An Owners Perspective on Investing in Hotels

New Zealand’s tourism industry, similar to Australia - is having a boom year. Visitor arrivals to the end of January was up 10.7 per cent on the previous year with occupancies in March over 90 per cent for three to five star hotels in both Auckland and Queenstown. The long term forecast is also looking positive for the industry. 

Hotel prices were up 6 per cent in the past year, well ahead of average prices around the world. This strong tourism growth is creating an upsurge in demand for new hotels as more accommodation is needed in the major tourist areas. 

This increase in visitor numbers is creating constraints in popular destinations such as Queenstown, Christchurch, Auckland, Rotorua and Wellington. This is putting pressure on existing supply and highlights the need for growth in the accommodation sector to sustain the positive tourism demand. 

Jones Lang LaSalle, a Property Consultancy Company has identified twenty one proposed accommodation projects in New Zealand’s main centres, with seven projects under construction. This represents a 5.4 percent increase in existing room supply. However this may not be enough to cope with the increased demand for accommodation. 

While this is positive news for the tourism industry, before investing in a new hotel an owner or developer needs to consider a variety of factors. 

Pre-Investment Checklist

The process begins with understanding the basics of development feasibility and ensuring professional research is conducted. The research needs to determine such key factors as; the size of the market, the strength of the proposed location, growth rates and the competitive intensity. The research should also determine from where demand is derived, what are the key market segments, what is the potential customer spend and is there an availability of qualified labour? 

 
 

Determine desired objective

This data determines the potential returns for the owner. Hotels are a long term investment and must have a specific objective and product to continuously attract the highest yielding business. While a five star hotel, is generally more capital intensive, it may not always be the best strategy for the location. Often during periods of strong demand mid scale hotels are in a better position to drive high yields and strong revenues per available room. 

Availability and cost of the land

The availability and cost of land also becomes a key factor, as lack of hotel supply means it is now possible to build a hotel for less than the cost to buy. Hotels add significant value to mixed-use developments which often lowers the risk to the investor. These developments also generally provide a good source of business in low demand periods. However hotels in mixed use developments may provide significant challenges in terms of how the hotel integrates with the larger development. Getting this right can be the difference in terms of how the owner maximises the assets value. 

Determine property structure

The next step is to determine the possible structure for property. What is the owners capacity for risk and what structure best fits the owners needs? Does the owner want short term income yield or, in the case with many Asian owners, long term capital gains? Possible structures to consider include; an operating lease, a hotel management agreement, a franchise agreement or as an owner operator. 

What concept fits the owners needs and what kind of hotel does the owner want to build?

Working with professional advisors and using market research, an owner can determine what concept best fits their needs. Historically profitability is driven by the rooms division. Keeping food and beverage, including meeting rooms to a minimum may be the best mix for a hotel. 

If a hotel does have significant food and beverage facilities, it is important to create a “destination concept”. This food and beverage concept needs to appeal to the local market as well as hotel guests. However the facilities and services that complement and enhance customer service delivery and provide long term profitability must be the first consideration. 

Determine building cost and identify the preferred hotel brand (if any) through an EOI

Once the hotel concept has been developed, the building costs determined, trading projections and return on investment completed the next step is to identify the preferred hotel brand. This is achieved, in many instances, through issuing an expression of interest (EOI) to the major branded hotel companies. An EOI can be particularly helpful for first time owners who may not be familiar with the offerings of the major branded hotel companies. 

Determine trading projections and ROI

Generally an affiliation with a hotel branded company is preferred because of their access to large distribution systems, loyalty programmes and their global marketing strength. Branded hotel companies, despite their fees, often provide lower reservation expenses due to their buying power. Obtaining financing is typically easier with a branded hotel than with an independently operated property. In the final analysis, it is a question of whether the operator or brand brings sufficient benefit to cover their costs and improve the owner's return. 

In our experience owners and developers are generally not always familiar with these processes. As a consequence they fail to maximise the profitability of their investment.  While New Zealand clearly needs additional hotel supply, to ensure they achieve their investment objectives, an owner or developer must complete this due diligence process. 


 

Author: David Shackleton, Partner of nem New Zealand.

David has over 40 years experience at senior levels in the hospitality industry. He has broad international exposure having worked in Singapore, Thailand, China, Korea, North America, Australia and New Zealand.

This article is based on research and opinion available in the public domain.