by Charles Human, HVS London Office
Following the sharp decline in asset values and market liquidity brought about by the recession, the global market has now entered a new cycle. In the United States values and activity have already shown strong recovery. The United Kingdom (UK) is following in its wake. Europe, however, is lagging further behind, with the market remaining both depressed and illiquid. We believe, however, that it is poised for recovery. This view is based on an evaluation of the recovery that has taken place in both the US and in the UK.
The United States, having shown the earliest signs of economic recovery, has experienced a sharp reversal in sentiment toward the hotel sector. As discussed in the lead article, according to the Hotel Valuation Index (HVI), hotel values across the United States rose on average by 16% in 1994, although with a wide disparity in performance between regions.
The rebound has largely occured as a result of sharply improved business confidence, combined with low interest rates, the availability of equity and the ability to purchase auality properties at prices well below replacement cost. The pace of recovery has been boosted by the realization amongst hotel investors that the window of opportunity will only be short-lived. In sharp contrast to the picture only two years ago, potential buyers now greatly outnumber sellers.
As illustrated by the graph entitled, United States Hotel Valuation Index, three years of uninterrupted decline plagued hotel values from 1989 to 1991. However, 1992 saw the initial stages of a recovery, followed by firmer upswings in 1993 and 1994.
What were the macro-economic and industry precursors to this recovery?
The UK hotel market too has experienced a marked recovery in performance and values - notably, in London - following the recession endured during 1991 and 1992. Economic recovery commenced in 1993, largely engineered by low inflation and low interest rates. GDP growth in 1993 was 2%, followed by 3.4% in 1994.
The fortunes of the UK hotel industry have tracked the economic recovery. It was in 1993 that a recovery in hotel operating performance and values first became apparent. HVS London's Hotel Valuation Index recorded its first year of increase, following two years of decline in 1991 and 1992. We determined that the value of Five-Star hotels increased in 1993 by 14.3%, Four-Star hotels by 8.9%, and Three-Star properties by 7.9%.
Continued economic recovery and a weak pound helped produce an even stronger rise in London values during 1994. Demand for hotel rooms increased dramatically, from both domestic and foreign guests. Average rates and occupany increased on average by roughly 7% and revenue per available room (RevPAR) by 14%. Despite higher interest rates, this sharp improvement in operating performance has translate into a similar increase in values. The latest London HVI shows that 1994 Five-Star hotel values were up by 12%, Four-Star by 13.9%, and Three-Star by 14.4%. Such is the scale of the rebound that Five-Star hotels have recovered to their 1990 peak in nominal terms, although no evidence exists suggesting that the "pride of ownership" buyer who is prepared to pay premium prices has returned to the market.
Transactions that have occurred in London have primarily involved Far Eastern buyers, although it is interesting that a number of indienous groups have more recently returned to the market - a very different picture from two years ago. UK hotel group Stakis purchased two central London hotels in 1994. The depth of demand for London hotels is such that we expect a continued rise in values, as shown in the graph entitled, London Hotel Valuation Index.
The economies of continental Europe are lagging that of the UK, having fallen into recession in 1992-93. Mirroring this pattern, hotel markets, too, have declined over the past two years, at a time when US - and, more recnelty, UK - hotel values were already on the road to recovery. Today, continental European values generally remain depressed. The question is: how soon and how strong a recover can be expected?
The extent to which hotel values have declined in European countries varies greatly. France and Spain have seen the sharpes declines. In Spain, in particular, Barcelona has suffered from large scale overbuilding in the run up to the 1992 Olympics. Within France, it is the regional markets that have been hit, with substantial oversupply in the budget sector, whereas Paris has remained reasonable stable throughout the recession.
Few, if any, major European cities have escaped decline over the last two years, which is illustrated by the index of room yield prepared by HVS International for a package of upscale hotels in a selection of major European cities (see the table entitled, European Cities Room Yield Index, on page 6).
A further feature of the markets, which is all too familiar to those involved in the US and UK markets during recessionary times, is the lack of transaction activity. This lack is due to the combination of two factors. First, owners have been reluctant to sell at depressed levels. Second, there has been a lack of liquidity among the traditional buyers of European hotels. Swedish, Japanese and Middle Eastern investors - all significant purchasers of hotels in the 1980s - have scaled back or stopped acquiring. Debt sources, too, are shying away from hotels, with some organizations, notably certain French banks having suffered considerably in the recession.
Europe's economies, however, have now turned the corner. France, Germany, Spain, and Italy all recorded positive GDP growth in 1994, after a year of decline. The outlook is positive, with most economists predicting average GDP growth for all European (EU) countries of approximately 3% in 1995, and similar rates for the following three years.
With hotel demand closely linked to the economic welfare of a country, we expect the GDP growth trend to shortly translate into stronger hotel demand. Indeed, certain markets have already displayed signs of turning the corner, notably Paris. Continuing economic growth in the United States and UK, two primary feeder markets, will further assist recovery, as shown in the graph entitled, European Growth Rates.
Two further factors suggest that a recovery in liquidity and values is not far off. First, unlike the United States, most major European cities have generally not been plagued by excessive new supply. Planning controls are generally strict in the historic capitals of Europe. The second factor is that many - if not most - of the major international hotel chains are looking to expand their presence in Europe. European hotel markets remain highly domestic in terms of management, with relatively little branding or chain affiliation. The proportion of Five and upper-end Four-Star hotels having some form of affiliation with a major global chain is relatively low, particularly in certain cities. Independent hotel ownership and management is very prevalent, with a number of markets offering scope for re-branding opportunities.
As has already been seen in the United States and Britain, a turn-around in hotel room night demand will trigger not only higher operating profits, but also greater liquidity amongst investors. A change in market sentiment towards the sector could occur fairly quickly.
It is our opinion that various pockets of the market offer considerable scope for the opportunistic investor:
A number of highly geared hotel companies, investors, and overstretched financial institutions need to sell properties, thus presenting opportunities for innovative purchasers. Interestingly, activity is gathering pace in the commercial real estate markets of continential Europe, with a number of specialist investment funds having recently been established to take advantage of conditions. We believe that similar opportunities exist for the hotel sector.
A clear pattern demonstrating the cyclical nature of property investment has once again emerged. In the hotel industry, this trend is presaged by the green shoots of economic recovery which appear and stimulate an increase in both room demand and investor liquidity. Then follows an upturn in investment activity, as buyers jostle for position while a window of opportunity is perceived to be open. These movements then result in values being squeezed higher. This pattern has already been observed in the United States and the UK. We predict that as the economic recovery in Europe becomes more solid, so the cyclical trend will be repeated in hotel markets.
The Hotel Valuation Journal
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