The Australian hotel market showed glimpses of recovery in November 2021 post the primary impact of COVID-19 but then the Omicron variant prevailed resulting in poor trading performance from December 2021 through to February 2022. There was a gradual recovery from March 2022 and by June 2022 many hotels were achieving gross operating profit in excess of that achieved in June 2019; albeit on the basis of lower occupancy but the higher average rate and better flow through due to leaner operating models evolved from the COVID 19 experience.

The escalating room rates are a consequence of recovering demand off a low base, a change in the business mix (less cheap inbound replaced by higher rate domestic leisure) and a reduction in supply. The supply impact mainly resulted from a reduction in grey supply wherein many private short-term accommodation providers (on platforms such as Airbnb) transferred their properties into the long-term rental market that is potentially offering lower returns but greater certainty of tenure due to the nationwide rental crisis. Some new legislative changes are also motivating this transition. City of Sydney’s private short-term inventory is about half of pre-COVID-19. Furthermore, many hotels are still not operating at 100% inventory levels due to housekeeping labour shortages delivering a further 5%-7% of rooms that may not be available for sale. This offers the perfect environment to allow room rate escalation on the back of rising demand and diminished supply.

Going against this momentum of improved trading has been the escalation in interest rates that have been in focus for most of this year but mainly evident from May/June 2022 motivating a number of market participants to withdraw from the market in anticipation of a reduction in hotel values. This was most noticeably US-based private equity investors that viewed Asia Pacific through the lens of the US market that was experiencing difficult operational circumstances and a high level of re-trades on hotel transactions.

The extent of a forecast reduction in values is open to conjecture, but the fact remains property values must retreat in a rising interest rate environment. This will not yet be evident in prevailing independent valuations as valuers typically reflect past transactional evidence and do not take on the role of predicting changes in value except where a particular market has a clear and obvious adjustment to supply or demand. Valuers have recently pushed up discount rates by 25-50 bps but mostly have not adjusted capitalisation rates.

Apart from escalating interest rates, there are numerous global situations impacting investor confidence and therefore values. However, if Australia can avoid recession (assisted in part by high commodity prices) the reduction in hotel values may be less than for commercial property. There are three key reasons for this forecast. Firstly, the supply/demand metrics are positive in most markets, as described above.

Australian Hotel Sales Above $30 million in Value Since Year 2000

Investor Type No. Hotels Sale Value %
REITS 23 $2,316,200,000 7.5
Domestic Fund Managers 76 $5,005,900,000 16.3
Private Equity 29 $3,213,980,000 10.4
Other Investors 261 $20,244,400,000 65.8
Total 389 $30,780,480,000 100.0

Secondly, to the extent certain investors withdrew from the market in May/June, they have been replaced by investors that are struggling to see value in commercial real estate, or seeking a superior inflation hedge, plus also attracted to the recovery in hotel trading. An example of this, was the withdrawal in June of a US based private equity group from exclusive due diligence on a Sydney hotel at circa AU$100 million only to see it contract with a private buyer in early September at a slightly higher price.

Thirdly, the Australian hotel market is highly liquid relative to our APAC neighbours. Since the year 2000, there have been AU$30.8 billion in hotel transactions of greater than AU$30 million in sale value comprising 389 hotels. Refer table above. Further examination of these sales reveals private equity investors reliant on high leverage to boost returns have not been major players, nor have local fund managers that typically have slightly lower return aspirations compared to private equity, and nor have REITS that stop buying when high-interest rates dilute distributions on new acquisitions. Some investors are pricing themselves out of the market by underwriting an increase in terminal cap rates by 50 bps compared to six months ago. If history is repeated, we see a new wave of investors returning to the hotel market or participating for the first time and the value diminution forecast by some may be overstated.

Finally, partial support for hotel prices has been a turnaround by certain major trading banks in their support of hotel property. We are seeing downward margin pressure due to competition to secure deals and more aggressive LVRs of up to 60%. We are hearing complaints from banks bidding at 2% margins on deals only to be outbid at 1.5%. There are several reasons for this newfound competition amongst the “Big Four” banks but clearly, part is the recognition they have given up too much market share to the non-bank lending sector that has demanded higher margins but in return offered more favourable commercial terms in respect of ICR holiday, higher LVR, lending on CAPEX and agreement to having mezzanine lenders in the capital stack.

Preferred Market Segments

The above overview offers a relatively positive picture of the Australian hotel market but there will be pockets of winners and losers over the medium term. The losers will include:

  • Regional hotel markets. The regional markets have received a sugar hit from COVID-19 that will be partly retained but eventually, the allure of cheap flights to destinations such as Bali and Fiji will impact the regional leisure market.
  • Nonprime hotels. Certain fringe or suburban hotels will find it difficult to recover to pre-COVID-19 trading due to oversupply (in place pre-COVID-19 but the impact more assertively exposed post-COVID-19) or in consequence to the substantive disruption to demand patterns due to work-from-home working arrangements. Locations might include Docklands and Southbank in Melbourne and certain suburban commercial precincts in Sydney.

The accommodation market segments HCP believes will outperform are:

  • Lifestyle Hotels. Demographics are changing, customer expectations are changing and the requirement to differentiate product all lead to the rise of the so-called “lifestyle hotel brands.” All the major global hotel operators have jumped on the bandwagon of lifestyle hotels. Some years ago, they were described as “designer hotels” but subsequent, the market has demanded more than just flamboyant design concepts. Successful lifestyle hotels should satisfy two key criteria. Firstly, a vibrant and profitable F&B business that activates the hotel lobby and draws on an equal number of external customers and house guests (not a common metric in Australian hotels). Secondly, the hotel should outperform its competitor set hotels on average rate and RevPAR including against those traditional hotels offering a larger average room size or more extensive facilities such as a pool or spa.

In the prevailing market, lifestyle hotels converted from traditional operating hotels are delivering levered IRR in the range of 14% – 18% post fees and taxes. Where there is a minimal value add from the conversion strategy due to the extent of the CAPEX requirement the returns will reduce by circa 200 bps.

  • Co-living. This is an emerging asset class in Australia and offers accommodation for a minimum of three months. On this basis, co-living is positioned between build to rent (12 months+ tenancy) and hotels (one to two nights average length of stay). HCP’s strategy for co-living is in part to convert hotels located in areas diminished as hotel locations (typically due to oversupply) but still attractive as a co living locations (proximity to work, university, hospitals, transport hubs or highly socialised precincts well serviced by F&B).

Co-living has emerged as an interesting investment class due to the steep climb nationally in residential rents and the inclination of a large market segment willing to forsake apartment size for the flexibility offered by co-living in terms of tenure plus the benefits of a furnished offering, no utility charges, free Wi-Fi and the social benefits of the communal facilities. Conceptually, co-living should also perform better in a low growth environment because trading is influenced more by the residential rental market and flexibility of the accommodation offering rather than the input of economic growth. In the prevailing market, co-living converted from hotels is delivering levered IRR in the range of 12% – 14% post fees and taxes. Existing co-living assets are selling on 4.75% to 5.25% yield (for scaleable properties) higher than build to rent but lower than hotel property for comparable locations which generally excludes CBD.

The HCP team has deep sector understanding . With a hands on and detailed management approach, the team executes the entire deal lifecycle from sourcing and deal execution, asset management to divestment, delivering superior risk adjusted returns to the investor. The success reflects the team’s intimate knowledge and capabilities across hotel real estate sectors and the value of true expertise in the operational lifecycle of projects and businesses.

Stephen Burt
Stephen Burt
CornerManaging Director

The company is headed by one of the most experienced and respected industry professionals, Stephen Burt, Managing Director with over 35 years experience across all aspects of hotel investment, hotel funds management, asset management, hotel brokerage and hotel operations.

Stephen was one of the founding partners of what is now JLL Hotels APAC, inaugural Chairman of Travelodge Asia, and CEO of Mirvac Hotels & Resorts and Mirvac Hotel Funds Management.

As a trusted advisor and fund manager, Stephen completed a lifecycle of four highly successful hotel funds representing the interest of sovereign wealth funds, private equity firms, high net worth individuals and listed companies. He has held the position of Responsible Officer for HCP funds and institutional funds.

Lucia Grambalova
Lucia Grambalova
CornerChief Investment Officer

Lucia Grambalova, Chief Investment Officer, and Head of Asset Management draws on over 20 years experience in the hotel industry with leadership roles across property investment, asset management, funds management and hotel operations. Lucia is an experienced and accomplished investment professional focusing on equity and debt investing.

During her career, Lucia led the execution of real estate investment and asset management mandates including sourcing and acquisition of hotel real estate investment globally, debt opportunities, deal structuring and capital raising together with the provision of bespoke asset management for companies such as Mulpha Australia Limited, CapitaLand (Ascendas) and Mirvac Group.

Previously a Responsible Officer for Ascendas Hospitality Funds Management and Mulpha Funds Management’s AFSL.