• Forecasting the top of the cycle

Any decent financial commentator knows that forecasting involves an element of nonsense. People who believe they really know the future will never tell you and if somebody is prepared to tell you, then they don't know.

Despite this truism, forecasts were as thick on the ground at this year’s International Hotel Investment Forum in Berlin as ever. And the favourite forecasts were about calling the top of the cycle. The consensus was that we are at the top, and perhaps even coming off the top, at the present time.

Speaking on the Leaders’ Panel, Kurt Ritter, CEO of Rezidor, was unusually candid for the head of a listed company. He said that the typical hotel market cycle lasts six to eight years and that the current cycle started in 2002.

The caveat that Ritter put on this assessment was that hotel managements this time around are much better at controlling costs. He further predicted that the real pain would be felt by the smaller chains and unbranded operators.

A further counter cyclical factor was the emergence of India and China. This structural change gives hotels further cause for hope.

The view of shrinking numbers of hotel brands was not shared by InterContinental’s CEO Andy Cosslett who said that his company’s research predicted that Europe was set for a proliferation of brands over the next five years.

After about 10 to 15 years, there would be a shake out, he conceded. He explained the new brands in part by the emergence of new guest needs, citing extended stay as an example. This segment was now 6% of the US market.

Earlier in the programme, Deloitte’s Nick Van Marken said that the emergence of hotels as an acceptable asset class was another factor that had helped drive the sector forward.

Chris Day from Christie & Co said added that this had been crucial in driving yields lower. But he sounded a note of caution by pointing out the uncertainty in the market at present: “We are seeing 30% spreads on the bids for portfolios. I’ve never seen it as wide as this before.”

Last week Savills put out research supporting the case for hotels outperforming other property asset classes, all be it by a small margin, going forward

Total returns, according to Savills’ forecasts based on historic data from IPD, showed UK hotels providing a 16.9% return in 2006, falling to a forecast 11.3% in 2007. UK all property is set for a 17.9% return in 2006 but this will fall below hotels to 10.1% in 2007.

Savills further predicted that over the next five years, total returns from hotel property will average 8.4% compared to 6.7% for all UK property.


HA Perspective: There is certainly a strong case for arguing that hotels have come of age and that they will now, at last, punch at their weight.

It is less convincing, however, to argue that this time things will be different. It is still a cyclical industry and there are no new paradigms – special factors such as India and China will impact but it is hard to see them being of sufficient scale to counteract the effects of the business cycle.

Better quality management within operators that is focused purely on brand management and operations, rather than property, will also take the edge of cyclicality but not eliminate it.

What is clear is that the rate of growth is slowing. The weight of cash looking for a home will continue to push yields lower but it is going to become harder and harder for these deals to provide investors with their expected returns.

Deutsche Bank’s Tim Lloyd-Hughes said that it was a “strange environment” where equity was cheaper than debt. But this of course only applies in the case of initial yields.

Hotel property investors increasingly understand that capital growth is a core component of the overall return and needs to be factored in. The residual value of hotel property investments, particularly for upscale hotels, is a much more important factor than for any other mainstream property asset classes.

But this also means that the point of the cycle at which you buy is more critical. And this brings us again to that problematic question of where we are in that cycle at present.

Forecasting is, as intimated at the start of this article, a mug’s game. Some believe that the current market jitters are no more than a mid-cycle slump. But there is clear nervousness, as Chris Day noted.

The shrinking hold period of private equity buyers can be seen as another example of nervousness. As Nick Van Marken pointed out, just 10 years ago the typical hold time was five to seven years and now deals are being flipped within 18 months.

The double digit returns seen in the last couple of years are now over, at least in aggregate, according to the Savills research.

A prolonged period of modest growth is probably the best thing for the hotel industry. A smooth downturn will help cement the hard-won respectability of hotels as investments.

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