Hotel Transactions post COVID-19


When COVID-19 struck, the Australian share market reacted. The ASX 200 price index nosedived 32 per cent when compared to the start of the year to a low of 4,546 points on 23rd March 2020 but with greater declines evident in those stocks which were perceived to be more acutely exposed to the crisis. By early June, the ASX 200 had increased by around 30 per cent but has plateaued over the past couple of months as uncertainty has become more pronounced and is currently 9 per cent lower than it was at the start of the year.  

 

ASX 200 – Monthly Close to August 2020

Hotels_Charting the Course_Hotel Transactions post COVID19 Graph_1

Source: Colliers International

 

Stock market declines are often swifter and more brutal when it comes to the pricing of assets.  Australian hotel real estate is a different ballgame altogether with much fewer transactions each year and annual price movements estimated through valuation.  Nevertheless, the stock market movements of accommodation and travel-related stocks may provide a useful predicator for Australian hotel pricing, particularly given the dearth of transaction evidence during periods of economic uncertainty. 

 

In this article, we discuss to what extent cues from the public markets and historical transaction and yield trends can be used to inform the hotel investment community of the likely impact of COVID-19.  

Taking cue from public market equivalents

Hotels – given their daily marked to market pricing fluctuations – have not been historically well regarded by the Australian share market and those listed stocks which do have exposure to Australian hotel real estate derive considerable additional revenue from other sources, e.g. gaming and entertainment.  Their usefulness as an indicator of the likely impact of COVID-19 on Australian hotels is therefore limited.   

Singapore’s h-REITs provide additional insight with many of these groups invested in Australian hotel real estate, whilst also being more exposed to other global hotel markets, where the impacts of COVID-19 has been more severe.

Using a weighted average stock price by market cap for selected stocks, our analysis shows how Australian hotel & leisure and Singaporean h-REIT stock prices declined by more than 50 per cent to their low point on 23rd March 2020.  This compares to a fall of 32 per cent over the same period by the ASX 200, highlighting the immediate impact of the crisis on the global tourism and travel market.  

 

Australian and Singaporean Hotel Stock Prices – Weighted Average Monthly Close to August 2020

Hotels_Charting the Course_Hotel Transactions post COVID19 Graph_2 and 3

Source: Yahoo Finance, Colliers International

 

As at the end of August, Australian hotel & leisure and Singapore h-REIT stock prices had bounced by 55 per cent and 37 per cent respectively.  Gains for Australian hotel and leisure stocks have outstripped the ASX 200 which increased by only 33 per cent when compared to the 23 March low. Pricing for Singaporean h-REITs remains weighed down by their exposure to international hotel markets and Singapore’s greater reliance on international tourism. 

 

In Australia, the re-introduction and extension of border closures and the stage four lockdown in Melbourne is expected to weigh heavily on the hotel sector but hotel & leisure stocks have proved resilient to date with investors buoyed by strong growth in retail sales and increased domestic travel through June when restrictions were first lifted.  This could suggest a potentially stronger bounce back for the Australian hotel real estate sector once border restrictions are finally lifted.  

 

Notwithstanding, hospitality stock declines are more pronounced than for the ASX more broadly with Australian hotel and leisure stocks approximately 27% lower and Singaporean h-REITs 33% lower than they were at the start of the year. 

Every cycle is different

If the past is a good reflection of the future, we should expect that the reduction in Australian hotel & leisure and Singaporean h-REIT stock prices to be reflected in hotel investments over the coming year.  During the global financial crisis (GFC) it took about six months for the first indication of US-hotel REIT pricing to be seen in the sale of hotels.  

Extraordinary levels of government stimulus pumped into the Australian economy during the current crisis has the potential to cushion the impact on hotel pricing for longer, but we may see a more substantial drop in pricing should the crisis persist beyond the end of 2020 – for example with the extended closure of state and international borders – as the period of reduced income will become a more substantial part of the investors’ hold period, bolstering the discounting effect to achieve a ‘pre-COVID’ level of return. 

To date, investors have focused on adjusting cash flow metrics (occupancy, ADR & RevPAR) rather than adjusting risk-metrics with no transaction evidence to support a material change in capitalisation rates.  Whilst historical transaction trends can provide insight as to the extent to which risk premiums and hotel cap rates may change, it is worth noting that not all crises are the same.  Risk-premiums include a combination of sector, geography, currency, location and asset-specific factors, many of which are markedly different today than they were during previous downturns.  Indeed, no investor could have previously envisaged the extended shutdown of Australian state and territory borders and the detrimental impact this would have on the country’s large domestic tourism base.  

The below chart maps Australian hotel passing yields and the cash rate since 2000 and highlights how yields increased by 290 basis points between 2007 and 2009 before declining again as investors started to price in the trading recovery. This compares to an increase of 140 basis points between 2002 and 2004, when the global hotel and tourism industry was impacted by Sept-11 and SARS.  In Australia, the collapse of Ansett Airlines and post-Olympic boom in Sydney also weighed heavily on domestic travel. 

 

Australian Hotel Yield Trends 2000 to 2019 

Hotels_Charting the Course_Hotel Transactions post COVID19 Graph_4

Source: Colliers International

 

The GFC differs again with a far greater degree of global financial stress. That crisis was conceived in the debt capital markets and with no clear indication for how long it would extend.  This created a liquidity crisis into which Asian investors stepped into the void.  Lessons were learnt and Australia’s banks are much more well-capitalised this time around. 

 

Whilst the cash rate increased between 2002 and 2004 by 50 basis points, it declined by 250 basis points between 2007 and 2009, reflecting the magnitude of the impact of the GFC on the global economy.  The cash rate is different again in 2020 having reached a historic low of 0.25% early in the year which will arguably apply further downward pressure on Australian hotel yields with most commentators projecting a ‘lower for longer’ interest rate cycle.  Yield metrics have also become somewhat meaningless in the short term, particularly where hotels are closed, and investors are expected to rely more heavily on the blunt ‘price per key’ metric.  

 

Australia enjoyed a ‘flight to quality’ in the period after the GFC as the Australian economy rebutted the global headwinds to avoid a technical recession. Income declines were marginal as a result and Australia was one of the first global hotel markets to experience an upswing in transaction activity during the recovery.  It remains to be seen if this will happen again but high levels of real estate transparency, good governance and a large domestic tourism base residing in an island continent may prove significant attractors to global hotel investment capital, once we can travel again. 

A tiered hotel investment market

Hotel investors typically give low regard to the short run performance of an asset, be that both the highs (e.g. Sydney Olympics) and the lows (e.g. COVID-19) with discounted cashflows evaluated over a five or ten-year timeframe.  In periods of crisis, ten years is more commonly used and reflects the fact that whilst investors may have a target hold period, they also need a safe exit strategy and will hold assets, if able, during periods of instability until market conditions stabilise. 

That said, new market entrants are currently playing a greater role in the Australian hotel investment market having acquired around 30,000 accommodation rooms or an estimated $11 billion of hotel stock in the major cities.  While some first-time entrants have gone on to build out portfolios, others are at greater risk with Australia’s major banks indicating a higher level of support for owners and operators with a proven track record of trading out of a downturn. 

Australian Transactions in the Major Cities – Proportion of New Entrants (by Rooms) 2000 to 2019

Hotels_Charting the Course_Hotel Transactions post COVID19 Graph_5

Source: Colliers International

 

Newly developed stock also faces greater headwinds in a weaker demand environment as hotels will struggle to gain share and stabilised trade is likely to be at a considerably lower level than the financial forecasts upon which construction projects were predicated.  Higher participation rates by non-bank lenders, particularly for more marginal hotel development projects, will also add to the stress for some new hotels.  It is these hotels which are more likely to come to market in the near term. 

 

Vacant possession opportunities will be rare however with many new hotels encumbered by hotel management agreements, particularly when compared to the last supply cycle as hotel operators have sought to protect tenure.  Repositioning through a change management will therefore be harder to achieve and with little alternatives for upside given the extent of newly developed stock. 

 

Australian Transactions in the Major Cities – Proportion of Vacant Possession Sales (by Rooms) 2000 to 2019

Hotels_Charting the Course_Hotel Transactions post COVID19 Graph_6

Source: Colliers International

Summary

With room night demand expected to come back in layers over the next few years, investors (and lenders) are expected to place laser-sharp focus on segmentation with geographic source of business and market mix becoming key factors to annual business planning and for underwriting future financial performance in hotel investments. 

Extended border closures have the potential to add further complexity to hotel transactions in a post-COVID era given the requirement for most investors to inspect assets prior to committing significant investment capital and the predominance of offshore capital in the Australian hotel sector.  Australian State and Federal Governments have also committed significant financial resources into growing the hotel and tourism industry in recent years through the promotion of the sector and attraction of foreign capital but are now leaving those investors and the broader industry sitting on a knife-edge. 

Consequently, we foresee that despite the obvious challenges, the uptick in the hospitality stock market indices both here and in Singapore, the availability of stock past a development phase and ongoing government support for the industry will result in bringing opportunities for medium to long term investors. 

'Charting the Course' series

 

Colliers International Hotels team have put together a series of articles to help the hotel and tourism industry chart the course to recovery, as one of the sectors most acutely impacted by social distancing measures introduced in response to Covid-19.

For more insights and articles, please click the image below to be redirected to our home page.

 

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