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.