Oct, 2010

Hotel Room Oversupply and Average Room Rates in South Africa

By on Oct 22, 2010

The Grant Thornton article entitled South African hotels not overpriced refers. In it, Martin Jansen van Vuuren, Director, suggests that hotels are not overpriced in South Africa. The writer provides a comparative analysis as evidence which puts the Crowne Plaza hotel in Rosebank against a similar hotel located in some of the most prestigious cities in the world to support his argument.

The tourism industry brings in valuable foreign currency for every inbound tourist who arrives here from our source markets. The hospitality industry creates much-needed direct employment opportunities for every tourist who visits our shores. Unemployment is generally regarded as a major contributor to the poverty situation and a direct cause of the crime problem in South Africa. For these reasons, it is easy to see how essential and important the tourism and the hospitality industries are to the South African economy. South African tourists, who happen to be the largest consumers of tourism product, have to bear the brunt of the high hotel room rates. In its key findings, P0351 – Tourism and Migration, July 2010, Statistics South Africa reported as follows: “In June 2010, there were 997 960 foreign arrivals to South Africa. The arrivals were made up of 16 368 non-visitors and 981 592 visitors. The visitors consist of 260 281 same-day visitors and 721 311 overnight visitors (tourists). The breakdown of the tourists by region is as follows: 277 345 from overseas; 398 085 from SADC countries; 22 989 from ‘other’ African countries and 22 892 unspecified”.

International tourists also find it hard to afford the high room rates when these are compared with our global competitors. Brazil, for instance, which is similar to South Africa in some respects, is geographically closer to most of the same source markets that we rely on for inbound visitors. “The upscale hotels in the major cities of Rio de Janeiro and Sao Paulo reported average room rates of between $300 and $400”. Although the South African equivalent is around $190 at current exchange rates, the difference can arguably be absorbed by the cost of travelling here, a destination which is generally regarded as a long-haul destination.

High room rates create conditions of an oversupplied market. Under normal circumstances, such a condition should bring about a decrease in average daily room rates as a result of market forces of demand and supply. Instead, what we have seen is a reduction in occupancy rates, despite the World Cup having been successfully hosted in South Africa recently.

Some countries have formulated various solutions to deal with the hotel oversupply problem. Others have not dealt with the problem and left it to market forces. As with any solution to this type of multifaceted problem, the good must be taken with the bad. Some solutions simply look good on paper only, while others that are implementable may not produce the expected outcomes. It is essential though in the first place to identify where this oversupply exists and to quantify its extent.

Hotel operators can start by discounting room rates. “The twin problem of reducing average daily room rates is that customers tend to think that the quality of the property has dropped, as well as that it is often difficult to raise them once conditions improve again”. “Instead of dropping rates, hotels are adding value, offering two-for-one deals where visitors get one night ‘free’ on top of the original booking, extras such as free bottles of wine with a dinner in the hotel restaurant or vouchers for various entertainment in the city. For the Christmas season, many held expensive buffet dinner celebrations, with entrance included in the room rate”.

Discounting average daily room rates when there is an oversupply of hotel rooms might help with occupancy rates. “However, such measures tend to only provide a temporary relief as the operators enter a price war while trying to undercut each other the whole time”. “The transparent nature of hotel pricing means short-term occupancy gains are quickly offset as competitors rapidly follow suit in cutting rates. This leads to a lower priced hotel market yielding lower revenues in the face of normally unchanged demand, proving that rate discounting alone does not induce additional hotel demand”.

The South African Reserve Bank could consider a further interest rate reduction to stimulate economic activity. South African interest rates at 10% per annum have not been this low since the 1970s. Inflation is within the target range of 3%-6% per annum. Our trading partners are also experiencing a low interest and inflation rate environment. GDP is low and an economic stimulus is required urgently.

The debate around the strength of the South African Rand is doing the rounds. Clearly, a devalued South African currency will help the export market, thereby increasing manufacturing capacity, which will in return increase domestic consumption for goods and services, including for hospitality product. A more competitive ZAR/dollar exchange rate will help make hotel rates more affordable for the inbound tourist market. However, not everyone agrees that currency devaluation will be without long term consequences.

Increasing the attractiveness of South Africa to our target markets via tourism marketing interventions and projecting the image of the country in the best possible light can help increase visitors across our borders. The South African Department of Transport could relook at increasing the number of airport slots for international airlines. This would help bring more visitors, bring down costs through competition.

In response to one of the worst recessionary environments that the world has experienced in recent times, the United States was the one of the first countries to bail out its industries with economic handouts. “But perhaps most daunting was the introduction of the National Asset Management Agency in Ireland. The program was designed to take over toxic assets throughout the country…”. The NAMA is an agency of the Irish government. One of its first actions was to take control of more than a hundred hotel properties with a view to avoiding insolvencies of the operators through paying out the creditors and then taking out the excess stock from the market. In this way, competition in the market was minimised and room rates were stabilised for the entire market. Although the taking out of competition is not always a good thing in a market economy, especially when taxpayers’ funds are utilised to achieve this goal, such drastic action is a further indication of the seriousness of the hotel room oversupply problem and the extent to which some countries would go to protect their tourism industries.

“NAMA may help alleviate the issue of oversupply of hotel rooms by forcing operators to review and make changes to their operations, for instance requiring all or part of a hotel to be converted to a different use or to incorporate seasonal closures, where NAMA believes that such changes will enhance the commercial viability of the hotel”. This is a rather draconian proposal because most hotels are designed with a specific market segment in mind and as such are not easy to realign without wasteful capital expenditure. However, to try to convert a hotel to an alternative use, for instance a office premises, is even less realistic for the same reasons. Office and hotel property investment life-cycles also tend to track one another. The Johannesburg Sun was mothballed in the mid-1990s. It was reopened in 2002 as a watered-down version of its glorious self.

The Ernst & Young House, an office block building in the centre of Johannesburg, was also mothballed and it stood that way for very many years. It was subsequently converted amid much media fanfare into a residential block. This was achieved at very considerable cost as the major cost component was the finishing works. The fact that the structural framework was already in existence did not provide a major cost advantage for the new owners, as the services had to be significantly re-engineered.

The Carlton Hotel in Johannesburg was also mothballed in the late-1990s. Although these examples have more to do with the impact of  urban morphology than with the hospitality industry dynamics, even when Johannesburg was experiencing a revival, not many people showed an interest in returning these two hotel properties to their glory days.

“Hotels are effectively in the property industry, and construction costs are the capital outlay that hotel incomes and profits have to provide a return on. For the same 8 years, tender price escalation, as an indication of construction costs, has averaged 12%, indicating that hotel returns are diminishing”. This argument creates a concern. The first rule of a viability study is that new investments must be introduced into the market only if the potential for the market to be able to sustain the room rate. By the end of 2007, most market commentators were already forecasting a that the “property bubble” was due to burst. The then Reserve Bank Governor was frantically issuing warnings to businesses and consumers alike to reduce their debt and to delay taking on more. Most of those hotels that entered the market without taking into consideration those warnings were really not supposed to have been built in the first place.

The prevailing environment of higher than inflation building costs when the country is experiencing deflationary conditions is also to blame for the high average daily room rates. The elements that make up building rates for the compilation of building costs are made up of materials, labour and overheads. In the recent past the rise in materials component has been much more than inflation and other building cost indices. The largest construction companies were also recently investigated by the Competition Commission for anti-competitive behaviour. Some of them owned up and were penalised.

Hotel owners could alternatively settle for a reduced return on their property investment in comparison to competing investments. This intervention would hopefully have the desired effect of reducing investment in new properties and help with the absorption of the existing oversupply.

For the investor or lender, the perception that average daily room rates is higher than it ought to be means that hotel properties are currently overvalued. Under conditions of overvalued properties, lenders tend to want to revalue the loan-to-value ratios on their loan books, with the undesirable result that under certain circumstances they might want their debtors to reduce the capital balance and their loans ahead of the repayment schedule.

Some bankers have gone further than conducting debt reviews. Instead of recalling loans they have on hotel properties they have gone and interfered with the market dynamics by unilaterally dropping rates. “Established hoteliers have bitterly criticised the actions of so-called ‘zombie hotels’ which have been taken over by banks and are undercutting rates for the sector in general”.

Hotel room oversupply has led to many problems for all involved in the industry, whether as customers or operators and owners. The solutions are limited, both in number and applicability. The solutions can also take a long time to achieve the desired result.

The following articles, listed in no particular order, were referred to and excerpted in drafting this article. Some of the links below will take you directly to the article itself. In certain circumstances you might have to go to the website itself by deleting the URL up to the address point and then searching for articles or publications.



http://www.hbcl.ie/news/HCR_May10_Con_Quigley.pdf http://www.ehospitalitytimes.com/?p=3577



http://business.highbeam.com/industry-reports/personal/hotels-motels http://www.hbcl.ie/news/HCR_May10_Con_Quigley.pdf http://www.rte.ie/news/2009/1111/hotels.html

http://www.tradearabia.com/news/real_185666.html http://www.irishtimes.com/newspaper/travel/2010/0925/1224279638589.html http://www.brandchannel.com/features_effect.asp?pf_id=497