While Australian hotels may have been slow to transact in recent times, a pick-up in activity is expected in the coming months
SOUTH-EAST Asian investors are starting to scour Australia's hotel market in the hopes of finding similar value to the hotel investments they made in the mid-1990s. It can be said that Asian investors were net real estate buyers between 1994 and 2003 before turning into net sellers between 2003 and 2006. That sell period was correlated to an improvement in hotel performances, lifting asset values, together with an appreciation of the Australian currency. This resulted in investors realising handsome capital gains when repatriating the funds back to their homeland.
Fast forward to September 2009 and a repeat cyclical trend may possibly be emerging. Indeed, as identified in the table above, all of the major hotel transactions that took place over the last 12 months are attributable to South-east Asian investors including Singapore's Hotel Grand Central, Thailand's TCC Land and Malaysia's TA Enterprises Berhad. Notwithstanding the sale of the Westin Melbourne, hotels have transacted between A$190,000 and A$320,000 (S$234,717 and S$395,313) per room. Based on anecdotal evidence, this would appear to represent an, at times, steep discount by reference to full replacement value (after factoring land cost).
Cushman & Wakefield is aware of a number of hotel properties available to investors, both on and off-market, at the 'right' price. While Australian hotels may have been slow to transact in recent times, a pick-up in activity is expected in the coming months. But let us first ask the obvious questions - why hospitality and why Australia?
Australian hotel investment - land of opportunity?
The hospitality industry holds a very distinct space in the real estate sector. Indeed, while hotels are located within a physical structure, much in the same way offices are, the similarity ends there. Hotels are businesses with income levels varying on a daily basis for a number of reasons: some in - and some out of - the manager's control. Such potential unpredictability in the income pattern can cause nervousness among investors. However, following careful analysis, investors in the hospitality industry can reap significant rewards in terms of total returns as well as diversification within an asset portfolio.
As with most industries, the hospitality sector overall suffered some setback in recent times, although the extent of the impact has differed depending on the type of market. However, in line with the overall economy, some 'green shoots' are starting to appear, which may open the doors for astute investors to enter the sector. The following paragraphs will concentrate on the Australian hospitality industry overall and that of its four main cities - Sydney, Melbourne, Brisbane and Perth - in particular.
Firstly, let us take ourselves back a few short years to a time when credit and capital was relatively readily available and investors' sentiments were sky-high.
The 'old' paradigm
The 'old' paradigm is a combination of circumstances that resulted in most hotel assets increasing in value:
Strong performance levels in the form of rising occupancy and achieved average room rates (ARR), which led to increasing revenue and Ebitda;
Competitive lending conditions whereby banks and financial institutions relaxed some of their investment parameters in the form of higher loan-to-value ratios (LVR); and
Positive investment sentiment towards the hospitality sector illustrated by a number of Australian institutions taking a position in the sector. As a consequence, a number of assets transacted, culminating in December 2007 with the sale of Australia's most valuable hotel (on a per-room basis), the 158-room Park Hyatt Sydney, for nearly A$1.3 million a room.
The 'new' paradigm
The 'new' paradigm is a volatile environment where uncertainties in terms of availability of capital and business conditions dominate. By reference to the old paradigm, the new paradigm exhibits the following characteristics:
- Declining performance levels driven primarily by a softening in demand for transient accommodation, which has a downward impact on revenue and Ebitda;
- A return to stringent lending conditions whereby lenders, compelled to deleverage, are tightening their criteria, forcing investors to reduce their LVR and placing a renewed emphasis on interest coverage ratio; and
- Subdued sentiment towards the sector as investors shy away from the perceived risks associated with the industry.
This has a significant impact, not only on asset values, but also on hotel transactions. From the 'dizzying' heights of 2006 and 2007 when well in excess of A$1 billion worth of hotel assets was transacted each year, only A$750 million worth of major hotel assets was transacted in 2008. And 20 per cent of that total was derived from the A$160 million sale of the Westin Hotel in December 2008.
Even so, the new paradigm is also opportunistic for those investors holding a long-term investment strategy. Indeed, investors, financiers and operators are all getting back to basics. And in terms of market fundamentals, Australia's star is shining that little bit brighter.
Firstly, from an economic standpoint, after weeks of uncertainty, the news came out in June that Australia had avoided the dreaded 'R' word after growing by a stronger-than-expected 0.4 per cent in the March quarter. That was followed by a further 0.6 per cent increase in GDP in the June quarter.
Is Australia out of the woods completely? Maybe not, but it is certainly regarded positively among the developed economies. In addition, from a political standpoint, Australia is perceived as safe, with transparent commercial guidelines conducive to foreign investment, as exemplified by the recent acquisition of well-known hotel assets by South-east Asian investors such as Hotel Grand Central Ltd and TA Enterprises.
Other aspects to consider when investing in Australian real estate are movements in the Australian currency, yield levels and the interest rate environment.
Secondly, Australia's hotel industry is in far better shape than that of its neighbours'. While it is indisputable that performances have weakened over the last 18 months and are likely to continue doing so over the short to medium term, the extent of revenue per available room (RevPAR - which is a measure of occupancy and ARR, and therefore also of value) decline for Australia's major cities is significantly less to that reported in China and India.
Thirdly, compared to the downturn of the early 1990s, banks are working with current asset owners to navigate potentially treacherous times and avoid a repeat of the dreaded fire-sale period that sent values into a downward spiral. Contrary to America, where distressed asset sales have been skyrocketing in recent quarters, lenders have so far been prone to work with their existing clients and trade through those difficult times.
However, the underlying message remains one of deleveraging and repricing of risks. Anyone with a refinancing deadline is aware that the combination of declining hotel value and lower debt levels is unsustainable. Hence, we believe that the Australian hospitality market is on the cusp of a new wave in the transaction cycle.
Lastly, the South-east Asian banks have escaped largely unscathed from the global financial crisis and may have some surplus cash to support their compatriots' investments in the Australian property sector.
The 'future' paradigm
From a trading perspective, some may say that Australia has come back to more 'normalised' conditions with occupancy levels in the major CBD markets reverting back to a long-term average of around 75 per cent; a level superior to the performances achieved in the majority of Asia's commercial hubs. And at the very least, while most Australian cities experienced a softening in demand, there is limited new supply over the short-term horizon, which is likely to limit any decline in occupancy levels.
The only exception is Melbourne, which is currently experiencing a boom in supply with over 2,500 rooms coming onstream by mid-2011. Looking ahead, the current lack of credit is also limiting the potential for new hotel construction, delaying the onset of a new supply cycle and providing some opportunities for hotel performances to recover.
From an investment perspective, the limited number of transactions in the last 12 months prove that a gap remains between buyers and sellers. However, while some investors speculated early this year that passing yields in the capital cities would increase to 10 per cent, a few recapitalisations later, it seems that sellers in the market were at least able to fend off the more opportunistic offers. And the market took note.
To say that investors are eyeing one another to see who will make the first move is an understatement. How long is that cat-and-mouse game going to last? The number of hotels for sale, both on and off-market, demonstrates that some hotel owners, and primarily hotel funds, remain under some sort of financial pressure that may only be alleviated either by an outright sale, or by the injection of fresh capital.
In summary, investors are looking for reassurance. As such, prime assets in CBD locations will continue to dominate their wish list. Australia, as a safe destination with relatively sound economic prospects and lower hotel asset values than in South-east Asian capital cities, may therefore still be regarded as a land of buying opportunity.
The writers are senior manager; executive director, Cushman & Wakefield Hospitality; and regional managing director, Capital Markets respectively
Source: Business Times, 24 Sep 2009
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