What’s driving investment in the hotel market by Grant Salter, Deloitte
Over the past year, reports on the hotel sector in the GCC region have highlighted falling revenue metrics and performance. Despite these reports, the overall number of hotel projects announced continues to rise. Grant Salter, director and head of travel
When considering the hotel investment market in the GCC, it is important to differentiate between investment/acquisition of existing operational hotels and the development of new assets. Given the limited secondary market in the region, it is difficult to highlight investment themes based on transacted or traded assets. The development market, on the other hand, remains very active.
Strong comparative global returns
Despite falling top-line metrics, certain markets in the Middle East continue to present an attractive investment opportunity on a global comparative basis. In 2016, Middle East hotels achieved an average REVPAR of USD 115, despite a fall of nine percent y-o-y, second only to Caribbean hotels, which achieved an average REVPAR of USD 135. Gross operating profit across the region averaged around 40 percent. Notably, while the hotel industry in the GCC looks to attract international interest, investment remains primarily driven by local investors, with the exception of investment from Indian nationals. From a local investor perspective, key motivations include longer-term investment, portfolio diversification, income returns and status through brand association.
Regional idiosyncrasies
Regional idiosyncrasies also come into play. In a region where cash is king, hotels generate a higher amount of income yield/continuous cash, compared to other assets, which can be further invested into other businesses. Another key factor is the regional push at economic transformation, with tourism being at the forefront of the diversification agenda. The introduction of the White Land tax in the KSA has also spurred hotel investment in the nation, as hotels are generally able to generate a higher income return compared to other real estate assets.
Despite falling top-line metrics, certain markets in the Middle East continue to present an attractive investment opportunity
Which markets and why
Not all markets are created equal and while geo-political issues affect the region as a whole, legal transparency, tourism economics and infrastructure vary across key markets and play a major role in attracting investment. The UAE, in particular, remains the most attractive market in this regard, with a strong tourism demand forecast. The Saudi market has strong fundamentals in terms of population and religious tourism demand, but is constrained by a limited, albeit developing, investment market. This is evidenced by the level of upcoming supply in planning or under construction, with the majority being in the UAE and Saudi Arabia. Oman has also seen increased hotel investment interest in Muscat, Salalah and new destinations, such as Sohar and Duqm.
Financing trends and access to capital
One way to look at the hotel investment market is through the capital structure. The financing structure for hotels in the region previously adopted the typical equity and bank debt sources. We have seen a shift in the way developers are raising non-debt finance. Due to tightening bank liquidity, developers are turning to alternative sources of finance, such as mezzanine funds for lastmile funding. Investment firms dominate the mezzanine financing landscape – with a rise in the formation of capital in the mezzanine and junior debt space in the UAE recently.
The bank perspective
From a debt perspective, the market is seeing stricter terms and increased due diligence, partly caused by its past over-exposure to the real estate market. Banks are no longer taking pure construction risk based on feasibility studies, even if the numbers appear attractive. Their criteria is shifting more towards the profile of the investor/developer. Liquidity is generally available for qualifying investors who have a development track record and alternative sources of free cash that they could use to service project debt until the project is able to generate cash. In addition,
banks are generally no longer willing to finance the cost of land, and typically require investors to include the land as a portion of their equity contribution. A typical term sheet for the major markets (UAE and KSA), would include a loan to value (LTV) ratio of 60 to 70 percent on hard construction costs only, at a cost of 5.5 to six percent. Loan tenure generally ranges between two and three years of construction, plus seven to eight years of amortization, with a 20 to 30 percent balloon payment. Local banks that have advanced leveraged finance capabilities on sophisticated structured financing deals will sometimes work with alternative lenders that generally play a role during construction.
Market outlook
Within the Middle East, sovereign wealth funds and government related-developers are likely to continue driving hotel development in their respective local markets, while family businesses are likely to focus on key regional cities. The largest issues deterring international investment are legal frameworks, currency risk and business process transparency. If these issues are addressed, the market could see a rise in activity within the secondary market and the development of a more mature real estate institutional investment environment. In the meantime, developers continue to explore alternative funding structures, such as real estate investment trusts (REITS), alternative debt and the Condo Hotel model. Bank debt, however, is likely to continue to be available for qualifying investors who have a development track record and alternative sources of free cash.