Aspects of Hotel Investments

Thesis (M.A.) 2012 128 Pages

Business economics - Investment and Finance


Table of Contents

List of Figures

List ofTables

List ofAbbreviations

1 Introduction
1.1 The Hotel- and Travel-Industry
1.2 Industry Specifics
1.2.1 Historic Development
1.2.2 Impacts of the global financial crisis
1.3 External Economic Factors
1.4 Scientific Attention

2 Hotels as an Investment
2.1 The Hotel Investment Market
2.1.1 Historic Development
2.1.2 Impacts of the Global Financial Crisis
2.2 Hotels as an Investment
2.2.1 Actors
2.2.2 Institutional Investors
2.2.3 Real Estate Investment Trusts (REITs)
2.2.4 High Net-Worth Individuals
2.2.5 Private Equity Companies
2.3 Performance
2.3.1 Expectable Yields as a Single-Asset
2.3.2 Expectable Yields in a Portfolio
2.4 Contracts
2.4.1 Lease Contracts
2.4.2 Management Contracts

3 Corporate Specifics
3.1 Hotel Accounting
3.1.2 Key Figures
3.2 Hotel Financing
3.2.2 Access to Equity
3.2.3 Capital Structure
3.3 HotelAsset-Management
3.3.1 The Asset-Manager
3.3.2 Risk-Management

4 Evaluation Tools
4.1 Business Plans
4.2 Feasibility Studies
4.2.1 Involved Parties
4.2.2) Features
4.3 Financial Feasibility
4.3.1 The Discounted Cash-FlowAnalysis
4.3.2 The Value of a Hotel

5 Empirical Part
5.1 Decision Making
5.2 Study Design
5.2.1 Hypothesis
5.2.2 Sample
5.3 Methodology
5.3.1 Content Analysis
5.3.2 Results of the Factor-Ranking
5.4 Analysis

6 Discussion and Outlook

7 Bibliography

8 Appendix

List of Figures

Figure 1: Hotel investment in Europe 2002-2006 (Source: Jones Lang LaSalle Hotels 2007 in Frehse 2007, p. 222)

Figure 2: World international tourist arrivals (Source: Papatheodorou 2009, P-4l)

Figure 3: Turnover in the hotel and restaurant sector in the EU-27 (Source: Smeral 2009, p.49)

Figure 4: Global hotel transaction volume (Source: Jones Lang LaSalle Hotels 2011)

Figure 5: Investment Recommendation (Source: PWC 2008)

Figure 6: Transaction Volume in EU (Source: HVS 2009)

Figure 7: Simplified Cash Flow Diagramm (Source: Adapted from Hess/Liang/McAllister 2001, p.55)

Figure 8: Buyer Analysis by Region (Source: HVS 2011)

Figure 9: REIT Equity Market (Source: Feng, Price, Sirmans 2011, p.29)

Figure 10: Market Capitalization byAsset Type (Source: Feng, Price, Sirmans 2011, p.30)

Figure 11: How Private Equity Firms add Value (Source Corgel 2008, p.11)

Figure 12: Global Trading Performance Expectations 2000-2011 (Source: JLLS 2011, p.1)

Figure 13: Cumulative Wealth Indices of Capital Market Securities 1995-2000 (Source: Quan et al. 2003, p. 84)

Figure 14: Role of the Asset-Manager (Source: Author's illustration)

Figure i6: Involved Parties (Source: Author's illustration)

List of Tables

Table 1: Private Equity Investment in Public Hotel Companies (Source: Badenes, Ρ·5) [16]

Table 2: Investment Strategies (Source: Adapted from Fidlschuster et al· 2001, Ρ·98)

Table 3: Returns 1995-2002 (Source: Quan et al· 2003, ρ·85)

Table 4: Correlations ofLPI with other Asset Classes (Source: Quan et al· 2003, ρ·87)

Table 5: Risk and Return 1982-2001 (Source: Petersen, Singh 2003, ρ·ΐ64)

Table 6: Cross-Correlation Matrixi982-200i (Source: Petersen, Singh 2003, p· 168)

Table 7: RevPar and GOP Penetration (Source: Rivera 2011, ρ·3)

Table 8: Performance ofWellington Hotel (Source: HVS London 2006 ρ·41)...

Table 10: Frequency ofThought Units (Source: Mason/Stark 2004, ρ·239)

Table 11: Weightings for Hotel Investment Decision Making (Source: Newell/ Seabrook 2005, ρ· 287)

Table 12: Factor Ranking (Source: Author's own illustration)

Table 13: Results of the Factor-Ranking

Table 14: Sub-Factor Ranking

List of Abbreviations

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1 Introduction

As many others, the hotel- and travel industry has numerous particularities that are inherent to the sector. One very unique characteristic, for instance, is the multitude of encounters with other parts of the economic system, any touristic venture, howsoever small will in any event have. So, in this connection, tourism experts tend to describe their field of interest as a cross-sectional subject matter: A matter that affects all realms of society and is likewise affected by them.

Nonetheless, touristic ventures are facing the same questions like most business ventures, especially the one ofhow to attract outside capital. To fulfil this task, a certain amount of information has to be provided to potential investors. Whereas start-ups use business plans for this matter, touristic ventures make use of so-called feasibility studies, which, because of the capital intensity of such ventures, can be determined even before the need for a business plan arises. This thesis will address to the question what type of information of these feasi­bility studies delivering which kind of message is crucial for what type of deci­sion maker and why.

To set the ground for answering this, the hotel- and travel-industry as the sub­ordinate economic sector will be outlined, regarding its historical development, its macroeconomic significance as well as the scientific attention towards it. In a similar manner, the hotel investment-market as the sector in question will be portrayed, yet focusing on the main actors in the market. Since those actors can be seen as the object of research, the second part will above all address their characteristics and their respective investment approach. To get a closer look at the hotel as the investment itself too, a concise outline of corporate specifics, like accounting and contract design, will also be provided. Understanding those corporate specifics is incremental for the comprehension of a feasibility study, whose basic structure is then depicted.

Knowing what kind of information is available to the investors, the empirical part concentrates on the question of how they derive their decision, based on the information and again, which part of information is crucial to whom.

The sample of the study was chosen in a way to reflect the entire variety of dif­ferent investor types active in the market. In spring 2012, interviews with six in­vestors, by twos representing a distinctive group of investors, were held. The analysis of those interviews will constitute the thesis.

1.1 The Hotel- and Travel-Industry

This first section will give a brief introduction in those aforementioned particu­larities as well as sketch the historic development of the hotel- and travel indus­try. Therefore, the focus will be on the two most influential touristic markets, namely the USA and Europe. After a discussion of the initial emergence of the industry, its chronological examination will culminate in the global financial crisis and its impacts on global tourism.

Remarks about the scientific attention given to the matter will complete this first chapter.

1.2 Industry Specifics

When discussing tourism in an economic or scientific way, you always talk about the so-called tourism and leisure industry. Besides, the term tourism co­vers everything that can be subsumed under hospitality (lodging, restaurants, tour operators, tourist associations etc.). Then, leisure would be anything else that includes facilities, which may be part of the touristic offerings of a region, but are also used by residents (Theme parks, zoos, ski runs etc.).

Bearing this in mind, one can see that the industry is very closely linked to the public sector respectively ofhigh public interest.

Especially in regions that depend very much on tourism, the touristic success is a key factor for the macroeconomic situation of the region. It can secure em­ployment and be a driving factor for innovation. Furthermore, it can help fund­ing environmental protection measures, streamlining the infrastructure and fa­cilitating the transfer of knowledge. Then again it can make the costs of living for the residents higher, boost the pollution etc. as well (Bieger, 2008).

In turn, a successful tourism depends on a lot of external factors that cannot re­ally be controlled, but are worth a much closer look, which will happen in chap­ter 1.2 External Economic Factors.

Whatever the circumstances are, the interdependency of tourism and the com­monwealth is indisputable.

1.2.1 Historic Development USA

In the United States, the first big hotel companies arose in the course of the great depression. The economic chaos of this era created opportunities for in­dustry consolidations that attracted financiers, such as Conrad Hilton, founder of the eponymous, globally known hotel-chain. He acquired his first hotel in Cisco, Texas in 1919. At the same time, another global player was born. Between 1920 and 1930, Ernst Henderson, founder of Sheraton, bought his first four ho­tels. Two years before the black Friday, a third one joined the party. J. Willard Marriott Sr. laid the foundation for his posterior imperium with the opening of a root beer stand in 1927 (Barrows/Powers, 2008).

After this initial boom period, the industry followed a very volatile path, always very closely linked to the global economic trend.[1] Then, during the oil-shocks, hotel business went down, while it prospered in the time of the expansion of the interstate section. Over the course of this development, a segmentation into dif­ferent hotel types commenced. The first Motels, all-suite hotels and extended- stay hotels developed.

Another effect of this, nearly 50 years lasting expansion was a mounting concen­tration of ownership, which peaked in the beginning of the 1990s. In fact, this amplified, when Real Estate Investment Trusts (REITs)[1][2]for the first time offered a particular investment vehicle that solely offered real estate investments (Hess/Liang/McAllister, 2001).

Despite all this, American tourism took a huge hit by something nobody ex­pected. Almost 100 year after the birth of the industry, the events of 9/11 were an external factor that had a huge effect on tourism. Although arrival figures in the USA did not shrink by more than 1%, it was the first time in a very long time that there was no growth, proportional to the previous year (Bon­ham/Edmond/Mak, 2006).

The first decade of the new century was the era of private equity investors that began investing in huge international Hotel Companies all over the world. Yield expectations started growing and suddenly most of the non-institutional inves­tors were out of the picture. This development culminated in the acquisition of Hilton through Blackstone, the largest deal ever seen in the whole industry. The private equity company made itself the biggest hotel company in the world, adding the Hilton group to its already large portfolio of hotel chains for the price of $ 26 billion (Carrey/Morris, 2010). Europe

Europe’s tradition in commercial hospitality started much earlier. It all began in the 16th and 17th century, with the Inns in England and Gasthöfe in Germany. In the late 19th century, when the middle class began to travel, enormous buildings, so-called Grand Hotels emerged in the Alps, the European capitals and the Med­iterranean. After that, World War II slowed down this development and in its aftermath, most of the touristic matter was destroyed (Dietsch, 2006). The post­world war boom again created a completely new phenomenon: mass tourism. By then, hotels mostly were held privately, but big tour operators already start­ed to buy premises in large numbers (Club Med, Tui etc.) (Hachtmann, 2007).

During the 1990s, at the time they already played a role in the USA, big interna­tional investors began to look for investment opportunities in the European ho­tel industry. Regardless of that, the European hotel industry and especially the one in Germany and Austria are still dominated by small- and medium-sized companies (Peters, 2007). However, this fact and above all the prevailing capital structure of those companies made them an attractive target for foreign inves­tors. Because European hotel companies always had a constant need for outside capital, big Anglo-American private equity investors spotted an opportunity to, on one hand provide those companies with the much-needed capital and on the other hand conduct a promising investment. As depicted in figure 1, in the years before the crisis, private equity investors already had gained a large share in the European hotel business (Frehse, 2007).

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Figure 1: Hotel investment in Europe 2002-2006 (Source: Jones Lang LaSalle Hotels 2007 in Frehse 2007, p. 222)

As we can see, the hotels business always has been playground of many. Despite its short history, in comparison to other business fields, it has already under­gone a lot of change, especially in the first decade of the new century.

1.2.2 Impacts of the global financial crisis

The global financial crisis (GFC), which had its offspring in the year 2008, shook the very foundations of the business world. The Travel Industry took a huge hit during this period as well. Two major fields of the sector were struck. On one hand, the amount of international arrivals hit rock bottom in 2009[3](see fig. 2).

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This, of course, affected the hotel business in a very crucial way. As depicted in figure 3, hotels, especially in Europe, recorded an unprecedented drop in sales.

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On the other hand, the consequential credit crunch virtually paralyzed the hotel investment market. This specific ramification will be thoroughly discussed in Chapter 2.1.2, Impacts of the GFC. Despite all that, there are voices that see those impacts of the GFC in a totally different way. Ritchie/Molinar/Frechtling (2010),

for example, argue that impacts of other events, such as 9/11, the H1N1 Virus and natural disasters, were a lot more severe than those of the GFC.

What is indisputable is that the behaviour of tourists changed during the years of recession. First and foremost, damage in domestic tourism was not as severe as in the international one. Smeral (2010) explains this phenomenon with the accessibility of domestic destinations by car and the reduced surprise factor when making holidays in the own country. Other mutations he recorded were that in general tourists economized the duration of their vacation, cut back on secondary holidays and relied much more on Last-Minute-Deals.

One of the most obvious ramifications was the heaviness of the drop of business tourism in comparison to leisure tourism. When a company is condemned to cut costs, one of the first things to bite the dust are business trips.[4]

However, there are many, who object, that there also may be some opportuni­ties presented by the GFC. Sheldon (2010) perceives a big chance for tourism operators and destination managers to revalue their competitive advantage in the long run and make internal structural realignment to enable renewal.

The behaviour of the touristic industry during and after the crisis was neither better, nor worse than those of other branches. If there are any lessons learned will be seen in the future, some impacts of the most recent crisis will though be noticed for quite a time from now on.

1.3 External Economic Factors

What we learned so far is that the tourism industry is very sensitive to changes in the global economy. There is a lot of evidence throughout literature, describ­ing the tourism industry as highly correlated to both expected and unexpected

inflation (Gyourko/Linneman, 1988). Barrows and Powers (2008) describe a standard cycle within a regional market in the following way:

Because of some non-industry-immanent circumstances, a certain region or city experiences a boom. This boom may happen due to an influx of a few big companies, or an enhanced accessibility of the city. Consequently, a demand for guest rooms arises. So the first big hotel company will already be on the doormat. In the course of their planning, other companies will access the new market as well.

Of course, without the other one knowing. At the time the compa­nies are aware of the fact, that they maybe not alone at this location, it is often too late to cancel the operation because of sunk costs.[5]At a certain point in time, the demand is met, but now, somehow all the big players want to be represented and not quit the field. So they try to create a demand not through new quantity but through new categories. Nonetheless, the number of potential customers hasn’t changed. Subsequently, many regions are now faced with a massive overbuilding.

This neatly describes how people tend to overstretch economic cycles. One should assume that the result of this behaviour, massive overbuilding in a par­ticular market, will stop the big players. But as we, for example, saw in the late 1980s, it did not. Even when faced with large operating losses, hotel companies kept expanding in markets that were already saturated. A possible explanation for this phenomenon would be that they clung to the hope that even though the operating business did no longer create any revenues, the appreciation of the underlying realty will secure their investment. What’s more, concerning the cir­cumstances obtaining at this time, this conclusion maybe was not even that off. However, over the course of time, (and as we will see in further consequence) this paradigm changed completely.

Bearing the internal dynamics in mind, the tourism industry is not to blame for all downswings in its history. Obviously factors apart from the global economy also had a strong impact on the prosperity of the tourism industry. Furthermore, we already discussed the effects of 9/11. Needless to say, other unexpected events, like SARS, HiNi, Hurricane Katrina or the Asian Tsunami affected the sector too. In addition to that, long time developments also shifted the global demand for touristic products. Demographic change, a mounting demand for products espe­cially designed for certain groups (homosexuals, pensioners, teens etc.) and changes in the income distribution all account for challenges, managers in the tourism industry will have to deal with.

1.4 Scientific Attention

As already mentioned, a neat expression for the tourism industry is cross­sectional subject matter: A matter that affects all realms of society and is like­wise affected by them. So the scientific approach for discussing the matter thus is a multidisciplinary as well as an interdisciplinary one. Issues range from or­ganizational management, human resource management, financial manage­ment and strategic management to issues, like, for instance, operations man­agement, marketing, service-quality and information technologies. All of those fields are examined in respect of their peculiarities within hospitality manage­ment in various research institutions all over the world.

Discussing touristic problems in a scientific way has developed quite differently in the world. For a long time now, the Anglo-American scientific community is concerned with tourism. Hospitality majors are part of the academic offering of all important universities in the USA and, driven by interests of companies, also research in the field has prospered since the late 1980s (Guilding/Lamminmaki, 2007).

In Europe, on the other hand, for a long time, tourism management was more or less an apprentice training, taught at vocational schools. Austria was one of the first countries to identify a need for a more scientific approach to tourism.

Discussions about the right approach to hospitality research are present in the scientific community since the existence of the field. Whether a multidiscipli­nary approach or a holistic approach might be more suitable will not be clarified within the next decades and, therefore, is not crucial to this paper, since its fo­cus is on a particular part of the industry, the hotel real estate investment mar­ket.

Nonetheless, within this side issue there are also a lot of quite different opinions on how to conduct studies and carry out research. Though we do also not want to take part in the discussion of how hotel real estate as a scientific discipline should be classified, it might be important to look at the areas it actually touch­es.

For a long time, hotels were treated as a real estate asset class like many others and were examined within this category. This, of course, fell short, because, as we know by now, hotels are far away from being a “normal” real estate.

Alongside the global change in the ownership structure of hotels, lodging prop­erties became an investment and, therefore, became the focus of many financial scholars. Their research regarding risk, return, the financing as well as the op­timal handling of such an asset, established the today very prosperous research field ofhotel asset management.

In the past few years, many other fields of interest evolved in the sector, mostly driven by actual problems of companies. The problematic relationship between operator and owner, for example, has attracted a lot of researches, engaged in corporate governance studies.

The conclusion one can derive from this is, that research in hospitality man­agement always has and always will be very closely linked to practice. This cre­ates a huge demand for studies and, therefore, it’s just natural, that there always will be a dispute about what hospitality management really is too.

2 Hotels as an Investment

Similar to most other industries, the hotel sector offers a source of revenue apart from the operating business. Since touristic ventures, above all hotels are very capital-intensive, only few entrepreneurs are able to finance a new project on their own. This need for outside capital created a whole line of business. Nowadays, most hotels are owned by a number of investors, all originating from diverse areas and all equipped with different levels of expertise and aspirations.

The second chapter of this thesis will thoroughly unravel the mechanics of the hotel investment market by depicting its development, introduce its key-players as well as analyse their respective investment approaches.

2.1 The Hotel Investment Market

As mentioned previously, the Hotel Investment Market in the years prior to 2000 depicted itself as almost inexistent. Small- to medium sized hotels were managed by their respective owners and also the big hotel chains covered both parts within their portfolios.

However, since the year 2000, the situation changed. Due to several circum­stances, hotels were discovered as a viable investment by most different types of investors. Those participants were in large parts new to the market, but they managed to leave their marks pretty quickly. Special investment vehicles were designed, designated hotel investment funds were founded and now, around ten years later, we are up against an industry that shifted almost completely.

But what constitutes the attractiveness of a hotel as an investment. Härle/Haller (2007) have summarized the most essential attributes of the hotel investment market.

-The hotel industry is one of the strongest growing branches
-Increasing transparency within the sector and knowledge of the key players
-Compared to other real estate types, high revenues
-High M&A Activity

Since their paper was written before the global financial crisis, the named three additional characteristics, which apparently got obsolete when the crisis peaked in 2008.

- Huge amount ofavailable capital by funds
- Willingness to give out credits by banks
- Low interest rate level

How the loss of those key features affected the industry will be discussed later.

This chapter basically should provide an overview of the crucial points in the evolution of the hotel investment market, introduce its key players and capture what in fact constitutes a hotel as an investment.

Furthermore, additional information should be given about the severe impacts the most recent economic developments had on the sector.

Broadly speaking, we are faced with an industry that only exists just a little bit longer than ten years, has already changed a lot up to now and keeps changing constantly.

2.1.1 Historic Development

As illustrated in figure 4 and already implied in the introduction, the hotel in­vestment market, illustrated by the progress of the global transaction volume in the sector, jump-started its rise in the early 2000’s. After a slight decrease in the year after 9/11[6], it continuously bulged up to the point when the real estate bub ble hit the world in 2007.

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Figure 4: Global hotel transaction volume (Source: Jones Lang LaSalle Hotels 2011)

But going back to the beginning of the new century, what prompted the un­precedented blast of the investment activity in this very industry?

Härle/Haller (2007) find the following explanation: In the mid-9o’s, big hotel- chains started to pursue a global expansion strategy. In the course of this, their need for outside capital grew. So, to get more fresh capital, a lot of them went public in this period. What they maybe did not have in mind was the possibility of a downswing, which promptly happened in 2000. Stock prices in all indus­tries dropped and so they did in the hotel industry. This led to a disparity be­tween the stock price and the actual value of all the properties of the respective company. Consequently, that triggered two phenomena in the financial mar­kets: For one thing, big private equity companies took advantage of the low prices, bought those companies and subsequently sold the properties while go­ing private again. The other effect was that a lot of consolidations took place be­cause of the low stock prices.

In the aftermath of this sale, private equity companies suddenly owned a lot of hotels, which were still operated by the previous owner. So they integrated it in their portfolio and all of a sudden recognised its quality in generating profits.[7]

On the other hand, the operating companies were also faced with a new situa­tion. They, however, quickly realised, how to make the best of it. No longer in possession of their properties, they could again focus on their core competence: managing the hotel. So they became proactive and sold all their residual real es­tate. The newly gained capital allowed a lot of innovation. With the exception that they now delivered most of their revenues to the owner of the property, they were back in business. Of course they lacked the return created by the property in this new order, but they also got rid of the corresponding risk. These circumstances led to a re-evaluation of the operating companies at the global financial markets.

To utilize this effect, management companies had to make sure that they would still be in charge of managing the hotels after they sold their premises. Inter­Continental Hotels Group accomplished this manoeuvre. They are still operating 88% of the hotels they sold between 2003 and 2006 (Badenes, 2008). The pro­ceeds of those sales were passed on to the stockholders of InterContinental.

But not all of the encounters between private equity companies and hotel com­panies ran down this way. A lot of the big public hotel companies are now, in their entirety, in possession of private equity companies, which made them dis­appear from the stock exchanges. Investors having a stake in those hotels, earn a lot more than they would have by investing in a listed hotel company (Beals, 2008). An overview of the largest transaction, following this modus operandi, is demonstrated in tab. 1. Highly notable is the already covered acquisition of Hil­ton Hotels by the Blackstone Group with the record prize of 26 bn. Dollar.

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Table i: Private Equity Investment in Public Hotel Companies (Source: Badenes, p.5)

Bearing in mind that notable activities in the hotel investment market first were seen at the beginning of the new century, the market already has seen a lot of ups and downs. However, the most profound shift was caused by the global fi­nancial crisis, which was triggered by events within the real estate sector.

2.1.2 Impacts of the Global Financial Crisis

In the years 2006 and 2007, when residential real estates already stumbled, hotel investments kept growing (see fìg.4). As far as what we know from research, commercial real estate is always a little behind residential. Therefore, it would have been safe to assume, that the rampant growth of the sector will come to an end sometime. However, some insiders, such as Steve Rushmore of HVS, al­ready had a hunch.

“My prediction: By the end of 2006 most of the hotel funds and investors that are buying up existing hotels at rapidly inflating prices will shift their focus to­ward new development. It will then take three to five years before excessive overbuilding occurs and we start heading down the cycle again. This doomsday timing either can be extended a year or two if he economy booms and demand increases rapidly, or it might be shortened somewhat if we go into another re­cession “ (Rushmore, 2006, p.28).

Three years later, he commented on the circumstances at that point of time, ap­parently bearing in mind that his prediction three years ago was not that off. The cycle headed downwards. The only thing he did not get right was the cause for this development.

“Today we’re facing a unique down cycle. While new hotel development had been heating up between 2005 and 2007, it didn’t reach the point of overbuild­ing. As a result, this downturn was not induced by an oversupply problem.[8]While there was abundant and inexpensive financing available until mid 2007, it was the collapse of the credit markets caused by the defaults in the sub-prime residential sector that led to a drying up of commercial financing starting in 2007” (Rushmore, 2009, p.18).

So what had happened in the meantime?

As in many other industries, the investment volume in the hotel sector went down dramatically. Jones Lang LaSalle reported that the global transaction vol­ume shrank by 76% in the first half of 2008. To get a good feeling of how inves­tors appraise the current situation, big players in the industry went into over­drive, regarding research. In April 2008, the Hospitality Department of PWC conducted a survey amongst 480 individuals, if they think that Hotels are still a good buy (PWC, 2008). Surprisingly, a lot of the interviewees answered this question with yes. They admittedly had some limitations. Furthermore, they, for instance, predicted a slowdown of the highly leveraged buyers and, based on that, a longer holding period of the investments. Still, their recommendations for the remaining year 2008 were positive. (As seen in fig. 5)

Investment Recommendation of Survey Respondents

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Figure 5: Investment Recommendation (Source: PWC 2008)

After all, history proved them wrong. As seen in figure 6, the transaction volume by the end of 2008 reached a new record low[9]. Economy was on the ground, debt was expensive and as a result, even those, who wanted to invest, were no longer able to do so.

Another defining aspect of these developments can also be seen in figure 6. The percentage of portfolio transactions, which, in previous years, averaged almost three quarters of the total transaction value, fell dramatically. However, this phenomenon can easily be explained with the already mentioned disappearance of the private equity companies.

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Figure 6: Transaction Volume in EU (Source: HVS 2009)

Though we know, that the GFC had struck the hotel investment market hard, it is still advisable to look at possible differences between the two major markets in the sector, the USA and the EMEA region.

The USA suffered most, with a decline of 81% (DEKA, 2009). Similar to other markets, the percentage of portfolio transactions dropped in relation to previ­ous years. Private equity companies could no longer accomplish their high lev­erage ratios within their investments, because the pool of available debt had al­ready dried out. This manifested itself in the fact that private equity companies were amongst the most active sellers in this period in the USA. Buyers mostly were REITS and institutional investors that did not rely on a high leverage ratio.

In the EMEA (Europe, Middle-East, Africa), the volume of transactions dropped by 61%. Like in the USA, portfolio transactions fell to only 45% of the overall transactions. The following number is also notable and characteristic of the scarcity of capital. Only 12 individual acquisitions were made, that were bigger than 100m $ in 2009 in Europe. In contrast to the USA, however, private equity companies were amongst the most powerful buyers. Furthermore, there was an increase of investors registered that came from the Middle East.[10]It is likely that those countries did not feel the impact of the GFC as much as the rest of the world did. TheAftermath

With the year 2009 still being a tough period for the sector, things slowly got back to normal in 2010. International investors returned to the particular mar­kets and the transaction volume started to grow again. Even the portfolio trans­actions that barely existed in 2009 began to prosper again.

What remains is that the key characters in the market changed and there is no sign that it will go back to pre-crisis conditions. Now, private equity companies account for just a small fraction of the activity. In 2010, HNWI and Hotel In­vestment companies were responsible for 72% of the global transactions (HVS, 2010).

Because of that and some other factors, the investment volume of 2011 is still just infinitesimal small, compared to the record year 2006.

2.2 Hotels as an Investment

The crucial characteristic of hotels as a real estate investment is its lack of op­tions for third-party utilisation. Within the hotel real estate market, you got what you bought and subsequent adaptations due to altered market conditions or shifted investment focuses in your portfolio are highly capital-intensive. What’s more, you are also faced with much higher development costs than in residential real estate and, furthermore, your leases will not be as high as they would be, if you owned, for example, an office building. When you finally got some reservations for your rooms, people can still cancel at very short notice.

So, when you invest in a hotel, you do not only commit a large amount of capi­tal for a substantial amount of time, there is also a big chance that you will nev­er see your money again. To cap it all, in contrast to other real estate classes, whose demand is local and can be predicted up to a certain extent, risk features of hotel investments are not easy to asses, because the demand for hotel rooms is always external.

Bearing this in mind, there seems to be no apparent reason to invest in hotels. But as one might have guessed by now, people still do so because of promisingly high yield expectations. Therefore, to mitigate these risk features, people have found ways to split the risk amongst several parties. First and foremost, only a few people invest in a hotel in a way that they own and operate the whole thing. As we know by now, most of today’s big hotel companies have an owner that is

distinct from its operator. To illustrate this relationship once more, figure 7 de­picts a simplified cash flow diagram of a typical owner-operator relationship.

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Figure 7: Simplified Cash Flow Diagramm (Source: Adapted from Hess/Liang/McAllister 2001, p.55)

The owner buys or develops the hotel and then “rents” it out to an operating company that will pay him a certain management fee, which does not depend on every day’s revenues. By this, he gets rid of the risk related to running the business. If the operating company is not successful, the owner can always ap­point a new one or, in the worst case, sell the underlying property.

Furthermore, to then again minimize the residual risk related to the property, the investor could hold a portfolio of properties in different locations. If the in­vestor does not want to commit his / her whole capital to this portfolio, there is always the possibility of getting other people to invest in your portfolio, which then would make it a fund. Even if these other people are highly risk-averse,

there is a remaining alternative. Many hotel real estate investments are included in a big investment fUnd that contains investments in many different sectors.

So, investing in hotel real estate now seems not so unattractive anymore, look­ing at the various possibilities you have tailored to your personal risk profile.

What investor types are present in the market, which investor is attracted by what kind of hotel and what his or her preferred way of undergoing this invest­ment is, will be answered in this chapter.

2.2.1 Actors

In the earlier days, mainly two players assembled the hotel industry, big inter­national hotel chains and stand-alone hotel owners. Both combined the role of the owner and the manager within their enterprise.

Alongside the global change of this paradigm, new players entered the stage. Jones Lang La Salle Hotels lists the following leading actors in the hotel invest­ment market in the year 2007. The Numbers in brackets show their share of overall-buyer activity in the years 2007/2010 (HVS, 2010).

- High Net Worth Individuals i. e.: Bahraini Royal Family 7%/23%
- Private Equity i. e.: The Blackstone Group, Colony Capital 42%/6%
- Institutional Investor i. e.: Deka Immobilien, PRUPIM ii%/25%
- Hotel operator i. e.: InterContinental Hotels, Accor, Marriot ii%/7%
- Hotel Investment Companies i. e.: Westmont Hospitality, Pandox SA i8%/23%
- Real Estate Investors i. e.: REITS ii%/i6%

The most noticeable change within these three years was the already discussed retreat of the private equity companies, caused by the disappearance of availa­ble debt. Their share was taken over by HNWI and institutional funds, whose capital structure was more applicable in the years of the crisis (HVS, 2010).

Since we now know who is investing, it has to be clarified, where these investors come from. The perpetual change in the industry as well as the effects of the GFC have led to a geographic distribution of buyers that depicted itself in an­other way every single year since 2008. This development is pictured in figure 9 for the European market.

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Figure 8: Buyer Analysis by Region (Source: HVS 2011)

As we can see, North America Asia and the Middle East suffered most in the peak year of the crisis (regarding their activity in Europe),while Europe, with its low share of private equity companies and portfolio transactions, regained some strength through its more conservative financing behaviour. In the year 2010, things somehow got back to normal. Private equity companies are still out of the picture, big institutional investors from North America or the Middle East are already closing their huge portfolio deals again, as they did before the crisis.

The number of investor types represented in the hotel investment market is ap­parently quite manageable. However, their individual preferences regarding ho­tel types differ a lot. This also applies to their preferred way of investing.

We already discussed the emergence of private equity companies in the industry. Nevertheless, we have to leave them out in this listing, because they do not show a clear preference for a certain type of lodging property. Whether or not, the others have branched out the market amongst them. Which investor is at-

racted by what kind of hotel and what his or her preferred way of undergoing this investment is, will be answered now. Fidlschuster et al. (2011) have put out an overview of the different investment strategies, investor types pursue.[11]

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Table 2: Investment Strategies (Source: Adapted from Fidlschuster et al. 2001, p.98)

The next section should portrait the most important investor types active in the business, including institutional investors, REITS, private equity companies and high net-worth individuals.

2.2.2 Institutional Investors

In the hotel investment market, a lot of different institutional investors are pre­sent. Just to name few, there are large insurance companies, mutual funds, pen­sion funds, hedge funds and investments trusts.[12]These organizations have pure real estate funds as well as mixed funds, in which hotels are often used as infla­tion hedge. The proven negative correlation of lodging properties with inflation, but also its negative correlation with the general stock market has attracted many investors. Furthermore, the stagnating returns of lodging-stocks have drawn many funds to the property section (Quan/Li/ Sehgal, 2002).

In today’s investment, market portfolio transactions are rare because of their difficult financing. However, institutional investors have managed to be the last remaining player in this field of business. In Europe in 2010, they accounted for a transactions volume of € 1.6 billion, which consisted of 14 single-asset transac­tions and five portfolio transactions. Their risk-averse strategy was a good ar­gument whilst the credit crunch, when it came to talking banks into giving out loans (HVS, 2011).

Regarding their preferred hotel type, they, of course, are looking for constant yields, which they mostly find in upscale-luxury, prime urban locations. But also large portfolios of midscale hotels can offer good yield prospects (Jones Lang LaSalle, 2011). As we saw in previous chapters, institutional investors have just recently gained a larger market share in the hotel investment market because of the omission of private equity companies.

2.2.3 Real Estate Investment Trusts (REITs)

By definition, REITs (Real Estate Investment Trusts) are corporations, which own and manage, but also finance real estate. To be classified as a REIT, those corporations have to fulfil certain requirements. Moreover, to give the preva­lence of this business model a push, governments all over the world offer fa­vourable taxation measurements to REITs, such as a total exemption from all corporate taxes.

Apart from some slight differences, there are a handful of requirements REITs have to satisfy in all of the countries (Sotelo , 2007/ Liu, 2010).

- No more than 50% of the shares may be held by five or less distinct owners. (Institutional investors do not account as one person)
- 90% of the income must be passed on to shareholders
- 75% of all revenues must be generated with real estate (leases, rents, selling)
- A minimum of 100 shareholders is required and shares must be conveyable at all time

REITs originate in the USA, where they were introduced in 1961. Since then, a lot of amendments were passed to design the tax designation described above. The Netherlands (1969), Belgium (1995) and France (2003) were the first coun­tries in Europe that passed corresponding laws. The UK and Germany eventual­ly followed in 2007. All of these countries (and the others around the world)[13]had to entrench certain REIT laws, where peculiarities, like, for example, taxa­tion, are regulated.

In the USA, different REIT classes have few distinctive features. This regularity is also seen in other countries with some negligible differences regarding their implementation.

Broadly speaking, there are two main categories of REITS. Publicly traded REITS and OTC REITS.

However, the prevailing type is the publicly traded REIT. This again can be sub­divided into mortgage REITS, equity REITS and hybrid REITS. These categories are pretty much self-explanatory. Equity REITS invest in actual real estate, mortgage REITS make their money with trading with mortgage obligations and hybrid REITS combine those two approaches (Jackson, 2008).

Regarding its shareholders, REITs turned out to be much more favoured by in­stitutional investors than by small investors. Besides, especially pension funds and insurances discovered REITS as a viable and most of all stable investment. This is perhaps down to the fact, that the scope of REIT managers is much more limited than the one of hedge fund- or private equity executives. Furthermore, this limited discretion minimizes the amount of free cash flow that could be spent on negative NPV-projects. This mechanism failed in the mid 1990s and promptly caused a sever depreciation of REITs. After regulations were tightened again, things got back to normal. This effect is perfectly in line with Jensen’s findings (1986), that Managers tend to grow companies beyond their optimal size (Jensen, 1986).


[1]This very unique characteristic of the industry will be discussed thoroughly over the course of time.

[2]see chapter 2.2.3REITS

[3]International Arrivals 2009 in comparison to 2008 (Smeral, 2008)

- Asia -Pacific -6%

- The Americas -5%

- Europe -10%

- Middle East -18%

- Africa +3%

[4]Also remarkable is the decline in the 4-5 Star sector. This can also be explained by trimmed expense accounts of managers.

[5]The problem of sunk costs in the planning stage will be discussed in chapter 3.3.2 Risk Man­agement

[6]Impacts of 9/11 on the hotel industry were already discussed in chapter 1.1.1 Historic Develop­ment

[7]The characteristics ofP.E. hotel investments will be discussed in chapter 2.2.5 Private Equity Companies

[8]As he predicted in 2006

[9]Figure is just depicting the European Market, which however is generic fort he global devel­opment in 2008

[10]Ratio of total sales by investors from Middle-East: 26,7% in 2008 to 6,8% in 2007

[11]Since Fidlschuster et al. solely covered investor types that are common in Germany, the list is completed by the author. REITs (Real Estate Investment Trusts) will be discussed in chapter 2.2.3 REITs

[13]Countries to have REITS installed in addition to he ones mentioned are: Australia, Japan, Canada, Korea, Singapore, Hongkong and Malaysia


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aspects hotel investments




Title: Aspects of Hotel Investments