Australian Property News

Opportunity for strong returns in hotel market

Posted on Tuesday, March 15 2011 at 4:29 PM

Hotel operators have a rare opportunity to take advantage of relatively high occupancy rates, according to a new BIS Shrapnel study.

The report, Australia's Eastern Seaboard Hotel Market Property Prospects 2011 – 2020, lays out a broadly positive scenario for the hotel sector.

It found occupancy rates are already relatively high in Sydney, Melbourne and Brisbane. In Sydney's four and five-star sector, they're at record levels.

"In a sense, the market is carrying on from where it left off before the GFC (global financial crisis) interrupted what was promising to be a strong cyclical upswing," says report author and BIS Shrapnel senior project manager Maria Lee.

With solid demand, underpinned by a rebound in corporate travel and constrained near-term supply, occupancy rates look likely to strengthen further. That sets the scene for substantial escalation of room rates, but BIS Shrapnel warns that may not happen.

"In inflation-adjusted terms, historical room rates paint a dismal picture," says Lee. "In Sydney and Melbourne, for example, real room rates have fallen by an average of 1.7 per cent and 1.1 per cent per annum respectively over the last two cycles. Owners and operators are seemingly quick to cut rates at the first signs of weakness in demand, while struggling to later recoup those losses.

"The behaviour of owners and operators in the pre-GFC upswing and post-GFC downturn does not fill us with confidence that they have the courage to raise room rates as much as they could in the coming upswing."

In the recent downturn, hotel occupancy rates fell only modestly, not falling below 73 per cent in any of the eastern seaboard capitals, which is considered to be a fairly healthy rate. But Sydney's room rates were cut by 11 per cent and in Melbourne and Brisbane rates were cut by around six per cent.

Although room rates are starting to be raised, especially mid-week in CBD hotels, the market is still some way off recouping the recent losses.

The report also highlights another concern in the potential opportunity for strong returns – the supply-side response.

According to Lee, there's a broad market agreement that, in the main, the financial logic for development does not yet stack up. But in the past she notes that new projects have come online seemingly triggered by high occupancy rates rather than financial feasibility based on current market conditions at the time.

BIS Shrapnel therefore expects that the upswing in the hotel sector will be cut short by overbuilding and may consequently be relatively short.

Market players should therefore act quickly and decisively to maximise their positions. The near-term prospective returns are strong, with a five-year internal rate of return (IRR) forecast at 18 per cent, which should match or better the returns on offer in other property sectors.

However, longer-term returns are considerably lower thanks to the anticipated overbuilding. Prospective 10-year IRRs are around 10 per cent, similar to retail property, but not as strong as BIS Shrapnel's forecasts for office and industrial markets.