International Sporting Events – Takeaways for Hotel Investors

Introduction

There is no doubt hosting a major sporting event boosts the profile of the country and city.  Who does not want to visit Rio after the recent FIFA World Cup and Olympics?  However, these events are only for a few weeks and even allowing for a year of visits from sponsors and managers in the lead up to the event and the boost to demand once the curtain comes down and the television cameras depart, does hosting an international sporting event justify building new hotels?

In this article, we review the possible impact of hosting the Commonwealth Games on the city of Durban and provide some advice for would be hotel investors.  We also share some of the lessons from the 2010 World Cup in South Africa, the London Olympics 2012, the 2014 World Cup and the Rio Olympics.

The Commonwealth Games and Durban

In a BBC article two years ago, the last Commonwealth Games in Glasgow in 2014 was listed as the fifth largest global sporting event.  They attracted 1,300,000 spectators to watch 4,820 athletes from 71 nations.  Television coverage was taken to 90 countries.  The next edition of the ‘friendly games’, as they are known is in Gold Coast Australia in 2018.

The Commonwealth Games 2022 have been awarded to Durban, South Africa. However, there are rumours that the city is facing the real prospect of losing the right to host the Games. This instability is not good news for investors who had been readying themselves to enter the Durban landscape with new hotel developments since the hosting announcement was made.  We assume this insecurity will soon be lifted and all parties can plan for a successful event.

Durban has hotels, swimming beaches, stadia and wonderful weather all year round. Hotel performance has not been stellar in the past couple of years however, with the city still having to work off the oversupply from the 2010 FIFA World Cup.  As things stand, the event will coincide with the countrywide Municipal and Local elections in 2022, and this may or may not interfere with the city’s ability to host a successful event.

PERCENTAGE CHANGE IN HOTEL VALUE PER ROOM

The HVS Hotel Valuation Index 2016 graph below illustrates the trend in hotel values since 2010, and it can be seen how these have suffered between 2010 and 2016. This can be attributed to the bedroom oversupply that affected all the major centres in South Africa.  Values are reported in US$. The weakness of the Rand against the Dollar also contributed to the poor performance. Over the seven-year period from 2010 to 2016 the CAGR for value is -6.1% for Durban, which compares to -2.2% for Johannesburg and 4% for Cape Town.

durbanchart

What Can We Learn from Past Events?

In 2010 FIFA was reported to have block-booked more than 450,000 bed-nights long before the start of the event in an effort to regulate room rates prior to the Games. This was also done before the devastating financial crisis of 2008 and 2009 and due to this, many prospective sports followers cancelled their planned trips into South Africa. However, since many new hotel development projects were kick-started shortly after the hosting announcement and before the financial crisis, a hotel room oversupply resulted.

London is a mature tourism market with a stable tourism flow. Wary that this stability would be disrupted, the organising committee block-booked hotel rooms prior to the Summer Olympics of 2012 and released them to the market closer to the start of the event. Average Daily Room Rate during the Games was up 86.1% compared to the same days the prior year, whilst occupancy was recorded at 88,5% for London hotels. RevPAR also increased during the same period, according to data from STR. So how did London manage to host such a successful event for the hotel industry? The answer lay in how the city kept a lid on building new hotels, and rather worked on adjusting the room rate to increase performance.

Leading up to the start of the 2014 FIFA World Cup, tour operators who had years before bought blocks of rooms, were desperately offloading their spare capacity. Discount rates of more than 40% were not unheard of. As in the case South Africa in 2010, FIFA’s accommodation partner, Match Hospitality, prior to the event, released unsold rooms it had previously block-booked. The unfortunate result was that some World Cup hotel room prices dropped to half of the levels the hoteliers were achieving two years before. Overall, hotels in Brazil saw a 50.1% ADR increase in June and a 36.1% ADR increase in July; occupancy levels across all host cities decreased when compared to 2013; Brazil saw a two percent supply increase in June 2014 on a 12-month-moving-average basis, according to reported STR statistics.

On the other hand, the 2016 Olympic Games in Rio de Janeiro were successful not only on the sporting front, but on the hotel performance side as well. Media reports leading up to the Games were dominated by the devastating impact of the Zika virus, with the resultant withdrawal of some athletes from across the world, and the political turmoil involving the Brazilian president. Despite these hurdles, Rio hotels achieved good performance ratings during the games. STR has reported a 199.2% surge in average daily rate for Rio hotels during the games. The combination of this growth in rate and a 26.6% increase in occupancy to 76%, brought about a 278.6% increase in Revenue per available room. These are glowing statistics and it is generally held that Rio hotels outperformed London hotels during the previous Olympic Games of 2012. The key point to note however is that Rio was oversupplied with hotel rooms leading up to the games and this supply overhang is likely to negatively impact occupancies in the future. STR has estimated this bedroom oversupply at 23% more than a year earlier.

How Are Other Host Cities Preparing for Future Games?

The FIFA World Cup 2018 will be hosted by Russia; Tokyo will be receiving visitors to Japan for the Summer Olympics in 2020, and the FIFA World Cup 2022 will be held in Qatar. With prospects of many thousands of visitors, hoteliers are hoping to make significant profits from hosting the Games. Hotel investors are also eyeing superior returns from new properties that are entering these markets. These countries’ and cities’ organizers would do well to heed the lessons from previous international events.

Russia’s foreign political landscape, the exclusion of its top athletes from the Rio Olympics and the FIFA corruption scandals relating to how Russia won the rights to host the 2018 World Cup do not bode well for the country’s prospects to host an untainted event. On the other hand, Hotel News Now has recently reported that “the end of uncertainty in the Russian economy coupled with growth of occupancy and other performance indicators might increase the number of new hotel projects in Moscow and Saint Petersburg between 2016 and 2018”.

STR has previously reported that the Tokyo hotel industry is a high performer, with “some of the highest occupancy levels globally and with rates continuing to rise – all against the back drop of limited supply in the pipeline”. This situation could be an indication that the hotel market in Tokyo will be lucrative for hotel investors as large numbers of visitors are expected to flock to the city for the Games in 2020. The proviso however is that the delicate balance between supply and demand should be respected always.

Conclusion

Hotel investments are by nature very cyclical, therefore a delicate balance needs to be struck between the variables of supply and demand. International events can throw this balance out, and market players that can skilfully navigate these events can extract maximum benefit. To ensure that Durban hotels derive maximum benefit from hosting the Commonwealth Games in 2022, it is essential that hotel supply is kept at reasonable levels. A six-week event does not justify a $20 million investment in a new hotel, however to time the opening of a new hotel with such an event can massively help with cash flow management in the tricky first year of operation.  Durban hotels may not enjoy a 280% increase in RevPAR that Rio managed for the Olympic Games last year, but a substantial increase should be achievable.

However, perhaps the biggest bonus for all current and future hotels in the city is four years of international marketing reminding people of all the attractions Durban has to offer. The hotel industry can have a huge impact on the success of the games.  It is therefore imperative that the hotel industry is properly represented in the organising committee to ensure both the success of the games and the long-term success of the hotel industry learn from recent events.

ENDS

HVS Cape Town: Hotel assets attract investor interest

The hospitality sector is poised for significant growth because of strong interest in local hotel assets, says global hospitality consulting and services group HVS.

According to the World Travel and Tourism Council, the direct contribution of travel and tourism to GDP in SA was R113.4bn in 2014 (3% of GDP). The contribution is expected to grow 4.6% per annum to R184.7bn (3.4% of GDP) by 2025, reflecting the economic activity generated by industries such as hotels and airlines.

HVS managing partner in Cape Town Tim Smith said on Friday, 15 July, that there was a real demand from prospective hotel investors for local assets. There was also optimism that the industry on the continent would grow, he said.

It was this potential that had led to the decision by HVS to set up shop in Cape Town as a springboard into the rest of Africa, Smith said. HVS undertakes valuations for new ventures and handles feasibility studies.

Smith said that following the post-World Cup slowdown, more companies and individuals had overcome doubts about risk and were prepared to invest in hotels. Occupancies reached a low of 53% in 2011, compared with 72% in 2007 before the global downturn.

“After the 2010 World Cup, there were too many hotel rooms and it took four years for the oversupply to be absorbed “¦ in the past two years, trading has been positive,” Smith said.

The Carlson Rezidor Hotel Group’s Marc Descrozaille announced in June that two new hotels would open in Cape Town in the next 10 months and another in Polokwane, highlighting the multibillion-rand investment the group is making in SA. Descrozaille said the company hoped to build 20 hotels in Africa by 2020.

The Hospitality Outlook: 2014-18 report by PwC says that although SA’s economy is facing headwinds, the hospitality sector is poised for growth in the next five years, in the wake of a number of inbound travellers into the continent.

Source: Business Day

Sun International subsidiary scraps development in South Africa

Casino developer Emfuleni Resorts (Pty) Ltd has decided to abandon its plan for a mixed-use development, which included a casino, on vacant land in Port Elizabeth, South Africa adjoining the Boardwalk Precinct.
The decision by the Summerstrand, South Africa-based subsidy of Sun International Ltd. (SUI:SJ), was made after a condition of their plan, the extension of the Boardwalk’s casino license, was not issued by the Eastern Cape Gambling and Betting Board. The current casino license expires in nine years and amendment of its 15-year term for an additional 20 years by the Gambling Board would have given the investors security to go forward with their development plans, according to InterGame.The development would have created 8,500 jobs and included a retail shopping mall and an events and entertainment venue. In addition, a 2,000sq.m Magic Company FEC, with cinemas, laser tag, and tenpin bowling, was also part of the plan for the location.

Had the ZAR1.3bn (€80m) development plan come to fruition, it would have been the city’s largest single investment in hospitality and tourism to date.

In other South Africa news, the decision by Rob Davies, the country’s minister of trade and industry, to award a new casino license to the province of North West has drawn criticism from operators and could face a court challenge.

Real Options And Property Development Decision Making

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.

Property Investment 101 – The Property Syndication Lesson

The recent reports and comments involving a very prominent property syndication company provide a case in point. Due to the inability of this company to make a mandatory distribution to its investors recently, various commentators have not lost the opportunity to criticise the property syndication investment model as being bad for investors. The main critics blame the lack of liquidity in the model for the said company’s problems. I do not believe that is a fair criticism for many reasons, some of which I will attempt to outline below.

Wikipedia defines liquidity as follows: “A liquid asset has some or more of the following features. It can be sold rapidly, with minimal loss of value, any time within market hours”. Property by its very nature is very illiquid. Bricks and mortar, unlike equities, cannot be turned over a short space of time. Too many variables enter the equation here. Timing is one of the most important of these. Entering and exiting the market has to be timed perfectly. It is said that a property investment cycle unfolds over seven-year periods. So it takes quite a long time for investors to start realising any serious benefits. Or, as some would say, property is a long term investment.

During this time, investors can either leave their returns in the investment or withdraw them every month. If they choose to withdraw their distributions, then they forfeit the capital growth that accrues to the investment as a result of compounded growth. In such a case then at the end of their investment period they can withdraw their capital subject to the ravages of inflation, or the time value of money. Over a period more than seven years, an investor who has left their funds in the investment are typically rewarded with a positive balance. So, such an investor would have enjoyed a monthly “dividend” plus capital growth.

Investors who are in property investments for the long haul by and large come out as winners. Advisors who direct their retired clients towards property investments when the latter cannot afford the time required to realise full benefits are doing the industry a disservice.

Long term investments, such as property syndications, do not as a rule generate “superprofits” from the annuity income from the property. However, in the long term, investors do realise very good returns. One of the reasons is that most urban environments do become attractive for other investors and they also inject their capital into the area. Those who entered the market earlier at a lower price can then sell their holdings at the appreciated price.

The liquidity argument sounds like a contradiction in terms because the long term nature of property investments is that your capital is tied down in the property for a long time. So, there is no point in looking for liquidity where it is not likely to exist. The problem with leaving capital tied down for long periods of time in any asset class is that risk also increases correspondingly. However, property is generally considered to be a “safe bet”, or as they say, property is as “safe as houses”. So, in theory, the timing risk should be adequately mitigated by the safety factor.

Property Unit Trusts were set up specifically to counter the problem of lack of liquidity in property investments. Legally, PUT operators are required to distribute their properties’ income minus expenses to investors every month. Also, investors purchase shares or linked units in the fund rather an indivisible share in the property, as in the case of property syndications. So, if an investor was to require immediate cash, then they could easily sell their shares at the ruling price on the Stock Exchange, just like they always do with equities. In contrast, investors who are interested in the physical asset would put their capital into a property syndication rather than in shares. The syndication brings together people who want to invest in commercial and retail property but cannot afford exclusive ownership in their individual right because of the large amounts involved.

Property syndications are likely to be successful when investments are made into an existing property, as opposed to when a company develops a brand new building. This is because with an existing building, the majority of costs that are payable upfront in any building have already been dispensed with. In a new development, most tenants have to invest large amounts of capital expenditure upfront, on which they have to pay financing costs and earn a quick return. Every cent that the landlord gets from the tenant has to be fought for with others. This puts pressure on rental negotiations, including turnover rentals.

When it comes to property developments, timing is of the essence too. The development profit equation is quite easy to follow – development income less development cost gives development profit. The most difficult thing in attaining maximum profit is to conduct proper research. If a developer starts a multimillion Rand development when building costs are very high, probably the highest in recent history, then the projected profits are not likely to materialise. On the other hand, when the tenant market is depressed, as most recent reports have highlighted, profits are likely to be squeezed even further.

Existing buildings are also far more preferable to new developments due to the certainty that a firmly established property management regime brings about. The process of running a management operation on a large property is a daunting task. The level of uncertainty that is brought about by forecasting the running costs of a new building can rattle even some of the most seasoned property management companies.

As with all other investment classes, the standing rules of investing in property have to be followed meticulously, otherwise the investment is likely to fail. To blame the property syndication model for failed investments when the rules were not followed properly is not fair.