This market snapshot is part of a series of articles that HVS produces on key hotel sectors across Africa. Our analysis is based on data sourced from reports and articles from the internet from various writers.
- Ethiopia benefits from a strong economy driven by the agriculture and manufacturing sectors. According to The Daily Maverick, “Over the last decade, Ethiopia has emerged as one of the fastest-growing – perhaps the fastest-growing – economies in Africa. Even though ‘double-digit’ growth has become something of an official mantra, independent appraisals still put it at over ten percent from 2003-13, double the sub-Saharan average. Growth is driven, rather, by a determined government policy of creating the conditions for development, notably through a massive level of infrastructural investment.”
- Ethiopia’s travel and tourism sector is still in a growth phase, and is largely supported by infrastructure improvements. The number of domestic trips reached 8.1 million, while international trips reached 681,000 in 2013 according to figures from the Ministry of Culture and Tourism (MoCT), the main source countries for which were China, the US, Nigeria, Sudan and Belgium. Over the foreseeable future, the sector is expected to record growth in the volume of inbound and outbound tourists as Ethiopian Airlines establishes new routes, increases flight capacity and launches airfare discounts;
- Meetings, Conferences, Congresses and market segment statistics showed a sharp increase from 15,721 to 47,516 arrivals from 2008 to 2009. The numbers dropped to 36,145 in 2010 but again rose to 50,531 in 2011. Ethiopia remains a major conference destination, according to the International Congress and Convention Association the country has achieved a global rating of 93rd and African ranking of 11th.
- The MICE sector in Addis Ababa has potential to grow substantially over the years due to the large diplomatic community and expanding economy. Africa’s global market share in the Meeting industry is only 3.3%, and within this much smaller market, Ethiopia is largely absent according to Managing Director of OZZIE Business & Hospitality Group, Mr Kumneger Teketel;
- Ethiopia’s primary hotel industry is to be found in Addis Ababa. There the hotels experience occupancies that are in the 80% region, and this is due to the high demand and lagging supply. Addis Ababa hotels have recently been reported to be achieving the highest room rates on the continent;
Hotel Demand Patterns
Politics and Economics
The Ethiopian economy has enjoyed sustainable double digit and broad-based growth. In 2012/13, real GDP grew by 9.7 percent, moderately higher than the previous year. In the first four years of Growth and Transformation Plan I (GTP-I) implementation, the GDP had grown on average by about 10.1 percent per annum. This achievement is slightly lower than 11.2 percent annual average growth rate target set for the entire GTP-I period. It should be noted that according to the reporter Ethiopia.com the Government of Ethiopia is set to unveil the second five-year plan–the Growth and Transformation Plan (GTP II)–which is believed to be more realistic and less ambitious when compared to its predecessor, GTP I. The first GTP, which failed to meet its target in various sectors, ended on July 7 July 2015.
Ethiopia’s economy is based on agriculture, which accounts for about 43% of the gross domestic product (GDP), 90% of foreign currency earnings, and 85% of employment. Generally, the overall economic growth of the country has been highly associated with the performance of the agriculture sector.
The industrial sector, which mainly comprises of small and medium enterprises, accounts for about 12.4% of GDP. Similarly, the service sector comprised of social services, trade, hotels and restaurants, finance, real estate, etc. accounts for about 45% of GDP. A strong fiscal stance, particularly measures taken towards improving tax administration and enforcement, improved the overall fiscal position. The fiscal deficit remains within an acceptable threshold albeit widened from 1.2% of GDP.
Due to the investment-friendly environment created in the country, the inflow of foreign direct investment (FDI) has been increasing over the last twenty-two years. Accordingly, out of the total investment projects licensed between 1992- 2012, FDI’s share is about 16%. The overall trend of investment since 2012, both the total number of projects and capital invested have shown slight increase.
Airport Demand & Border Crossings
International tourism arrival figures as measured at Bole Airport have shown a steady increase in the past decade. According to the Airports Council International the total passenger movements have increased from 1,3 million in 2003 to 8,85 million in 2013, a compound annual growth rate of 21%. During the same period international passengers have increased at a CAGR of 14,3% and domestic passengers by a CAGR of 26,5%.
Further opportunities to increase tourism figures can be generated through the Africa Open Skies policy as contained in the Yamoussoukro Decision of 1999. The Yamoussoukro Decision committed 44 signatory countries to deregulating air services and to opening regional air markets to transnational competition. The implementation of this agreement, however, has been slow, and the benefits have not been realized.
An independent study by InterVISTAS has calculated that through the implementation of the Africa Open Skies, Ethiopia can potentially attract 55,000 more tourist visits and generate 14,800 additional airline industry employment as well as 59.8 million US dollars of GDP.
|Arrivals of tourists at Ethiopia’s borders, by purpose of visit|
|Leisure, recreation and holidays||128,533||99,394||138,070||171,414||183,008|
|Visiting friends and relatives||26,337||25,482||35,593||28,672||37,116|
Bole International Airport is the largest airport in Ethiopia and is the home of Ethiopian Airlines, which is reported to have already become the largest airline in Africa based on fleet size, and could overtake South African Airways in 2015 as the largest based on passengers carried. The airline has also been reported to have purchased an additional fleet of aircraft to boost its capacity.
A capital project to expand the airport was embarked upon in 2012, and this is expected to be completed in 2018.
The tourism industry is growing because of Government commitment to provide an enabling environment. Enormous opportunities exist for tourism investment in international standard eco-tourism, specialised international restaurants and guided and independent tours.
Potential foreign investors can take full advantage of these opportunities through direct investments or joint ventures with Ethiopians. Opportunities also exist in this sector in the construction of star-designated hotels and resort hotels all over the country.
The direct contribution of Travel & Tourism to GDP was 4.1% of total GDP in 2014, and is forecast to rise by 1.2% in 2015, and to rise by 4.7% pa, from 2015-2025 to 3.3% of total GDP in 2025. In 2014 Travel & Tourism directly supported 979,000 jobs (3.6% of total employment). Visitor exports generated 35.4% of total exports in 2014 and this is forecast to fall by 1.8% in 2015, and grow by 4.0% pa, from 2015-2025. Travel & Tourism investment in 2014 was 3.7% of total investment. It should rise by 4.6% in 2015, and rise by 4.6% pa over the next ten years to 2.9% of total investment in 2025.
Hotel Performance and Seasonality
The Ethiopian climate is considered to be suitable for all-year round tourism. The country’s rich cultural heritage, its peace-loving population and its position as the head office of the African Union helps Ethiopia to attract all tourism market segments all-year round. Over time, in the medium to long term future, the Ethiopian hotel industry will mature to a level where hotel industry statistics will be available to assist in the measurement of performance and seasonality.
Demand & Supply
The stock of hotels in Ethiopia has increased sharply over the last few years. While tourist accommodation is available as the major attraction, improvement as well as new construction is taking place. The GTP’s target on the number of tourist arrivals by the end of 2014/15 was set at 1 million in-bound tourist arrivals. The total number of hotel rooms and beds of all hotel establishments in Ethiopia was 19,025 and 24,083, respectively in 2011. A total of 37 investors have taken investment permit in Addis Ababa alone to construct hotels with star ratings in 2012/13. Furthermore, the projected unsatisfied demand for hotel single night rooms in Ethiopia in the years 2015 and 2020 is forecast at 1.3 million and 3.1 million, respectively. Awash International Bank note, in line with this, sectoral distribution of outstanding loans of the banking system in Ethiopia indicated that credit to hotels sector accounted for an insignificant amount of 2% in 2010 and 1.85% in 2011. Therefore, improvements of the banking system in extending credit services would be helpful for the hotel industry.
According to AFKInsider, Addis Ababa has the most expensive hotels on the continent. This is not surprising as Ethiopia is undersupplied with hotels for the amount of demand the country is experiencing. On the other hand, it has been forecast through various research studies that the unsatisfied demand for hotel nights in Ethiopia will be 1.3 million in 2015, giving out a warning that the figure could rise to over 3 million by 2020 if new hotels are not built, according to SEA Africa. From the foregoing, it is clear that it will be quite a long time before room rates start to normalize in line with comparative countries.
At the end of the 2014 AHIF, it was announced that many hotel development agreements were signed between the various industry participants and conference delegates. “The burgeoning nation now has the prospect of seeing its international hotel brands growing to 10, with the signing of six agreements between international hotel management groups and Ethiopian real estate owners”.
There were six agreements in all for international hotel brands in Ethiopia. Marriott has had a deal with Sunshine Construction for the past four years, and their hotel, located on Cameroun Street, is expected to begin operations in 2015. The Louvre Hotel Groups has already opened Golden Tulip Addis; Tsemex and Intercontinental Hotels Group to open the Crowne Plazza Addis; Wyndham Hotel Group and ADM Business Plc for the Ramada Addis Hotel; Accor Hotel Group with Enyi General Business for the Pullman Addis Hotel and Best Western International with Great Abyssinia Plc and Noah Real Estate for the Best Western Plus and Best Western hotels. All these hotels are expected to be opened between 2015 and 2017, with the next year seeing Crowne Plaza, Marriott and Ramada Addis coming into business. Last on the list will be Pullman Addis in 2017.
Hotel Investment and Values
In 2012 the HVI reported a room value average of $290,759 for Addis Ababa, which rose the following year to $301,739. In 2014 the average room value for Addis Ababa dropped to $294,478, which translates to -2.4%, against a rise of 3.8% the previous year. We anticipate the growth in the market, through increased demand and the supply of high quality hotels will ensure the value of hotels in Addis Ababa and Ethiopia generally remains high and significantly ahead of the African average.
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For further information about the services of the Cape Town office, please contact Tim Smith, Managing Partner, +27 797 342296, email@example.com or Tshepo Makhudu, Senior Consultant, +2782 301 4572, firstname.lastname@example.org
About the Authors
Tim Smith, MRICS, is Managing Partner of our Cape Town office, focusing on the Sub-Saharan market. He graduated from De Montfort University with a degree in Estate Management and has worked for firms of chartered surveyors since 1995, focusing on the valuation and sale of hotels and other leisure property throughout the EMEA region.
Tshepo Makhudu is a senior consultant in our Cape Town office. He has many years of property industry experience in development, management, finance and strategic consulting. He has held employment at leading property, banking and telecommunications multi-national institutions. Most notably he worked in the hospitality industry during the most vibrant era of the industry in South Africa, with a responsibility for the efficient delivery of hotel and casino development projects. Tshepo studied commerce and property development and management at leading universities in South Africa and received leadership training in the USA.
The store window is the first thing that the visitor notices about your store. Therefore, you want to be as innovative and clear in your branding for the window as you can. There are a lot of unique options to brand your glass. We describe a few commonly used ways to brand your glass and the materials used in the process. You can use them in isolation or combination for your own store.
1. Color vinyl cutting: Plotter cut self-adhesive vinyl into the shape of letters, logos and messages is an age-old technique that allows you to deliver your message without obstructing the view inside the store. We have all used these to make sale announcements, advertise new products and notify costumers about new seasons. But the problem is that it is dull and overused.
2. Translucent prints: Digital prints on translucent vinyls can be conveniently pasted on glass. They can also be cut outs as per your creative. The major benefit here is that you can have a large creative, maybe cover the glass top to bottom and also allow the customers to look what’s going on inside , behind the glass. It doesn’t make the glass seem like a wall but an entry into a new dimension of awesome drool-worthy (aka your) products.
3. Opaque creatives: While translucent prints are great, it is possible, that they might not make enough impact as a solid opaque print would. The limitation here is that you must keep the size small so that your glass still allows inside activity to be seen. This kind of effect is achieved by printing on opaque self-adhesive vinyl (with our without a cut out) and pasting it directly onto the glass.
4. Etching Vinyl: Frosted/Etching self-adhesive vinyl was invented to give clear glass a etched look. Frosting is a physical process done on glass that makes selected portions rough and opaque. This film nicely emulates that quite well. The frosted film can be cut into any shape and can be used to represent your brand logo or your branding message. Further, this vinyl can be printed and it gives a really unique result in terms of aesthetics.
5. One way vision: The one-way-vision/mesh printed vinyl contains a mesh-like structure. The speciality of this material is that from the outside it looks like a solid print (maybe around 75% opacity) but from the inside of the store everything outside is visible. This is a good option if you want to print huge creatives and cover the whole window. If your store is inside a mall or has a good amount of lighting inside, the opacity from outside further reduces (approximately around 50%).
Since you now know the basic tools to brand your glass, ask your design team to play around with these ideas and create something unique to showcase your brand and it’s identity.
About the author: Maniraj Singh Juneja is the MD at Amitoje India. His company provides retail printing and branding services in Delhi, India to a huge number of retail companies. Feel free to contact them for questions or followups.
E-commerce is trending but what seems like a “low-investment-fast-growth” business idea to entrepreneurs might not be an accurate assumption. Treat this not as discouragement to start something new, but as a caution note from a person who has faced/seen people facing such problems. If you do have time and money, invest it into something everyone else is not doing. E-commerce is becoming cluttered very quickly and this creates only problems. Read on to understand the major pitfalls of e-commerce as it exists today. These simple points will help you understand the problems a novice entrepreneur or a retail will face when stepping into e-commerce.
1. Capital Intensive: E-commerce is retail in disguise. In fact, it is a bigger, hungrier form of physical retail and all the troubles like warehousing, inventory and supply chain come along. An e-commerce store is expected to have a larger range and as well as cheaper prices. Plus delivery times are always an issue so stocking inventory becomes a must in most cases – and here comes in the role of capital. So either start looking out for investors (which is not an easy task unless you’re a big-shot) or get ready to invest huge sums of your own money. But wait, if you have huge sums of money, why are you throwing it down the e-commerce drain? Buy some gold.
2. Low profit margin: This comes as a shock to anyone outside the e-commerce industry but is obvious to people inside – everyone in India (where I am from) is currently bleeding investor money. Everyone is making a loss. Even the biggest names you hear in the industry (yeah, all the karts, marts, hearts etc) are burning millions every month to acquire customers, reach a massive scale and waiting for others to die out before they can start making any profits. They’re taking returns, replacing products and pampering the consumer while bearing all these expenses just to become larger. There are several reasons why good profit margin is a far-fetched dream for companies:
a. Unit economics: The biggest mistake any uninformed entrepreneur could make is the negligence of contributions like payment gateway cost, packaging cost, shipping and handling cost and effective cataloging cost of articles to the overall margin. In e-commerce, the sourcing margins and effective margins are very different mostly because of these costs. Thus some articles are a better fit for e-commerce and some are not since even on very huge volumes, unit economics don’t work out to be positive. If the selling price of the item is low (and hence absolute sourcing margin is also low), the gateway charges, packaging, shipping and cataloging cost will easily overpower the margin and hence lead to a loss in the transaction.
To head one’s head around this, I coined a term called profit density defined as the ratio of sourcing margin to the additional e-commerce costs incurred in selling it (a major contribution of which is usually shipping cost). Profit densities are different for different categories of products. Books and beauty products have an extremely low profit density and real jewellery and apparel have a relatively high profit density. But since the universe has the habit of leveling things out, items with high profit densities are slow movers and harder to sell online and one’s with low densities are quicker and easier.
b. Cash on delivery: Since it has now become almost necessary to offer a cash on delivery service, it is very counter intuitive to know that all logistic companies actually charge to collect cash on your behalf. They actually charge a huge fixed amount (could vary from as Rs. 30 to Rs. 150 (that’s 0.5 to 2.5 USD) or sometimes even more per package depending on the provider, total volumes offered and also package value) to use your cash! This strongly degrades the unit economics.
Secondly, we all know how valuable cash is for a startup and in such an arrangement a lot of your cash-flow is stuck with the logistic company because they will take a certain amount of time to remit the money they’ve collected on your behalf.
Thirdly, almost always the logistic service provider will actually owe you more money (the cash they collected) than you owe them for delivery, thus making dealing with them a little more difficult (read hell).
Fourthly, customers are much more likely to return packages in cash on delivery cases since they haven’t paid for it. Post which the business has to incur double the shipping cost, lose out on precious inventory for a long time and still maybe end up with something that cannot be sold again, and a customer who will never buy again.
c. Lost, damaged articles: Business owners forget to take into account lost and damaged articles – which neither the service provider nor the customer will be liable for. Who else is left to bear the burden of lost/damaged inventory? This is especially harmful when you’re counting on low margins with huge volumes.
d. Competition: Consumers expect you to be the cheapest. Since you’re on the Internet, you save on the rent of a physical storefront and can pass on that benefit to the customer (very faulty premise which every customer carries in his/her mind). Moreover, pricing on the internet is very transparent so you have to keep a rock solid heart and offer the lowest margins humanly possible. In fact, cash rich competition will also sell at a loss just to drive you out of business. Competition will do everything – low prices, expensive advertisement, relaxed return policies, free shipping etc and these things start becoming must-haves instead of differentiators.
3. Logistics co-ordination and reconciliation: Since you cannot deliver everywhere all by yourself (at least initially), you will need to be dependent on logistic service providers. Fortunately or unfortunately, the performance of your service provider will determine the goodwill you create with your customer. It is certain that you will lose good and loyal customers due to a 3rd party’s poor performance and there is nothing you will be able to do about it. Customers will call your company and your operators will be recipients of heavy verbal abuse from disgruntled customers. Your operator will have no answer because they don’t know what has become of the package after it left your premises. Account reconciliation with service providers is also a similar harrowing experience wherein every kind of case and exception that can arise, will arise. Moreover, each provider will have its own format of reconciliation and reporting which you will need to adapt to.
4. Super strict IT requirements: If one of your founders is not a tech genius, quit right now. IT is the backbone of an e-commerce company and you will need it at every nook and corner of your business. The tech team will need to understand the entire business from end-to-end and develop technology to support every operation along the way. This is one section where mediocrity will fail you badly. An e-commerce company is not just “a website” which firms will make for a few thousand rupees. If you have any intention of making it big, don’t ever think of outsourcing this.
5. Marketing and SEO: Are you a marketing genius? Are you full of ideas on how to sell your product? Can you see how the current companies are doing it wrong? Think again. Marketing for an e-commerce company is a completely different ball game. It requires more of tech knowledge than anything else. You will hear terms like SEO, SEM, SMM floating around in the market and you might not understand them completely, but since you trust your marketing gut you’re brave enough to venture out into an unknown territory. The smarter choice is to keep someone who’s experienced in the field of online marketing close to you or of course to experience and learn yourself. The even smarter choice is to understand that it’s not the same as regular marketing! There are many ways of getting traffic and sales on your site, but they will require a lot of expertise, experimentation, analytics, research and dollars. Ranking #1 on google is like snatching flesh from a hungry lion – it’s hard!
In e-commerce marketing, there are only two aims to fulfill. Generate trust (by highlighting USPs and being persistent) and make yourself discoverable (bring traffic). The former will need time and effort, the latter needs money. In the competitive market out there today, advertising online has become so expensive recovering your spend seems utopian. Again, if you just started up without investor money you will face huge problems in this regard because today the online consumer has unlimited choices to buy from. If you already have raised investor money then there’s no point reading this – you can’t back out now.
6. Vendor management: If you’re thinking of sourcing from various vendors, you might be fine in the short term but this becomes a huge issue when the numbers increase. Every brand/manufacturer/distributor will have their own styles of packing, logistics, billing and measurement. Reconciling all of them is not insurmountable but a very cumbersome task. It is not possible to have everything in stock and usually you will end up accepting orders for items not in your inventory. Vendors in India will never be able to provide a synchronization system wherein you will be able to understand if item is actually in stock even with your supplier(s) for a long time to come. Moreover, manufacturing defects will then become your headache since you’re the seller and your goodwill is at stake now.
If you are a manufacturer and want to extend your physical store, this might not apply but the other problems still live unscathed. But even in that case since you cannot produce everything, you will ultimately end up sourcing from other suppliers. The better solution might be to become a vendor to already established e-commerce websites.
7. Distribution networks: If you want to sell grocery, pharmacy or other items wherein you plan to tie up with retailers, be aware that you will always end up with a very rough experience for the customer. The operations are hugely manual and hence cumbersome and delivery time is of utmost importance.
E-commerce is currently booming and everyone wants to start a website to sell stuff. What people miss are some subtle points that make e-commerce a difficult creature to rein. A genuine question that arises is that if no one is making profit, why are people continuing, why are investors investing and why are new e-shops opening everyday. The truth is everyone is playing the top-line game – not worrying about the bottom-lines at this moment. Companies want to increase their top-lines to a very large scale and rule their respective markets post which their marketing spend would decrease and a huge customer pool would have been accumulated. Beyond this point profitability would be possible but there would only be a handful survivors.
The only exit strategy that remains for e-commerce companies is either an acquisition or an IPO. Fire sales and shutdowns happen all the time but they’re not noticed by a lot of people – examples are Letsbuy and Taggle. So if you’re fully convinced that e-commerce is your life path, best of luck but be very cautious of the problems described above.
What’s your opinion?
About the author: Maniraj Singh Juneja is an experienced entrepreneur and director at Amitoje India – India’s leading retail/POP branding and execution firms. You can visit http://www.amitoje.com to know more. Write to maniraj[at]amitoje[dot]com. He founded an e-commerce company called madeinhealth which later got acquired by a larger player.
Is it conceivable that some day in the future we will be able to visit retail facilities like shopping malls without leaving the comfort of our homes? I would dare to suggest that this is not at all inconceivable. Recent and certainly and ever accelerating technological advancements have made this type of project possible. At the alpha or prototype development phase such technologies exist. An example of this is the “Twister”, which allows users to experience a three-dimensional, true-to-life reality of their travel plans and wishes through the use of multimedia virtual reality technologies and the Internet. What are the reasons that would possibly make it a compelling case for a company to embark on such a project and the shopper to support it commercially? Would such a project find place in the retail space and possibly create competition for shopping facilities? Well, let us briefly look at the retail environment over the past few years.
The recent financial crisis, which has recently started to look like it would be making a return, has devastated many jobs and slashed many disposable incomes through job losses. Consumers have as a result opted to reduce their spending drastically, if not by force. Tied to the financial crises of individuals, travel to the retail facility is increasingly being seen as a luxury. Most retail facilities are well designed in terms of parking facilities and the entry and exit thereof, whereas others are just a major challenge and a headache. For those that are more environmentally conscious, the prospect of putting more greenhouse gases into the atmosphere is most repugnant if one can do most of their shopping online.
The article entitled “Online boom set to boost SA commerce” which was published on page eight of the Sunday Times of 8th August 2011 provides some evidence of the online shopping phenomenon that is sweeping the South African shopping landscape. A most recent article was published on http://www.eprop, the trusted and one of the most frequented property websites in South Africa entitled The Online Retail Red Herring? This title might be a bit misleading as the fact of online shopping is a reality, even as the content therein attests to such.
In 1995, probably earlier, the Internet spread much fear and anxiety among many property owners, investors and retailers alike. They started to imagine a world where their customers would stop patronising their facilities, preferring instead to do all their shopping via the Internet. Back then, the internet was still in its infancy. Data was extremely expensive and browsing speeds were nothing like the kind of speeds we are getting today, and these need to improve some more. The Telkom monopoly was well-entrenched and the industry was completely hamstrung. The industry has now been deregulated to some extent and new players are bringing about increased competitiveness. Whereas this fear may have been overstated then, now it should be taken a bit more seriously.
The following maps illustrate the proliferation of data cables that have recently been landed on our shores. We have all been watching much excavation taking place on our pavements as the fibre network is being extended in rapid fashion in line with the submarine cables. The satellite footprint on the continent is also spreading, albeit with some latency issues. The alternatives are starting to become widely available. Seacom has recently reported that it will invest some R100 million in their submarine cable due to increasing demand. On the other hand, access to this increasing capacity is being facilitated by the latest technologies consumer devices like smartphones and tablets. The cherry on top is that these gadgets are getting better and simpler to use.
Submarine Cables To South Africa
Satellite Footprint – Southern Africa
The reality that now faces retailers and investors alike is that in addition to the risk factors that impact on the sustainable lifespan of a new building now include economic obsolescence arising as a result of technological advancement. The concept of “online retail morphology” is increasingly looking like a reality. Internet hotspots are proliferating. There is now talk of a wireless Internet standard the could make a 31000 kilometre radius hotspot possible. Whilst it seems like a long shot idea, who is to say that some or other company could not take advantage of such an idea and make profitable business out of it? The concept of Cloud Computing has started to gain a foothold on the South African business landscape. For example a recent article spoke about a relationship that was entered into between an online shopping website and a leading regional supermall in Gauteng. This company, Africa Trade Route, proposes a “cloud computing” type of concept, whereby they “offer space to existing shop owners…who want to penetrate the online market”.
Retailing seems to be “morphing” online, slowly but surely. There is no need for it to happen at the expense of retail facilities.
The Department of Rural Development and Land Reform has marked the Development Facilitation Act No. 67 of 1995 (DFA) for repeal. This particular piece of legislation had as its main objective the acceleration of the delivery of housing to the poor of South Africa, post the first democratic elections of 1994. The DFA became necessary because the process of approving land use applications, under the control of municipal authorities across all property types, was painfully slow. Despite the promulgation of the DFA, housing delivery has not caught up with the growing population numbers of the targeted population sector. In the meantime, however commercial and high value residential developments accelerated at an unprecedented pace in one of the largest property booms in South Africa, to the dissatisfaction of the municipal managers.
During the period 1998 to 2007, South Africa experienced an unprecedented property boom. This anti-poor property boom brought about the current conflict between the DFA and the legacy legislation, this being the Townships Ordinance 15 of 1986 – anti poor because it did not assist in the provision of housing for them while diverting bulk services to these luxury developments. It did create some temporary job opportunities in the construction sector though.
When the DFA was enacted the Ordinance was not repealed. The drafters at the time hoped that for the sake of meeting the promises made to the electorate, the two pieces would co-exist harmoniously side by side. The other reason for not repealing the Ordinance was that the target areas where the accelerated development was required did not have town planning schemes, which the established suburbs had. On the other hand DFA had time frames were incorporated in its provisions within which the municipalities were forced to have reached certain milestones in the application assessment process.
The DFA however ended up being used by commercial and luxury residential developers to circumvent the townships ordinance to get approval for their developments. Clearly, the target population could not benefit from the latter’s developments. Even worse, these developments were perceived to be creating urban sprawl and bulk utility services were being rapidly depleted, to the detriment of the target communities. Such a state of affairs is not how the politicians wanted things to go, so the DFA had to go.
The municipal planners and the politicians were now of one mind in that the DFA did not meet their needs. The municipal authorities went to the law courts where they lost some major cases and the DFA stayed, if only for a while. This Act is about to be replaced by the Spatial Development Act of 2011, currently in the Draft Bill stage. Only time will tell whether this new piece of legislation will go the full distance to becoming an Act of Parliament. A very important Bill was also put through Parliament some five years ago, by the name of the Government Immovable Asset Management Act, but it was never enacted. Another important government initiative which was started but never seen through is the Urban Renewal Project in the Tshwane Central Business District.
Municipal planners and developers will always be positioned on opposite poles of human behaviour. While developers have traditionally been seen as the evildoers who have excessive profits as their only motive, at the expense of the public, municipal planners and environmentalists have been seen as the defenders of the public good. Certainly with the last property boom most developers did make superprofits, however, the ancillary costs, such as land holding costs during a lengthy low activity period, were also very high. Consumer behaviour is something very difficult, if not impossible to plan for. Developers are people who have chosen a career path of studying consumer behaviour and then planning for meeting people needs well in advance. For this, they are often required to take extreme risks, for which it is only fair that they are rewarded accordingly. Authorities and planners can never dictate the direction of development. Their duty should be the guidance of the development process in order to create a harmonious environment for the benefit of all society, be it the end-user or the supplier. If the municipal planners were truly dynamic, then there would not have been a need for the DFA after all.
The DFA is a very effective piece of legislation. It has helped to facilitate one of the strongest property booms in South Africa. It did a good of exposing the weaknesses inherent in the Ordinance. It remains to be seen how the new Bill will consolidate the strengths of and minimise the weaknesses of the DFA and the Ordinance to take advantage of worthwhile development opportunities.
Real options are increasingly being promoted in the academic world for use by developers to make more informed decisions on the timing of property development and the valuation of development land. The proponents of the theory propose that property development investments provide developers with several options that can increase value through flexibility of decision-making.
Decision-making under conditions of uncertainty requires managers to make financial decisions that affect the future, whilst they are unable to predict future events with absolute certainty. Any decisions that are being made now assume a certain amount of inefficiencies arising from the risk of making a partially incorrect decision due to the inability of managers to predict the future with absolute certainty. The converse statement to this is that one can wait a bit longer for more information to make better decisions, which delay gives rise to an option. Real options theory claims to be able to value the option contained in this delay.
Various decision-making methods, like the discounted cash flows (DCF) are used extensively to forecast the future. One of the most common DCF techniques is the net present value (NPV) technique. This technique holds that an NPV calculation that returns only a positive result means that a development should go ahead. An NPV calculation only uses information that is known at the time of the calculation, whereas property development is an at-least 50-year decision. NPV evaluates a development project as if it will be completed, regardless of whether they it still makes sense mid way through the project or not. Cash flow and discount rate variables change over time and as a result the NPV should also change. A project that may look positive now may not be attractive a few months later and vice versa, thereby increasing the chance that the wrong decision can still be made.
Property development is an extremely complex activity which involves significant numbers of people and skills, utilising extensive resources over an extended period, for the provision of physical buildings in the future. It all starts with the provision of development land. The most popular method of valuing the land component in a development is the residual valuation method. Briefly, this method works by calculating the development’s NPV and confirming that the project should be embarked upon. Thereafter the building cost must be subtracted from the total investment outlay, thereby arriving at the residual value of the land. It therefore not scientific in that it works in reverse logic.
Other questions arise when the DCF is used, for example: what discount rate should be used on the future cash flows? What are the variables used to build up the discount rate? What time period must the calculation be done over? How is the risk premium to be calculated? Practitioners often do away with the complexities of the NPV and dispense with the investment decision by capitalising the first year’s projected net income with an appropriate rate to arrive at a value estimate.
NPV gives no indication as to when the decision should be implemented, whereas real options can help with such a determination. The decision as to when to proceed with a particular development has generally been based on the position of the rental growth curve in relation to the building cost growth curve, as observed over a period of time. However, the exact timing as to when this condition will be reached and for how long it will last can never be predicted accurately. Another trigger used to to time hotel development is to observe what is called the hurdle rate, and again, as with NPV, once discount rates get used then the chance exists that an incorrect decision could be made. The hurdle rate is tied to to the company’s cost of capital.
Real options mean various things to various people. The synthesis below explains what they say about real options as they could be applied to property development. In finance, an option is a contract between a buyer and a seller that gives the buyer of the option the right, but not the obligation, to buy or to sell a specified asset (underlying) on or before the option’s expiration time, at an agreed price, the strike price. Real options are an off-shoot of financial options, and can be defined thus: A situation in which an investor is able to choose between two different decision options where both choices involve tangible assets, such as real estate. Real options allow developers the ability to treat vacant lots of land as options to wait to develop. By considering developments which provide the ability to react accordingly to the uncertainty of future forces, developers can better manage the risk associated with a potential weak market while also gaining the potential to benefit in a strong one. Flexibility of this type in real estate is generally known as a real option. Real options add value to a project by providing developers with flexibility to minimize downside risk or take advantage of upside potential as conditions change from deterministic expectations. The model proposed values these managerial flexibilities and shows improved risk management, identifying the optimal strategy and timing for the construction phases.
The assumption with NPV is that the investment decision must be made now or never. However, many projects create future opportunities or threats, which may be a significant source of value or loss. These opportunities can be modelled as real options. With this view, an investment decision can be considered as a call option. The value of the project is just the value of the option to invest. The exercise price is the cost of the investment, and the gross option return is the discounted expected value of the investment returns. This option is exercised when the gross return is high enough. The DCF method fails to evaluate this option correctly.
Short term land speculators also use options extensively whereby they pay a fixed sum to a seller of a prime parcel of land, subject to a higher, final payment should a development be proceeded with on the land. If the development does not go ahead then the option lapses and the land reverts to the seller, together with the initial payment. This is a powerful example of how options can be used in property development. However if the entire development decision is treated as an option, even better land-banking decisions can be made. Banks have, much less now than in the past, used financial options to facilitate loans to their blue chip corporate clients for property developments. Real options are different in that the option is integral to the entire development and the valuation methods used to value the options do not rely on discounted cash flow analyses.
Real options use some intricate mathematical tools, which are not the subject matter of this article, to value the subject land and the development. Suffice it to say that the list includes decision-tree analysis with probability theory, binomial theory, derivatives and stochastic processes and others. However the techniques seem to cover most of the abstract mathematical concepts that DCF does not cover. Perhaps in a later article I will attempt to explain the mechanics of the proposed theory works in practice.
The flexibility inherent in real options is the cornerstone of this theory in that it allows developers to make better decisions as they have the option to delay making a decision. The abandonment option is a problem because most construction contracts do not allow for abandonment, especially when the contract is of the fast-track kind. The disadvantages of real options at the moment are that developers are still content to use the NPV. South African developers are not quick at adopting new methods of doing things, as evidenced by the slow adoption of the NEC construction contract documents.
Real options theory has been written about extensively in property development journals. Some reputable Universities are teaching real options as part of their property education curricula. Through the way that real options promise to deal with the problems inherent in NPV analysis, developers should at least look to see if its applicability in their projects can be justified.