27 Apr, 2001

The Future Of Hotel Investment

Imtiaz Muqbil

Accor Asia-Pacific Chairman David Baffsky makes his predictions on the future of hotel investments in this speech at the PATA 50th anniversary conference in Kuala Lumpur.

By David Baffsky, Chairman, Accor Asia-Pacific

Speech delivered at the PATA 50th anniversary annual conference in KL

I was asked to discuss “what was required to encourage investment in hotels” in the current climate (in Australia). If that was the sole topic, it would be a VERY short speech because I have one recommendation to make about investing in new hotel developments today and that’s DON’T. That’s not a blanket ‘don’t’ but it certainly applies to new, large scale projects in city centres.

The hotel industry – like all others – must heed the principles of supply and demand. There is excess supply in the 4 and 5 star markets in just about every location in Australia. There are a few pockets left, particularly in resort areas, where development may be justified, but these are few and far between.

Here’s an example that puts the current hotel investment situation into perspective.

The Novotel Sydney at Darling Harbour performs as well as, if not better, than any other 4-star hotel in Sydney. It has the benefit of a highly visible location – particularly after the Olympics – and has the further benefit of being located next to the Sydney Convention and Exhibition Centre. It has been refurbished in the past few years, is supported by a global sales and marketing network, and has strong support in both the leisure and business markets, but the reality is that it still has an average rate in real terms that is much the same as it was five years ago.

That is hardly an inducement to invest in developing new hotels, especially when some of the new 5-star hotels have been advertising rates of $100 per room on lastminute.com, and when some independent 4-star hotels have been touting rates for groups between $60 and $70 per night.

Let’s put this in perspective. Sydney has had an increase in rooms of 35% over the three years leading up to the Olympics. Sydney attracts some 2.3 million international visitors per year. Paris – which attracts something like 16 million visitors a year and expects to increase that substantially with the extra arrivals capacity at Charles de Gaulle airport – had room growth of 1% in 1999, and about the same in 2000. You have to be an Einstein to see that Australia’s hotel industry has been very optimistic in its ability to generate enough demand to soak-up the new supply.

Furthermore, most of the room growth in Paris has been in the economy and mid-market areas, whereas in Sydney specifically, and Australia more generally, growth has been focused on the top end of the market. I read a story a few weeks ago that called for 5- star hotels to hold the line and not drop rates. That is a noble attitude, but apart from one or two hotels in Australia, there will be few that can withstand the rate pressures caused by the excess supply. And the dilemma of the industry in Australia is that rates are driven by the five-star category and things go from the top down, rather than the bottom up.

So if you have some supposed 5-star hotels offering rates between $100 – $150 you can imagine what the rest of the industry is doing, irrespective of what they will admit to doing. It is a case of survival of the fittest.

To get back to the original question of how to attract more investment to the hotel sector, the best way is to show that the industry is conservative in its forward estimates and financially realistic.

Today the sector shows remarkable parallels to the situation a decade ago. At that time, the bicentennary and plentiful finance saw a staggering increase in the number of rooms in Sydney and beyond, once again largely in the top-end of the market. The analysts predicted that demand growth would continue in much the same vein as it had in the late 1980s. What they didn’t factor in was a world-wide and local recession, the Gulf War and the Australian pilots dispute.

On this occasion we are facing at least an economic slow down, but fortunately the Olympics and the plight of the Australian dollar has promoted an inbound boom, while the local airline price war and the Accor-sponsored “See Australia” campaign has seen domestic leisure take up some of this vast increase in room supply.

The latest figures show that domestic air travel has increased by over 15% in the past year, and while that is affecting the likes of Qantas, Ansett, Impulse and Virgin, it is a great bonus to the hotel sector. Domestic business represents more than 70% of occupancy.

The World Tourism Organisation estimated that in 1999, 664 million tourists were on the move. By 2020, WTO predicts that 1.6 billion people will take a foreign trip. That is more than double in just over 20 years. And, when you realise that the largest growth in world travel is going to come from Asia, Australia is in a unique position.

So there are differences between the downturn of a decade ago and today, but in NO WAY can it justify the increase in 4 or 5 star rooms in the country over the past three years. Adding to the situation has been the absolute explosion in serviced-apartment development. While traditional hoteliers would like to believe that this is a different species the simple fact is that serviced apartments are making major inroads into the hospitality sector.

When serviced apartments began to take on the hotels on the Gold Coast they were initially very amateurish. Reception was little more than a converted broom closet and the word ‘service’ obviously had not appeared in the staff manual. But that’s changed, and with the establishment of serviced apartment chains, they now have the benefits of a strong support network.

Serviced apartments, or apartment hotels as many have become, also had the benefit of being able to attract financing from the general investing public, especially retirees, young investors and overseas buyers who were allowed to buy as long as the development was a new one.

Sydney, Melbourne, Brisbane and Perth were suddenly awash with these apartments and thanks to the Olympics AND OUR TAX SYSTEM, every apartment complex seemed to end up being offered as quasi-hotel apartments. In fact, under the few cranes that remain on our city skylines, there are still some serviced apartment blocks ready to join the fray.

Many of these developments will fail or will not be able to meet the guarantees promised in the prospectuses. As the economic environment tightens, those that cannot drive business, that don’t have a sales and marketing network, international reservations, and don’t have brand recognition will not be successful. Price alone will not sell the product, as they cannot communicate that they are there.

Accor is selectively involved in apartment hotels but we are also using the apartment style hotels in our timeshare company, the Accor Premiere Vacation Club, which we launched last year with Becton. With timeshare entering a completely new phase – and image – the availability of such accommodation is ideal for both the new venture and for hotels involved.

We have to look at more imaginative ways of selling our traditional product. I think many people thought that timeshare could never be relaunched in Australia after the white shoe brigade gave it such a bad name in the 1970’s. Timeshare is fundamentally different today and with the right product and the right environment – as we have now – it not only can work, it does work.

Not all areas of the traditional hotel sector are over-saturated and can take further new development. The one area where there is still potential is the economy or 2-to- 3 star sector, an area where Accor globally has made a priority. We’ve had the sector almost exclusively to ourselves because it has been very profitable and continues to offer excellent returns. That’s why we have recently opened Formule 1’s in Newcastle, Dandenong, Brisbane Airport and Canberra. We have new ones set to open shortly in western Sydney and we started building our first Formule 1 in Japan this week and we are very excited at its potential. We are also expanding our Ibis chain.

I hate to use the airline analogy because it is cliched, but it amazes me that the hotel industry works in completely opposite fashion to that of airlines. While the majority of airline seats are in the economy section, the majority of new hotel developments in recent years have been in the business class and above sectors.

In 1999 for instance, of 131 tourist accommodation developments that were under development or in the process of upgrading around Australia over 80% of them were in the 4 – 5 star bracket. How can that make sense? Well, clearly it doesn’t.

Certainly, 4 and 5 star hotels are more attractive in terms of marketing. They are the ‘sexy’ end of the business, and when you are designing glossy prospectuses, obviously it is much easier to “sell” marble and rich timbers compared to functional, compact 2 and 3 star hotel rooms. However, if you are looking for decent returns – then you have to look at the demand end of the equation.

Even corporate travel is overwhelmingly skewed towards this sector of the hotel market. This was highlighted in a recent survey by American Express of corporate travel management in Australia. The survey of 271 large and small companies across eight industry sectors revealed that 88% of the respondents stated they had a company policy of placing their travellers in 3 and 4-star accommodation. The leisure market will similarly be attracted to the mid-market as well as “budget” brands.

Accor on a global level has benefited from having a balanced portfolio. A few weeks ago we were able to announce the seventh consecutive year of rapid growth in profits. One of the main contributors to this has been Accor’s choices for strategic development and the fact that we cover all segments of the market, which means that even if one region or one sector has a difficult year it is usually balanced out by good performances elsewhere.

Many thought that Accor would be a natural bidder for the Forte hotel group in London, but the message is straightforward – we have avoided overly expensive purchases which would negatively impact the company’s profitability and balance sheet. On the other hand, earlier purchases such as Motel 6 and Red Roof Inns in the US and the development of various high-profile Sofitels in the US have proven to be extremely well timed, given the strength of the American market and the US dollar over the past few years.

In Australia, it would be fair to say that the financial sector and stock-market haven’t really understood the hotel sector in the past, which is one reason why I am cautious about encouraging investment in new hotels when the situation currently doesn’t warrant such investments – at least at the top-end of the market.

We need to present ourselves as being both dynamic – as indeed the tourism industry is – and prudent. Our immediate objective should be to increase demand, which we are doing quite well, and therefore yield, which has obviously been affected by the oversupply of rooms.

Demand growth is encouraging but our industry is cyclical and while there is no reason to assume that the annual inbound increases of 10% that are being forecast by the Tourism Forecasting Council can’t be realised, the affect of the Olympics shouldn’t be overstated. We have already seen Sydney miss out on some key convention business from the United States despite the Olympics, and the latest inbound figures have shown that travellers from Japan and Asia are becoming more cautious with their travel because of the economic uncertainties.

Still, the likely long-term trend is that we will continue to win a large amount of business from young Europeans, Americans and Asians, though they will not be looking to stay in five or even four- star hotel rooms. They will want clean, comfortable, quality accommodation, and with their currencies now able to command greater purchasing power, they might be able to upgrade from backpacker to 2 or 3 star accommodation.

So what WILL BE the key factors influencing the hotel property market in the next five years?

Consolidation will be the key. The reality globally is that stand- alone companies probably have a limited future because most people are looking for consistency, frequent flyer and loyalty programmes, one-stop shopping and so on, and it’s really only the global groups who can deliver that. What that essentially means is that you need somebody who has a combination of European and American and Asian visibility to capture the globalisation.

Owners always determine the appointment of a management company based on their ability to deliver guests and the bottom line. SIZE will increasingly count. New world-wide reservations systems currently being implemented will improve revenue management efficiency and again very large investments.

Equally with e-commerce. While still to deliver its full potential, the Internet is a vital sales tool that has entered a new phase in the hotel sector with Accor combining with Hilton and Forte to create a new website aimed at the corporate traveller. These three groups, along with Starwood in Asia Pacific, can obviously deliver the largest combination of hotels to the potential traveller, and is another reason for owners to select a global group.

In an era of oversupply, it is the hotel group with the network and the sales, marketing and reservations support that can deliver the promised returns to owners. Does this mean franchising will come back for individual owners? Yes – but only if the brand truly delivers all the elements I have mentioned PLUS consistency.

Finally, a positive message about investment in existing hotels. Generally speaking, in Australia, we have reached very close to the bottom of the supply/demand curve. If new developments are undertaken based on sound financials, the prospects for existing properties are outstanding. If you want to make money from real estate in the tourism industry today, the message is BUY, DON’T BUILD.