significant cost inflation in areas like labor, insurance, and supplies. The combination of subdued revenue growth (low single-digit ADR gains that trail general inflation) and higher costs has led to shrinking profit margins in 2025. According to CoStar data, for the first half of 2025, “GOP and EBITDA margins [were] lower compared to the same period in 2024” due to rising expenses for labor, materials (even basics like food/eggs), and insurance. Such margin compression directly impacts NOI and thus cap rates: if investors expect sustained higher expenses that eat into income, they will pay less for the same asset (higher cap rate) unless offset by greater revenue growth.

Labor costs are a major pain point. The hospitality sector is labor-intensive, and post-pandemic labor shortages have driven wages up. Stricter immigration policies have exacerbated the shortage – an estimated 30% of U.S. hotel housekeeping staff and 15% of all hotel employees are foreign-born, so reduced immigration tightens the labor pool and drives wages higher. Hotels must pay more to attract and retain staff, from housekeepers to front desk and F&B workers. As a result, in full-service hotels, total labor cost now averages about 35% of revenue, and grew over 13% year-on-year in 2023. Many operators have responded by trying to streamline operations (e.g. offering less frequent room cleaning or automating certain tasks), but the savings often don’t fully offset wage inflation. For investors, higher labor costs reduce EBITDA (earnings before interest, taxes, depreciation, and amortization), which is effectively the cash flow that cap rates are based on. All else equal, a hotel with materially higher labor costs (or one in a market with new higher minimum wages) will command a higher cap rate than before, since buyers expect thinner margins until/unless costs can be passed on via higher rates.

Insurance costs are another growing burden. Property insurance premiums have surged in many regions, partly due to more frequent severe weather events (hurricanes, wildfires) and higher replacement costs. The CoStar report notes “rising insurance premiums, fueled by climate change and extreme weather, are expected to further pressure operating margins”. In a sample full-service P&L for 2023, insurance expense was relatively small (1.5% of revenue) but jumped nearly 25% year-over-year. In high-risk locations like coastal Florida or California wildfire zones, hotels have seen even steeper insurance hikes or difficulty obtaining coverage, adding uncertainty to future NOI. These cost pressures tend to make investors more hesitant, especially if they worry that expenses will continue rising faster than revenues – a scenario that justifies higher cap rates to compensate.

Finally, tariffs and trade policies can indirectly affect hotel cap rates by increasing construction and renovation costs (affecting supply) and by dampening travel demand. Tariffs on imported building materials (steel, lumber, aluminum, etc.) and goods can “drive up costs for new developments and renovations, further slowing supply growth”. A slower supply pipeline can be positive for existing hotels’ performance (less new competition, as discussed later), but it also means that any buyer planning property improvements will face a higher price tag – effectively raising the all-in investment cost. Brand-mandated renovation cycles (PIPs – Property Improvement Plans) are a known factor in hotel deals; as brokers note, a change in ownership often triggers a PIP that “can effectively double the anticipated price per room” for the buyer. If tariffs and supply chain issues inflate construction costs, these PIP expenses grow and can “render many transactions financially unviable” unless the sale price (going-in value) is adjusted downward. Thus high cap rates may sometimes reflect not just current NOI, but an anticipation of immediate capital expenditures needed post-acquisition.

Tariffs can also influence demand. International trade tensions and tariff uncertainty have had a chilling effect on some travel segments. For example, the “intermittent implementation of tariff regulations” in recent years introduced economic uncertainty that affected both leisure and corporate travel decisions. CoStar’s analysis pointed out that aggressive tariff rhetoric (such as toward Canada in 2025) has correlated with a 30% drop in cross-border travel from Canada to certain U.S. markets. Less international visitation, whether due to tariffs or other factors (e.g. visa policies), can particularly hit luxury and upper-upscale hotels in gateway cities – which then filters into investor expectations for those segments’ performance. Overall, while tariffs are a more indirect factor than interest rates or labor costs, they play into the broader macro mosaic that influences cap rate trends.

Hotel Segment and Property-Specific Factors

Beyond macro conditions, hotel cap rates vary significantly by segment and property attributes. Investors differentiate between a luxury urban hotel and a roadside economy motel in terms of risk, growth, and required return. Here are some key sector-specific drivers:

Chain Scale & Target Market: Luxury and upper-upscale hotels (typically full-service, high-rate properties) usually have lower cap rates than economy or midscale hotels. Higher-end hotels often are in prime locations, with multiple revenue streams (rooms, banquets, restaurants) and a cachet that can command premium pricing. They attract institutional investors willing to accept lower yields for iconic assets. By contrast, midscale and economy hotels (often limited-service) are considered more utilitarian investments – they tend to trade at higher cap rates, reflecting perceptions of higher income volatility or lower growth potential. The national data bears this out: as of mid-2025, the market cap rate (pricing yield) for Luxury & Upper Upscale hotels is about 8.1%, versus 9.5% for Upscale & Upper Midscale, and 10.5% for Midscale & Economy hotels. In other words, the luxury segment is priced roughly 200 basis points “tighter” (lower) than the economy segment on average. This spread has widened in recent years – pre-pandemic (2015–2019) the gap between top and bottom segments’ cap rates was closer to 1.0–1.5%, but by 2025 it’s about 2.4% (8.1 vs 10.5), indicating risk aversion has grown more for the lower end.

Earnings Growth and Stability: Hotels that demonstrate stronger RevPAR growth or more stable occupancy are rewarded with lower cap rates. For example, properties in markets with diversified demand (business, leisure, group) and barriers to new supply often have steadier performance, which investors value. On the other hand, a hotel highly dependent on a single demand source (say one corporate account or highway passthrough traffic) or in an overbuilt submarket will be seen as riskier. Segment-wise, Upscale/Upper Midscale hotels tend to recover faster in downturns because in soft economies many travelers “trade down” from luxury to cheaper options. CBRE notes that in recessions, upper-midscale RevPAR falls less and rebounds faster than luxury, which likely makes investors slightly more comfortable with that segment’s risk profile. Indeed, during the 2020 pandemic and 2021 recovery, many economy and midscale hotels kept operating (serving essential workers, long-term stays, etc.) and bounced back occupancy more quickly, whereas luxury hotels in big cities suffered longer. This dynamic influenced cap rates: by 2022–2023, some observers saw hotels as “a less risky sector compared to offices,” etc., and within hotels, limited-service properties had relatively stable cash flows. However, by 2025 the playing field has leveled somewhat – luxury hotels have seen a robust ADR-led recovery (luxury ADR is up to $275 in 2025 from ~$219 in 2019), whereas economy hotels face softening demand in some budget segments. High-end hotels’ ability to push rate has restored a lot of their NOI, even if occupancy hasn’t fully regained pre-COVID peaks (e.g. luxury occupancy ~67% in 2025 vs ~72% in 2019). Midscale/economy hotels, by contrast, are running ~55% occupancy nationally – slightly below their pre-COVID norm (~58%) – and their ADR gains are modest in absolute dollar terms. Thus, investors may see more growth upside in higher-end hotels (through pricing power and demand recovery) than in economy hotels, partially explaining the divergence in cap rates.

Operating Efficiency and Margins: A crucial internal factor is how efficiently a hotel converts revenue into profit. Two hotels with identical RevPAR can have very different NOI depending on cost structure. Full-service hotels (common in luxury and upper-upscale) typically have multiple revenue departments (rooms, food, beverage, catering, spa, etc.) but also higher expenses in each. Limited-service hotels (common in midscale and upper-midscale select service) primarily earn room revenue, which is high-margin. For example, in U.S. full-service hotels, the rooms department profit margin is around 73% (since direct rooms expenses are only ~27% of rooms revenue), but food & beverage departmental margins are often only ~28% (with F&B expenses ~72% of F&B revenues). This pulls down the overall profitability: industry data show an average EBITDA margin of about 25% for full-service hotels in 2023. In contrast, a limited-service hotel with no restaurant can often achieve EBITDA margins of 35–40% or more, because nearly all revenue is from the highly profitable rooms division. Investors are keenly aware of these differences. Higher operating margins mean a hotel can better withstand revenue dips, and also that more of each revenue dollar translates to NOI (supporting value). Thus, limited/select-service hotels
(Upscale/Midscale) are often seen as more recession-resilient and easier to underwrite, which is appealing in volatile times. Indeed, branded limited-service and select-service hotels have been a favorite of developers and lenders – roughly “70% of rooms under construction are in the lower chain scale categories” (i.e., upscale & below) – precisely because of their relative efficiency and simpler operations. This investor preference can sometimes compress cap rates for newer select-service hotels in good markets (the CBRE Outlook noted newer select-service assets in markets with modest supply growth are among the most attractive targets in 2024). Meanwhile, a full-service resort with many outlets might trade at a higher going-in cap rate if its expenses are cutting into profits or if a buyer sees turnaround potential in improving operations (higher going-in cap can mean the market is pricing it on current depressed earnings with the view of future improvement).
Capital Expenditure Needs: Hotels have high capital expenditure (CapEx) requirements for periodic renovations and brand standards. An investor will factor in upcoming CapEx when evaluating their true return. If a hotel has just been renovated, a buyer might accept a slightly lower cap rate knowing there’s less near-term investment needed. Conversely, an older hotel facing a costly renovation or brand PIP will effectively have a cap rate adjusted upward to account for that expenditure. As noted, some limited-service hotel deals in 2024–25 fell apart because the required PIP after sale would double the effective price per key, making returns unworkable. In such cases, either the seller must drop the price (raising the realized cap rate) or hold off selling. Thus, the condition and CapEx profile of each property introduces dispersion in cap rates even within the same segment.
Location and Market Trends: Real estate is always about location, and hotel cap rates reflect local market prospects. A luxury hotel in New York or San Francisco might trade at a much lower cap rate (perhaps 6–7%) than a similar quality hotel in a tertiary city, because top markets attract global capital and promise stronger long-term demand growth. On the flip side, an economy hotel in a small town might fetch a very high cap rate (>10%) due to limited buyer pool and higher perceived risk, whereas an economy hotel that’s part of a national portfolio sale might go for a bit less. For brevity, our focus here is on national-average segment cap rates, but investors should adjust for specific markets. Notably in 2025, Sunbelt and leisure-heavy markets have seen more investor interest (post-pandemic) than some dense urban markets that are still recovering business travel. That said, by late 2024 and 2025 there was renewed interest in certain urban hotels (for example, large group-oriented hotels in cities with improving convention demand are on investors’ radar). These micro-trends influence cap rate negotiations deal by deal.
With the general drivers outlined, let’s drill down into the cap rate trends and performance metrics for each hotel segment.

Cap Rate Trends by Hotel Segment (Luxury to Economy)

Using national data from the MMCG database as of August 30, 2025, we can see clear distinctions in cap rates and performance across the three broad hotel scale groups: Luxury & Upper Upscale, Upscale & Upper Midscale, and Midscale & Economy. We will examine each in turn, looking at recent cap rate trends, underlying occupancy/ADR/RevPAR performance, and segment-specific factors.

Luxury & Upper Upscale Hotels

Luxury and upper-upscale hotels include high-end brands and full-service properties often located in prime urban centers or resort destinations (examples: Ritz-Carlton, JW Marriott, Four Seasons, Hilton Upper Upscale brands, etc.). These properties cater to affluent leisure travelers, corporate groups, and high-end events, with a heavy emphasis on service and amenities.

Cap Rate Trend: Luxury/UUpper-Upscale hotels command the lowest cap rates among hotel segments. As of 2025, the market cap rate for this segment is around 8.1%. Pre-pandemic, this segment saw cap rates in the mid-7% range (the CoStar price index shows ~7.4–7.7% during 2015–2019). In the pandemic turmoil of 2020, there were few trades, but by 2021 cap rates for high-end hotels dipped to historically low levels (~7.1% average on actual transactions) as the few trades were often high-quality assets and debt was cheap. Since then, cap rates have climbed back above 8%. The data suggests a peak around 2025–2026 at ~8.1–8.2%, with a slight forecasted improvement to 8.0% by 2028–2029. In other words, cap rates for luxury hotels rose roughly 70–100 bps from their trough and are expected to stay around 8% in the near term. These levels are the highest in nearly a decade for this segment. Industry experts foresee that high-end hotel cap rates will “remain above pre-pandemic norms” given the higher debt costs and recent value corrections.

That said, there’s a bifurcation within the segment. Trophy and “irreplaceable” luxury assets can still trade at lower yields. For instance, in 2024 Ryman Hospitality paid $865 million for the JW Marriott Desert Ridge (950 rooms in Arizona), a massive resort asset. The price per key was about $910,000, after the seller had invested $100 million in upgrades. Such premium valuations (including multiple deals topping $1 million per key in 2024) imply cap rates in the mid-single digits for those specific assets, reflecting their strong income and long-term prospects. The fact that “five hotels sold for over $1M/key” in 2024 underscores continued investor appetite at the very high end. REITs like Host Hotels have been active buyers of high-end properties (e.g. Ritz-Carlton in Hawaii, 1 Hotel Central Park NYC), focusing on quality even in a tighter market. These trades are outliers compared to the average, but they pull down the average cap rate and show that capital is available for top-tier hotels – often from institutions betting on long-term asset appreciation.

For the more typical upper-upscale hotel (say a big-box branded hotel in a secondary market), cap rates might be higher than the 8.1% index. Deals for older full-service hotels that need renovation or face slow recovery have been quoted in the 8.5–9.5%+ range by brokers, but many owners are not willing to transact at those levels, leading to the stalemate and low volume noted earlier. The CoStar data YTD 2025 shows an average cap rate of 8.5% on completed luxury/upper-upscale transactions (through mid-year), slightly above the modeled market cap of 8.0%, indicating that the actual deals skewed toward assets with some pricing discount (possibly due to issues or simply reflecting the small sample of trades).

Performance and Outlook: Luxury and upper-upscale hotels were hit hard by the pandemic (occupancies plunged to ~35% in 2020) and have recovered gradually. By 2022, pent-up luxury leisure travel and the beginnings of group/business return boosted this segment – RevPAR in 2022 jumped ~43% as occupancy and ADR bounced back. As of 2025, national occupancy for luxury/upper-upscale is about 67–68% and ADR about $275, yielding a RevPAR around $185. These figures are slightly below 2019’s occupancy (which was 72.5%) but well above 2019’s ADR ($219), meaning high-end hotels have used rate growth to compensate for not fully restored volumes. However, that rate growth has essentially plateaued: through July 2025, ADR was up only ~1.1% year-over-year, and in real (inflation-adjusted) terms, luxury rates are now declining. Group demand in particular has been a soft spot – CoStar notes that group business fell 3% in Q2 2025, reversing its Q1 gains, and has seen four consecutive months of decline through July. This has disproportionately affected upper-upscale hotels that rely on conferences and corporate meetings. The near-term consequence is slower RevPAR growth for luxury hotels at a time when costs are climbing, which pinches margins. Indeed, many full-service luxury properties are facing margin pressures from the labor and insurance issues discussed.

On the positive side, luxury hotels benefit from high guest spending (on F&B, spa, etc.) which boosts total revenue. And as seen in the P&L data, rooms revenue still provides a solid ~70% gross margin to cushion other costs. Many luxury hotels also have a buffer of fees (resort fees, destination fees) and diverse revenue streams that can help drive incremental profit if managed well. Another macro tailwind is the return of international travel: the U.S. is expected to get a surge of overseas visitors in 2025–2026 (with events like the World Cup and hopefully continued easing of travel frictions). Luxury hotels in gateway cities stand to benefit disproportionately if, say, Chinese and European tourists return in force. For example, if international arrivals in 2025–26 climb back toward 2019 levels (an extra 4–5 million visitors, per CBRE’s scenario), that could boost occupancy by over a percentage point nationally, with much of that uplift in high-end urban hotels.

Investment Outlook: Investors in the luxury segment are generally playing a long game. They often underwrite that these assets will appreciate and yield strong total returns over a multi-year hold, even if the initial cap rate is modest. Currently, investor sentiment for high-end hotels is mixed – there’s cautious optimism for well-located “fortress” assets (as evidenced by continued institutional buys in 2024–25), but also concern about slower recovery in corporate travel and high operating costs. The fact that “trophy assets continue to command premium valuations” despite the market slowdown is a good sign for the top of this segment. Looking ahead, if interest rates indeed start to ease by 2025–26 and the cost of capital comes down, luxury hotel cap rates could compress slightly (perhaps back to the high-7% range from low-8% today). The CoStar forecast data implies cap rates might inch back down to ~8.0% by 2028, which aligns with an assumption of gradually improving financing conditions and NOI growth. However, for now around 8% is the norm, and any significant compression would require a combination of economic recovery (driving better NOI growth) and investor risk appetite returning. In the meantime, high-end hotel owners are focusing on margin improvement (to protect NOI in an inflationary environment) and creative revenue strategies, knowing that every dollar of stabilized NOI is extremely valuable under the current cap rate regime.

Upscale & Upper Midscale Hotels

This category encompasses the large cohort of select-service and limited-service hotels that cater to mid-market travelers, including brands like Courtyard, Holiday Inn Express, Hampton Inn (upper midscale), up through Hilton Garden Inn, Marriott, Hyatt Place, etc. (upscale). These hotels typically offer limited meeting space and fewer F&B outlets (often just a breakfast or bar), focusing on the rooms business. They form the backbone of many portfolios and are popular among private investors and REITs alike for their balanced profile of moderate ADRs, decent margins, and broad demand base.

Cap Rate Trend: Nationally, Upscale & Upper Midscale hotel cap rates are averaging ~9.5% in 2025. This is a mid-range cap rate for hotels – higher than luxury, lower than economy. Prior to the pandemic, this segment’s cap rates hovered in the high-8% to low-9% range (the CoStar series shows ~8.4% in 2015, drifting up to ~9.0% by 2019). During the 2020-2021 period, there were limited transactions, but by 2021 the average cap had dipped to ~8.4% (reflecting low interest rates and the popularity of this segment as a recovery play). Since 2022, cap rates have risen again: 2023 saw roughly 9.1%, 2024 ~9.4%, and 2025 ~9.5%. The forecast in CoStar’s data shows a peak of ~9.7% in 2026 followed by a slight ease back to 9.5% by 2027–2029. In essence, this segment’s cap rates have increased by about 100–150 bps from their low and are now at the highest level in a decade, paralleling the overall market trend.

Upscale/upper-mid hotels generally track the overall industry closely in terms of cap rate movement, since they constitute a large share of the market. Importantly, there was significant transaction volume in this segment in the post-pandemic rebound year of 2022: nearly 2,000 sales totaling $17.3B, as investors eagerly acquired these hotels when travel bounced back. The average cap rate then (2022) was about 8.3% (market pricing basis) – quite compressed – thanks to strong competition for assets and readily available debt. Fast forward to 2024, volume fell to $9.3B (just over 1,000 deals) and cap rates moved up to ~9.4%, reflecting the cooling environment. Through mid-2025, around 693 upscale/upper-midscale hotels changed hands (YTD $5.4B) at an average cap in the high-8s to 9% range. The data suggests that by mid-2025, market bid prices imply roughly a 8.8% going-in yield (YTD avg), but the modeled cap rate (for stabilized, market-wide) is still ~9.5%. This discrepancy could mean that many of the YTD trades were either in stronger markets or had upside (hence transacted at slightly lower cap rates), or simply that cap rates are in flux and might still rise. Given interest rates remained high through 2025, it wouldn’t be surprising if cap rates for this segment stay around the mid-9% range into 2026.

Performance and Characteristics: Upscale and upper-midscale hotels have been stalwarts of the recovery. National occupancy for this segment is around 66–67%, and ADR roughly $150, for a RevPAR near $100 as of 2025. These figures indicate a solid return to pre-pandemic performance: in fact, RevPAR slightly exceeds the 2019 level (which was about $89 ADR * 69.6% occ = $62 RevPAR for upper-midscale alone, but combining upscale yields near $100). During the pandemic, this segment didn’t fall as far as luxury (many hotels in this tier served as lodging for essential workers or saw “drive-to” leisure demand). By 2022, upper-midscale hotels saw a huge RevPAR percentage increase (~28% in RevPAR, as per CoStar) thanks to reopening and stimulus-fueled travel, and by 2023 they were essentially back to stable growth. Through mid-2025, however, growth has leveled off: occupancy is flat-to-down slightly (a 0.7% dip YTD) and ADR growth basically nil. So, like the industry at large, upscale/upper-midscale hotels are facing a stalling of RevPAR growth. This is attributed to a mild oversupply in some areas and a consumer trading down to lower price points (or alternative accommodations) in the face of economic uncertainty. Still, this segment’s occupancy (~67%) is the closest to its pre-COVID normal of any segment, indicating a relatively healthy demand base.

An advantage of these hotels is operational simplicity combined with brand strength. They often benefit from loyalty program business (e.g., Marriott Bonvoy or Hilton Honors members filling rooms) and require fewer staff and amenities than luxury hotels. This translates to higher profit margins. While we don’t have a full P&L breakdown in the CoStar data for select-service, industry averages show limited-service hotels can achieve 30-40% EBITDA margins, versus mid-20s% for big full-service properties. Lower labor per guest (no banquets, simpler housekeeping due to limited stayover service, etc.) and limited F&B (often a free breakfast or minimal offerings) keep costs in check. During the labor crisis, these hotels rebounded faster because they had less trouble staffing minimal service levels, whereas resorts and luxury hotels struggled to rehire enough workers to reopen all outlets.

One challenge for this segment is new supply. As noted, roughly 70% of new construction is in the limited/select-service space. As of mid-2025, about 83,700 rooms were under construction in the Upscale & Upper Midscale segment – by far the largest pipeline among the classes. This continual addition of new Courtyards, Hilton Garden Inns, Hampton Inns, etc., can cap occupancy and rate growth, especially in suburban and highway markets. The CoStar data shows ~42,000 rooms in this category were delivered in the past 12 months, increasing room supply by about 1.7%. The pipeline (83k under construction) is equivalent to ~3.4% of existing upscale/upper-midscale inventory, to be delivered likely over the next 1-2 years. That pace of new openings outstrips luxury (which had ~29k under construction, on a much smaller base) and economy (20k under construction). The development of select-service hotels has historically been supported by their favorable economics and lower risk – they’re cheaper and faster to build and can be profitable even at moderate ADRs. However, today’s high interest rates and construction costs have started to constrain development. CoStar notes that overall U.S. hotel rooms under construction fell to about 136,000 as of mid-2025, the lowest in five years. Many projects are shelved because construction loans at “SOFR + 650–750 bps” are “prohibitively expensive”. So, while select-service is still the focus of new builds, the volume is not as high as it would be if financing were easier. For existing owners, this is a silver lining: a slowed pipeline means less competitive pressure on occupancy in the near future, which supports NOI and values.

Investment Outlook: Upscale & upper-midscale hotels are often regarded as the “sweet spot” for many investors. They attract interest from a wide range of buyers – from major REITs and private equity (which like portfolios of Courtyards, Hampton Inns, etc.) to regional owner-operators and 1031 exchange buyers looking for stable cash flow. The segment’s mid-market positioning also means it could fare relatively well if the economy softens (as budget-conscious travelers trade down from luxury, potentially boosting upper-midscale demand). However, if a severe recession hits, all segments will feel pain – so far forecasts are for a mild slowdown, which this segment can likely navigate.

Given the current environment, cap rates around 9–10% make these hotels’ cash yields quite attractive relative to historical norms. In fact, the spread between hotel cap rates and other real estate was noted as narrower recently, meaning hotels haven’t blown out as much as, say, office yields have. For investors with capital, buying an upscale hotel at a 9.5% cap in 2025 – if one believes interest rates will drop in a couple years and that the hotel’s performance will be steady or improving – could prove very lucrative (both from current cash flow and future value uptick when cap rates compress). This logic is likely why we still saw billions in transactions in this segment even in 2024–25, albeit less than in 2021–22.

The near-term outlook per industry analysts is that transaction activity will remain muted until debt costs fall or seller price expectations adjust. We expect cap rates for this segment to hold in the high-9% range over the next 6–12 months. If the Fed starts cutting rates in 2025, there might be a lag but eventually more buyers will step in, possibly compressing cap rates to the low-9% or even high-8% range for high-quality, newer select-service hotels. Also, certain sub-segments like extended-stay hotels (often upper-midscale products like Residence Inn or Homewood Suites) are in high demand due to their resilient performance – these could trade at somewhat lower cap rates than the segment average.

In conclusion, Upscale & Upper Midscale hotels are the workhorses of the industry with broadly appealing risk/return profiles. Their cap rates have risen with the tide, but investor interest remains relatively strong given their operational advantages. Caution around new supply and short-term earnings dips is warranted, but many see this segment as well-positioned for stable performance even in an economic downcycle, which should support valuations once the financial clouds (interest rates) begin to clear.

Midscale & Economy Hotels

Midscale and economy hotels represent the budget end of the market – brands and independents that offer basic accommodations with few frills, targeting cost-conscious travelers, truckers, construction crews, etc. Examples include Quality Inn, Days Inn, Econo Lodge, Red Roof, Super 8, as well as economy extended-stay like Motel 6 Studio 6, and many independent motels across the country. These properties typically have the lowest ADRs and often lower occupancies, but they also operate with very lean staffing and minimal services.

Cap Rate Trend: Not surprisingly, Midscale & Economy hotels have the highest cap rates of the segments. In 2025, the market cap rate for this group is around 10.5%. This is up from roughly 9.0–9.5% in the mid-2010s; for instance, in 2015 the average cap was about 8.4%, rising to ~8.7% in 2018 and then jumping to 9.9% in 2019. Interestingly, CoStar’s model shows an anomalous rise between 2018 and 2019 (8.7% to 9.9%), which may reflect investor concerns at that time about oversupply in limited-service or an anticipation of an economic slowdown (2019 did see the yield curve invert and some pullback in select-service performance, especially with Airbnb rising). During COVID, few economy hotels traded – those that did may have been distress sales at high yields – but by 2021 the data shows cap rates actually dipping to ~9.1% (likely because the economy segment performed relatively well and any trades were at decent pricing). Then as the market normalized, cap rates climbed again: ~9.4% in 2022, 9.9% in 2023, 10.3% in 2024, and now ~10.5% in 2025. Forecasts suggest a peak around 10.6% in 2026 before edging down to ~10.4% by 2028–2029. In short, cap rates for economy hotels are now in the low double-digits, a level not seen since perhaps the aftermath of the Global Financial Crisis. These properties have borne the brunt of rising financing costs and investor skittishness, as they are considered the most risky.

Transaction data underscores this: 2022 saw a record wave of sales in this segment (over 3,100 deals totaling $14.6B) at an average cap rate ~9.4%. Many older roadside motels changed hands as their owners took advantage of the hot post-pandemic market to exit. By 2023, volume fell to $5.5B (about 2,023 deals) and cap rates rose to ~9.9%. In 2024, activity remained high in count (1,768 deals) but a lot of those were smaller transactions; total volume $4.5B, and cap rates around 10.3%. Through mid-2025, a hefty 1,225 economy/midscale hotels sold (likely many small motels) for $2.5B, at an average cap just under 10% (YTD 9.9%). The price-per-room on these trades is very low (YTD ~$53k/key average), which is expected for economy hotels – and the high cap rate is partially a function of that low price relative to operating income. Often these deals involve private buyers (individuals or small firms) rather than large institutions, and financing may come from local banks or SBA loans, which have also become more expensive.

It’s also important to note that within this category, there’s a wide spectrum. Well-located, newer midscale hotels (e.g. a 5-year-old Holiday Inn Express off an interstate) might trade closer to 9% cap, whereas an old 40-room independent motel might only sell at a 12–13% cap or higher if it has operational or condition issues. The averages around 10% reflect a mix. The data showing 10.5% market cap suggests investors generally require a double-digit yield for the perceived risk in this segment in 2025.

Performance and Challenges: By their nature, midscale and economy hotels achieve lower occupancy and ADR than higher segments. Currently, national occupancy for midscale/economy is ~55% and ADR about $87, for a RevPAR around $47-48. These figures are somewhat lower than pre-pandemic – in 2019 this segment was at ~58% occ and $75 ADR (RevPAR ~$44). So ADR has grown (from $75 to $87, which is +16% vs 2019, roughly keeping pace with inflation), but occupancy is still several points below 2019’s level. The occupancy gap implies some loss of market share or demand at the low end, possibly due to competition from upgraded midscale hotels, shift of some customers to alternative accommodations, or closures of certain demand sources (for example, fewer oil-and-gas crews traveling post-pandemic, etc.). Also, leisure travelers who tried nicer hotels with pandemic discounts might be less inclined to go back to budget motels unless necessary, affecting demand.

During the height of COVID, economy extended-stay and motels were relatively resilient – some even had high occupancies housing relief workers, etc. But as of 2023–2025, many of those unique demand sources have dissipated. Meanwhile, inflationary pressures hit lower-end consumers harder: many economy hotels rely on guests who are very price-sensitive (e.g. road trippers on a tight budget, or locals in need of temporary housing). With high gasoline prices, rising rent costs, etc., some of that transient demand may have softened. Additionally, the budget segment has less pricing power – raising ADR from $85 to $95 is a big percentage jump and could drive away customers, so these hotels often lag in rate growth during inflationary times. Indeed, CoStar data shows midscale/Economy ADR in 2024–2025 was flat or even down slightly in real terms (2025 ADR –0.6% vs 2024). That contributed to a small decline in RevPAR YTD 2025 (–1.6%). So while absolute performance is near or slightly above pre-pandemic dollars, momentum has stalled.

On the cost side, economy hotels typically have skeleton crews and minimal amenities, so labor and utilities cost increases, while impactful, are on a smaller base. Many economy properties are owner-operated (family run) which can keep payroll low. However, they are not immune to property insurance spikes or property tax increases, which can hit hard on a limited revenue. Also, many older economy hotels are facing renovation needs to remain branded or competitive. Unlike upscale hotels that could postpone a soft goods renovation a bit, a small motel might lose its flag if it doesn’t upgrade as required – a costly prospect in this inflationary period with high materials costs (exacerbated by tariffs on things like furniture or construction materials). Thus, expenses and required reinvestment can be significant relative to an economy hotel’s small revenue base, which drags on NOI margins.

Operationally, economy hotels can have decent margins percentage-wise (because absolute expenses are low), but the total dollars of profit per room are much smaller. For instance, an 60-room economy hotel at 55% occupancy with $50 RevPAR yields only $1.1 million annual revenue. Even if it runs a 30% EBITDA margin (which would be ~$330k), that may not be enough to cover debt service if the hotel was purchased at a high leverage – especially with today’s interest rates around 7-8%. This is a risk unique to the small asset, small income scenario: many mom-and-pop owners are squeezed by higher interest payments on floating-rate loans or refinances, which might force more sales in this segment. Indeed, distress is creeping up more in economy hotels (e.g. delinquency rates on certain hotel CMBS, often containing limited-service assets, have inched up). Investors factoring in this risk require higher cap rates to compensate.

Investment Outlook: The midscale/economy segment historically offers the highest going-in yields but also the most variability. In good times, these hotels can produce outsized cash flow relative to purchase price, but in downturns their RevPAR can drop quickly and their mostly fixed costs (even if low) mean profit can evaporate. The segment is also highly sensitive to local economic drivers – e.g., one factory closure can tank an independent motel’s performance. Therefore, buyers often underwrite conservative scenarios or demand seller financing to make deals work (especially for independent motels where financing from banks can be tricky).

In 2024–2025, a lot of the transaction activity in this segment has been smaller deals, possibly reflecting older owners exiting. The higher cap rates (10%+) indicate that buyers are pricing in a lot of risk and/or needed improvements. Some experienced investors find value here by picking up under-managed motels at high cap rates and then renovating or rebranding them to boost performance, effectively “flipping” them at a lower cap rate later. But that strategy is harder when interest and construction costs are high.

From a portfolio perspective, large investors have mostly focused on the top two segments; however, there is interest in certain economy/select-service niches like economy extended-stay (e.g. Woodspring Suites, Extended Stay America) because those have proven very resilient and can run at 40-50% margins with weekly rentals. Such assets might actually trade at cap rates closer to 8-9% despite being “economy,” due to their strong NOI profile. So one must distinguish sub-types.

Overall, expect cap rates for midscale/economy hotels to stay around 10% or above until there’s clear evidence of improving fundamentals or cheaper capital. The CoStar projection of easing to ~10.4% by 2028 likely assumes some recovery in this segment’s performance and better financing. But if a recession hits lower-end travel harder, we could even see cap rates temporarily spike higher (with fewer buyers except at distressed pricing). One positive factor: limited new supply in this segment. Only ~20,000 rooms are under construction in midscale/economy nationally, a modest pipeline (for context that’s <1% of the existing stock of 2 million economy/midscale rooms). Developers have largely moved upmarket or into extended-stay; building new economy hotels is relatively unattractive now due to high costs and low ADRs. This supply constraint should help existing economy hotels maintain their occupancy levels in the long run, assuming demand remains steady or grows with population.

In summary, midscale and economy hotels offer high yields but come with greater risk and often require intense hands-on management. The current market reflects that, with double-digit cap rates prevalent. Astute investors may find opportunities in this space, especially when buying well below replacement cost (which is almost always the case for economy – you can often buy at 50% of what it would cost to build new, or less). But the success of those investments will hinge on micro-market dynamics and the investor’s ability to run a tight ship operationally. Many will continue to monitor this segment but perhaps hold off aggressive buying until financing costs ease or distress creates even more compelling prices.

Operational Economics and Margin Performance in Full-Service Hotels

An important aspect of understanding hotel cap rates – especially when comparing segments – is the difference in operational economics between full-service hotels and limited-service hotels. As hinted earlier, full-service properties (common in Luxury & Upper Upscale, and some Upscale) have multiple revenue streams, but also complex cost structures that result in lower net profit margins. Limited and select-service properties (common in Upper Midscale and Economy) focus on the rooms department, which has higher margins, thereby often yielding better profit percentages.

According to data from the MMCG database, in Full-Service Hotels (which typically include luxury, upper-upscale, and many upscale convention hotels), the breakdown of revenues and expenses is roughly as follows:

Rooms Revenue: ~63% of total revenue on average for full-service hotels. This is by far the largest contributor to revenue. The direct operating expense for the rooms department is about 27% of rooms revenue, implying a 73% gross margin for room sales. This high margin underscores why the rooms business is so critical – it effectively subsidizes other departments.
Food & Beverage (F&B) Revenue: Combining restaurants, bars, banquets, and other F&B outlets, F&B can be ~28% of total revenue in full-service hotels (16% food, 5% beverage, ~7% other F&B). However, the cost of F&B is very high: roughly 72% of F&B revenue goes to departmental expenses (cost of goods, kitchen and service staff, etc.). This yields only a ~28% departmental margin for F&B operations – much thinner than rooms. In our 2023 sample P&L, food department expense was 71.8% of food revenue, and beverage 7.1% (likely beverage cost of sales is lower percentage, but when combined with labor it was similar order). Overall, F&B contributes to revenue but almost not at all to profit in many cases. It’s mainly offered as an amenity/expectation for guests, or to drive higher room rates and group business (e.g., hosting banquets and conferences). Some full-service hotels actually lose money in their restaurants but consider it a cost of being a full-service property.
Other Revenues: Minor departments like spa, parking, gift shop, etc., and miscellaneous income (resort fees, cancellation fees, etc.) make up a small portion (~8–10% of revenue combined). These often have varied margins; for instance, spa could have high labor costs; resort fees have nearly 100% margin. But collectively, they don’t move the needle much on total profits.
Undistributed Operating Expenses: These are costs not tied to one revenue department – administrative & general, sales & marketing, maintenance, utilities, etc. For a typical full-service hotel, these can total ~20-25% of revenue. In our example, Admin & General was 8.4%, Sales & Marketing 8.2%, Maintenance 4.4%, Utilities 3.1%, etc.. These expenses are necessary overhead to run the property and don’t scale down easily with lower occupancy (they are more fixed in nature).

After all departmental and undistributed expenses, the Gross Operating Profit (GOP) margin for full-service hotels is about 34.7% of revenue in the 2023 data. Then, deducting management fees (usually ~3% of revenue) and an allowance for fixed costs like property taxes, insurance, and ground lease or rent, we arrive at EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization) or NOI. The sample shows EBITDA at 24.7% of revenue for 2023. This indicates roughly a quarter of every revenue dollar is true operating profit available to pay debt or equity – a fairly slim margin compared to other real estate like apartments (which often have 50%+ expense margins but with far less revenue volatility). It also shows why high revenue growth is needed to significantly boost hotel net income: so many costs chip away at revenue.

Full-Service vs. Limited-Service: In a limited-service hotel (no restaurant, no banquet space), the revenue is nearly all rooms and maybe a small bit of miscellaneous. The expense profile is leaner: rooms department expenses might be similar (~25-30% of revenue), but there’s no F&B department eating up 70% of its revenue. Undistributed expenses (A&G, etc.) might be lower in absolute terms too, since a 100-room limited-service hotel can operate with a much smaller management team than a 500-room big-box hotel. As a result, it’s not uncommon for a limited-service hotel to have a GOP margin in the 45-55% range and an EBITDA margin in the 35-45% range (after paying a franchise fee and management). Those higher margins mean that for every $1 of revenue, the limited-service hotel turns more of it into profit. Therefore, even if its ADR and RevPAR are lower than a luxury hotel, it might have comparable NOI per room relative to its value.

Investors love this aspect of select-service: more profit reliability and less complexity. It’s one reason that in valuations, many buyers will pay almost as low a cap rate for a well-performing upscale limited-service hotel as they would for an upper-upscale full-service, even though the latter has higher room rates. The trade-off is that full-service hotels have the potential for higher total revenue per room (with F&B, etc.), which, if managed exceptionally, can lead to higher absolute profits. They also have perhaps more long-term upside if one can improve operations or if market conditions allow both rooms and banquet business to flourish simultaneously (leading to big flow-through of revenue to profit). But such upside comes with volatility and execution risk.

Case in point: Full-service hotels saw huge profit swings during COVID; many went deeply negative when revenues collapsed (they still had to maintain certain staff, security, upkeep of big buildings). Limited-service hotels were quicker to break even with just modest occupancy because their cost breakeven is lower. This reinforces investor perception that limited-service is lower risk. That said, a top-tier full-service asset in a prime location may have irreplaceable value – something a limited-service hotel rarely has. Thus the valuation has to weigh cash flow vs asset prestige and long-term potential.

For cap rates, typically a full-service hotel might trade at a higher cap rate than a select-service in the same market if the full-service’s current performance is weaker or its costs are out of line. However, if the full-service is a trophy asset with a strong stabilized cash flow, it could conversely trade at a lower cap (because of the aforementioned trophy premium). In general, however, the broad trend in recent years has been investors gravitating to higher-margin assets. Many big hotel owners like REITs rebalanced portfolios to shed lower-tier full-service hotels (where returns were lagging) and acquire more select-service or luxury resort assets where they saw better margins or barriers to entry.

To highlight an example: food and beverage contribution in full-service hotels averages about 28% of revenue, but contributes effectively 0% to EBITDA after its costs. In contrast, a limited-service hotel that provides perhaps a free simple breakfast might count the cost of that in rooms expense, and there’s no separate revenue, so it’s just part of the 27% rooms cost. The limited-service model essentially converts what would have been F&B revenue (and associated labor) into either no revenue (if free breakfast) or outsourced revenue (if there’s a leased restaurant space, for instance). This often improves profitability or at least risk-adjusts it in favor of the owner.

Rising costs impact on margins: It’s worth noting that labor and other costs have grown faster for full-service hotelsin the last year, squeezing their margins more than limited-service. For example, total labor as a percentage of revenue in the full-service sample climbed to 34.8% in 2023 (up from 32.4% the year prior). Limited-service hotels, with far fewer employees per room, felt the labor cost increase too, but on a smaller absolute base. Similarly, insurance and property taxes hit large full-service assets (often located in city centers with high taxes) harder in dollar terms. These factors cause some investors to demand a premium (higher cap rate) for full-service assets unless they can be bought at a discount or repositioned.

Management Intensity: Another consideration is that full-service hotels usually require professional management companies, whereas an economy hotel might be run by an owner-operator. This difference can influence who is willing to invest. Some private buyers avoid full-service because they don’t want the complication of managing 200 staff and multiple departments; they prefer a hands-off limited-service with maybe 20 staff, or even a triple-net lease scenario if available. Institutional investors do have the capacity to manage full-service but they scrutinize management performance closely. If a full-service hotel is poorly run, its NOI might lag the potential – which, ironically, can present an opportunity (investors can buy at a higher cap rate and then improve operations to create value).

In the context of cap rates, a hotel with low margins effectively has a lower NOI relative to its top-line, which can put upward pressure on its cap rate (since buyers may price to a certain yield on revenue, not just NOI, if they think NOI is under-optimized). Conversely, a hotel with high margins can justify a lower cap rate because each dollar of revenue carries through to more cash flow.

In summary, understanding the operational differences explains why not all RevPAR dollars are equal and why segment cap rates differ. Luxury/upper-upscale full-service hotels might generate double the RevPAR of an upscale select-service hotel, but if much of that extra revenue is eaten by expenses, the end result (NOI per room) could be similar, yet the luxury hotel might still trade at a lower cap due to its long-term growth prospects or real estate value. Investors weigh these factors – and in 2025, many are clearly favoring the operationally efficient models given the margin pressures in the industry. As a result, cap rates have risen most for the properties where costs are surging and less for those that can run lean.

Impact of Construction Pipeline and Transaction Activity on Cap Rates

Beyond the internal dynamics of hotels, supply and investment market liquidity play a role in asset pricing. Let’s touch on how the construction pipeline and recent transaction trends influence hotel cap rates:

New Supply Pipeline: The threat of new competition can affect cap rates. If investors know that a market is about to get a bunch of new hotels, they may demand a higher cap rate for existing properties to offset the risk of future occupancy/ADR pressure. Nationally, the hotel construction pipeline has been constrained in recent years. As of mid-2025, about 136,000 rooms are under construction in the U.S., down from ~212,000 pre-COVID. For twenty consecutive quarters, the number of rooms in construction stayed in a narrow band (150k–160k), but it has now declined further due to developers facing difficulty financing projects in a high-rate environment.

Construction loans at terms like SOFR + 6.5–7.5% (and only 65% loan-to-cost) are “prohibitively expensive for many developers”, leading them to defer projects. This means future hotel supply growth is slowing – good news for owners of existing hotels. CoStar notes that as of July 2025, some developers are waiting for “interest rate reductions” before proceeding, meaning some pipeline projects are effectively on hold in planning. The pipeline composition also matters: as mentioned, ~70% of the pipeline is limited or select-service, which means segments like upscale and midscale will see more new competition, whereas luxury supply growth is minimal (and often requires special circumstances like mixed-use with condos to pencil out).

Implication for cap rates: With supply growth muted, existing hotels have a better chance to increase occupancy and rates over time, which can improve NOI prospects. This can help keep cap rates in check (or even compress them) because investors see less risk of oversupply undermining future earnings. For example, the fact that “the number of rooms under construction has dropped to its lowest level in five years” is a supportive factor for hotel valuations broadly. It’s one reason that despite economic headwinds, the hotel industry hasn’t seen fire-sale pricing – many owners know that replacement cost is high and new competition is limited, so they are holding out for better days. In contrast, if we were in a building boom with thousands of new rooms coming online, buyers would be far more demanding on cap rates to compensate for the coming fight for market share.

That said, supply effects are local. Some markets still have substantial pipelines (e.g., Nashville, Austin had many hotels under construction), which does put pressure on asset pricing in those markets. National cap rate averages might not fully capture that nuance, but a savvy investor will adjust yield requirements based on local supply outlook. Also, construction costs skyrocketing (partly due to tariffs and labor shortages) means replacement cost per key is very high in 2025. This often sets a floor on values – if it costs $200k per room to build a new midscale hotel, an investor might feel comfortable buying an existing one at $100k per room even if current NOI implies, say, a 10% cap, because they’re buying at half of replacement. As long as the asset isn’t obsolescent, that can be a value play expecting that eventually either earnings will grow or a new build would need much higher ADR to be worth it. Thus, ironically, the freeze in development could make existing hotels more attractive assets in the medium term and potentially compress cap rates once interest costs abate.

Transaction Volume and Liquidity: The liquidity of the hotel investment market influences cap rates as well. In a liquid market with many buyers and sellers, pricing tends to be more efficient and competitive (cap rates lower). In an illiquid market, buyers demand a premium for difficulty of exit (cap rates higher). The last couple of years have seen declining transaction volume – U.S. hotel sales went from an all-time high of $64B in 2022 (post-pandemic catch-up, including some big portfolio sales) to $25.5B in 2023 and about $22–23B (projected) in 2024. In 2025, volume is trending even lower; Q2 2025 was just $5B, down from $6B in Q2 2024. High interest rates are the main cause, as noted: “persistently high interest rates have depressed deal activity”, and 2024 was the second year of volume decline. With fewer deals, price discovery is harder – it’s challenging to appraise an asset when comparables are scarce. This often leads to a widening bid-ask spread: sellers anchor to prior valuations, while buyers underwrite with pessimistic assumptions and higher financing costs, resulting in lower offers. Many deals just don’t transact unless there’s distress or a motivated reason.

The CoStar report highlights some reasons deals do happen: pressure on private equity funds (Limited Partners wanting their money back as funds reach end-of-life) can compel General Partners to sell assets even at less-than-ideal prices. So far this dynamic has not flooded the market, but each passing quarter likely brings more motivated sellers who need liquidity. Another factor: some owners are finding alternatives to selling, such as refinancing through the rebounding CMBS market or other debt sources. In 2024, CMBS issuance for hotels surged to $20B (more than 2022-2023 combined), providing some owners the ability to refinance at around 7% all-in rates (SOFR + ~275). This is still high interest, but for many it’s preferable to selling at a punishing cap rate. Thus, liquidity from debt markets has reduced the urgency to sell for some, ironically tightening the supply of hotels for sale and helping hold the line on pricing to some degree.

Implication for cap rates: The currently low transaction volume likely means cap rates we see are a bit notional – they reflect either the best assets that can still trade or distressed deals. If/when volume picks up (say interest rates fall and buyers come back), we might see a flurry of trades that re-rate the market. If that influx of trades is mostly from eager buyers, cap rates could compress quickly. Alternatively, if it’s due to forced sales (sellers capitulating), cap rates could even tick higher in the short run until the excess is absorbed. The investor sentiment mentioned is key – if sentiment turns positive (e.g., belief that the Fed will cut rates and the economy will have a soft landing), we could see capital pour in, which would drive cap rates down (bidding up prices) especially for quality assets. Conversely, if a recession hits and there’s distress, some high cap rate sales could reset comps lower, hurting valuations broadly.

For now, the market seems to be in a holding pattern: “continued optimism expressed by brokers” at conferences, but deals still hard to pencil due to the bid-ask gap. Brokers often talk about a lot of dry powder (ready capital) on the sidelines waiting for the right moment. When clarity improves (perhaps in late 2025 or 2026 if interest rates are clearly trending down), we may see those investors step off the sidelines. That could mean a relatively rapid shift in cap rates for hotels – historically, hotel cap rates can move faster than other real estate classes in both directions, given hotels’ short lease nature and high sensitivity to the economy.

Also, as noted in Hotelsmag’s piece, hotel cap rate spreads to Treasurys normalized by Q1 2024. If Treasury yields drop but hotel cap rates initially lag, that spread could widen again, flagging a potential opportunity for investors. Many will be watching macro signals for the right timing.

In essence, low new supply and tight transaction supply have been stabilizing forces for hotel values in a difficult environment. They prevent a free-fall in pricing. However, the flip side is low liquidity – which some investors dislike. The situation is dynamic: any change in interest rates or economic outlook could quickly alter buyer/seller behavior.

For now (August 2025), we summarize the scenario as: Hotel cap rates are elevated (luxury ~8%, upscale ~9.5%, economy ~10.5%) due to high interest rates and cost pressures, but further increases have been tempered by limited new competition and reluctant sellers. If economic conditions improve and financing costs decline, we expect more buyers to re-engage, which could drive cap rates down modestly, especially for the segments with better growth prospects (likely upper upscale and upscale select-service). Conversely, if interest rates stay higher for longer or the economy worsens, cap rates might inch up a bit more, predominantly in the more vulnerable midscale/economy segment.

Conclusion

Hotel cap rates in the United States have undergone a significant upward shift from the ultra-low levels of the late 2010s and pandemic recovery period. As of 2025, cap rates are hovering around the 8% range for Luxury/Upscalehotels and 9–10%+ for Midscale/Economy hotels, reflecting a re-pricing of risk and return in the face of higher interest rates, operating cost inflation, and moderate growth prospects. We’ve seen how these cap rates are calculated (NOI divided by value) and influenced by a web of factors:

Macro forces: High benchmark interest rates and expensive debt have been a key driver pushing cap rates up. Economic uncertainty and inflation concerns further add to investor required yields. Until there’s confidence in a lower interest rate regime and more robust demand, cap rates are likely to remain elevated above pre-2020 norms.
Sector-specific performance: Slower RevPAR growth and rising labor/insurance costs in 2024–2025 have squeezed hotel profits, putting upward pressure on cap rates as investors won’t pay yesterday’s prices for today’s thinner margins. Segment-wise, luxury hotels enjoy strong ADRs but face higher expense ratios, whereas limited-service hotels boast better margins but have less pricing power – these nuances are reflected in the spread between low and high-end cap rates.
Operational dynamics: Full-service hotels with multiple revenue streams operate at lower EBITDA margins (~25%), making their valuations more sensitive to cost escalations. Select-service hotels with simpler operations often maintain higher margins, which investors reward with comparatively lower cap rates given the cash flow stability.
External factors: Everything from tariff policies to labor availability to alternative lodging (Airbnb) can sway hotel fundamentals and investor sentiment. For instance, tariff-driven construction cost increases slow down new supply (a boon for existing assets), but tariff-related travel reductions can hurt demand in certain markets. Meanwhile, high insurance premiums and wages are eroding profits, which investors carefully factor into their underwriting.
Market cycle and liquidity: The hotel investment market is in a low-liquidity phase – many owners are holding off selling due to unfavorable pricing, and many buyers are on the sidelines waiting for either distress or cheaper debt. This has prevented forced sales from flooding the market (so far), thereby preventing a dramatic spike in cap rates, but it also means transaction evidence is thin. When the logjam breaks (whether due to economic improvement or mounting pressure on owners), the next wave of trades will set the tone for cap rates.

Looking ahead, most analysts expect cap rates to stay relatively high in the near term, then potentially compress slightly if interest rates ease by 2025–2026. The CoStar/MMCG forecast implies that 2025–2026 might mark the peak cap rate levels, with modest declines (perhaps 20–50 bps) by the end of the decade as conditions normalize. However, cap rates are unlikely to return to the historic lows of 2019 anytime soon. The phrase “new reality” has been used to describe a market where debt costs and risk premiums are structurally higher than the 2010s, suggesting investors should underwrite with more conservative exit cap rate assumptions.

For investors, higher cap rates today mean higher going-in yields, which can be attractive if one believes in the long-term resilience of hotels. After all, hotels are cyclically risky but also have the ability to reset rates daily – which is a hedge against inflation in the long run (room rates can be increased as the price level rises, unlike a long-term lease). The challenge is navigating the short-term cross-currents: ensuring the asset can cover its debt at current interest rates and that it’s acquired at a basis that accounts for any needed CapEx or operational improvements. The dispersion in cap rates across segments offers choices based on risk appetite: from stable-but-expensive luxury assets at ~8% to high-yield but operationally intensive economy motels at 10%+.

In conclusion, the state of U.S. hotel cap rates in 2025 is a story of recalibration. Investors are seeking a balance between opportunity and risk: the industry’s recovery has largely occurred, but growth is muted and costs are up, so underwriting is cautious. Yet, hotels remain a unique asset class with the potential for outsized returns when the cycle turns. Many are positioning for the eventual easing of interest rates and a fuller travel rebound (with catalysts like global events and the return of international visitors on the horizon). In the meantime, cap rates are doing what they should in an uncertain climate – providing a higher yield to entice investment. As the playing field changes – be it through Fed policy, supply-demand shifts, or global events – hotel cap rates will continue to be a critical barometer of market sentiment and asset value in this dynamic sector.

August 30, 2025, by Michal Mohelsky, J.D., principal of MMCG INvest, LLC, Hotel feasibility study consultant

Sources:

MMCG Invest, LLC database

HVS Research – insights on interest rates and cap rate relationships (2024)

Hotelsmag/CBRE – hotel cap rate spreads and investment risk analysis

CBRE Hotels Outlook 2024 – industry trends and average cap rate

Investopedia – definition of capitalization rate