Australia hotel market boasts signficant investor potential

AUSTRALIA The hotel industry in Australia offers “golden opportunity” for medium-term investment, according to Sydney analyst firm BIS Shrapnel.

BIS Shrapnel’s report, “Australia’s Eastern Seaboard Hotel Market Property Prospects, 2011–2020,” lays out a broadly positive scenario for the market. Occupancy rates are already relatively high in Sydney, Melbourne and Brisbane—indeed, they are at record levels in Sydney’s 4 and 5-star sectors. With solid demand, underpinned by a rebound in corporate travel, and constrained near-term supply, occupancy rates look likely to strengthen further.

“In a sense, the market is carrying on from where it left off before the [global financial crisis] interrupted what was promising to be a strong cyclical upswing,” BIS Shrapnel Senior Project Manager Maria Lee.

Nevertheless, she cautions that significant risks remain for the Australia hotel market. “In inflation-adjusted terms, historical room rates paint a dismal picture,” Lee says. “In Sydney and Melbourne, for example, real room rates have fallen by an average of 1.7% and 1.1% 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 behavior of owners and operators in the pre-[crisis] upswing and post-[crisis] 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, occupancy rates decreased only modestly, not falling below 73% in any of Australia’s eastern seaboard capitals, and this is generally regarded as a fairly healthy occupancy rate, the firm says. Yet Sydney’s ADR fell 11%, and Melbourne and Brisbane’s rates dropped by about 6%. Although rates are starting to be raised, especially mid-week in business hotels, the market is still far from recouping the recent losses.

The other key area of concern highlighted in the report is the supply-side response. There is broad market agreement that, in the main, the financial logic for development does not yet stack up. This fact, together with continued difficulties in financing development due to high cost of funds and a scarcity of lenders brings comfort to market participants, who cite the constrained supply pipeline as a key factor in their positive outlook for the market. Yet government bodies working to boost tourism are surely disheartened by the same situation, as growth in inventory is a necessary part of growing the contribution of tourism to the Australian economy.

However, Australia’s hotel sector has a poor history of matching supply to demand; in the past, hotel development in Australia has defied logic, with new projects coming online seemingly triggered by high occupancy rates rather than financial feasibility based on market conditions. High occupancy has led to unrealistic assumptions of ADR growth.

 “Melbourne has added some 2,500 rooms to its 4- and 5-star stock over the last two years, despite market players telling us that it didn’t stack up to build,” Lee says. “There’s every chance that we will see too much too soon again in the coming cycle.”

BIS Shrapnel expects the upswing will be cut short by overbuilding and may, therefore, be relatively short. The company is advising market players to act quickly and decisively to maximize their positions. Overall, near-term prospective returns are strong, with a five-year IRR forecast at 18%.