The accommodation hotel market has been through significant disruption since March 2020.
Capital city hotels are only now starting to recover, but bedroom occupancy levels are still low. Conversely, hotels in regional tourism locations are trading above pre-COVID levels due to a captive market caused by travel restrictions.
New hotel supply is slowing the recovery in some cities. Melbourne and surrounding suburbs saw 2,686 new rooms in 2021, with over 4,000 new rooms over 2022 and 2023. However, there is an expectation some new developments, not already under construction, may not proceed due to construction cost increases and some existing older hotels will come out of room inventory for conversion to alternative uses.
HOTEL MARKET UPDATE
Hotels sales volumes fell 60% to $0.8 billion in 2020, but exceeded $2.8 billion in 2021, the highest levels since 2015 as investors looked for alternative forms of investment and an expectation that tourists will return. The hotel market is generally tightly held, with a limited number of sales each year.
Sydney and Melbourne CBD opportunities are rare, but we anticipate some high-profile transactions in 2022. We have seen significant demand for hotels that have been available, now dominated by domestic investors and some new entrants, but overseas demand remains high, especially from a source of capital.
During the Global Financial Crisis (GFC), hotel capitalisation rates softened by 100 basis points with a number of mortgagee in possession sales, which resulted in discounted pricing. Today’s investors that are waiting for a bargain could be disappointed.
To date, the banks have been supportive and are less willing to appoint receivers. Forced sales will be used by valuers as evidence, which could have a negative flow-on impact to bank loan books. Something they want to avoid.
Sales evidence in the last two years have shown that values have remained relatively steady and, in some cases, increased compared to pre-COVID levels. Capitalisation rates have either held firm or tightened whilst any decline in values has been attributed to the loss of income.
WHAT’S NEXT FOR HOTEL PROPERTY IN 2022?
As hotels start to ramp up occupancy and gear up for the return of tourists, serviceability without reputational damage is a concern. COVID-19 caused a pause in overseas net migration that could take years to recover, revealing a shortage of skilled labour.
Government-introduced visa application refunds for working holiday makers (WHM) to encourage backpackers back to Australia. A lack of skilled labour and supply chain issues, including a lack of linen, has meant some hotels are not able to operate at 100% occupancy even if there was sufficient demand. We are seeing 70% as the new 100%.
During COVID-19 many operators saw the opportunity to increase efficiencies and reduce costs. These initiatives could be offset by the increase in labour and costs of goods. Average room rates may not be able to keep pace with inflation.
Historically, after a market downturn, hotel operators discount their room rates to attract business and boost occupancy. Hotels look for lower-yielding corporate and group leisure business to provide baseline occupancy during the week, with the hotel becoming more and more profitable once occupancy exceeds 70%.
With hotels unable to maximise occupancy, a strategy of rate discounting may not occur. Hence this market recovery could be quicker and look a lot different to prior trends.
- Long-term hotel initial yields are 6.4% but were sub-2% in 2021. This will increase as hotel profits start to improve.
- Owners have to service debt, so profits need to improve over the next 12 months to avoid any potential distressed sales.
- Inflationary pressure on operational costs mean operators should pay close attention to room booking channels, source of business and room rate strategy.
Conferences and events:
- As people reconnect, meetings and events are returning, albeit at a smaller scale. Assets with flexible meeting space are reaping the benefits.
- Online meetings will continue, but face-to-face meetings will never cease to exist. We are seeing corporate travel is more focused, with several interstate meetings held over a few days, as opposed to day trips, which is boosting hotel room demand.
- Bookings are last minute, with attendees generally not committing to travel until the last minute, which presents operational challenges for hotels. A deep pool of casual staff is needed.
Luxury vs economy hotels:
- There is pent up leisure demand, with weekend capital city room rates up and popular regional tourism destinations performing well.
- Economy hotels perform well at high occupancy levels and limited facilities mean operational costs can remain lean, even during today’s labour and supply chain issues.
- After the GFC, luxury hotels led the recovery with Sydney’s luxury segment RevPAR up 6.2% per annum between 2020 and 2016, compared to 5.0% for midscale hotels.
- COVID-19 was not a financial crisis and significant capital remains, with a strong desire to return to travel and be pampered. We believe the luxury segment will outperform all other segments over the next few years.
This article is part of our valuer insight series, where valuers from across Australia share their insights on different valuation specialties. If you want to share your valuation insights, email [email protected] for more information.