The Mid – Market Math

Nov 26 • Highlights, Hotels, Local Diary, News & Features, Travel • 578 Views • Comments Off on The Mid – Market Math

The mid-market hotel segment in Dubai has been a lot in focus recently. Everybody is in agreement that there is a massive shortage in comparison to demand, so what is really holding back investors? Curiosity Middle East talks to Grant Salter, Director – Head of Travel, Hospitality and Leisure Advisory (Middle East Region), Deloitte Corporate Finance Limited, to find out what is going on in the region

As low cost airlines rise in popularity across the region, budget travelers are finding Dubai a more attractive destination and in so doing are pushing the demand for mid-market lodging in the city. However, if Dubai has to achieve its goal of 20 million annual visitors by 2020, it must widen its appeal amongst the fast growing middle class in emerging economies of Asia and Africa. And in doing so, it needs to provide more affordable accommodation options. Currently, 5-star and luxury hotels dominate the market, with a market share exceeding 60 per cent giving the well-heeled travelers abundant choice. Out of the existing stock of hotels only 10 per cent of room supply is in the upper midscale and midscale segments.

The tourism authorities realize the destination’s shortcoming and are, therefore, pushing the development of mid-market hotels. According to Dubai Department of Tourism & Commerce Marketing (DTCM) statistics, Dubai currently boasts 634 hotels and hotel apartments with 88,680 keys. This number is expected to almost double touching 160,000 rooms within the next 6 years by Dubai Expo 2020. Nearly 30 per cent of hotels will be in the mid-market category in the upcoming supply.

The demand for mid-market remains strong but the challenge is to get the supply rolling. So, why are investors shy on putting their dollar in this segment, given the staggering potential for growth? High cost of land and construction are the two primary reasons holding back investors. Alternative construction methods, such as modular-built, appear to be the way forward to make the economics work.

How well is the Middle East region performing in terms of travel and tourism and what are the key trends emerging in the hotel sector? The Middle East is doing very well in relation to the rest of the world. If one looks at RevPAR growth, according to STR Global data, the Middle East grew at 5.5% for YTD July 2014 while Asia Pacific grew at 1%, Europe 4.4%, North Africa 3%, Southern Africa 6.3%, North America 7.7%, Central America 3.5% and South America 17.1%. The region’s contribution to GDP at 2.5% is slightly below the world average of 2.9% but is set to increase by on average 4.6% per year over the next 10 years whereas the world average growth is expected to be 4.2% with only Asia Pacific, and Africa growing at a higher rate.

In terms of pipeline growth, the anticipated growth in hotel rooms in the Middle East based on data from STR Global is close to 41%, Asia Pacific 14%, Europe 3%, Africa 8%, North America 7% and South America 15%.

Some of the key trends emerging include the following:
Shorter stays more often:
Time pressure has meant that in general the days of 3 to 4 week holidays are no longer the norm. Shorter breaks of between 5 to 10 days have become the norm with visitors taking extended weekends or at most two weekends with the week in-between. This changes the way resorts in particular need to market themselves and their product offering as people want condensed experiences whilst they are travelling.

Millennials:
The traveling public is becoming younger with Millennials travelling more frequently and generally in groups. The Millennial traveler wants ‘experience’ based travel and doesn’t mind paying for such experiences. The range and intensity of the experience is important to the Millennial traveler and they typically choose their destination based on these experiences/attractions.

In terms of accommodation, this market tends to seek accommodation options that are different to your stereotypical ‘hotel’ again seeking to have an ‘experience’ rather than simply a bed. A number of the top hotel operators have developed product to tap this market. Citizen M, Moxy, Malmaison etc. are brands that seek to offer products that offer “non-typical” or unusual design and experiences at a midmarket price point to capture this market. Millennials also typically travel at short notice making planning for this type of travel (from the hoteliers point of view) quite challenging. Technology/Connectivity: The tourist is now much better informed than ever before and this has impacted the way the market has to approach its customer. Social media and review websites/apps have created challenges for hotels but those that are able to embrace this technology and respond to their customers’ needs are winning loyalty.

How do you foresee the hospitality landscape in Dubai in the next five years?
I think the market in absolute terms will continue to grow from both a supply and demand perspective. In the short term, supply growth is likely to outpace demand growth as the world economy grows at a slower pace over the next few years. I think the main recovery period has occurred already and we will see healthy growth in demand going forward but not at the pace that we have seen over the last two years. The lag in demand growth vs supply growth could impact rate performance in the market as hotels seek to compete to maintain their occupancy levels. In addition to this there will be a rise in the supply of mid-market hotel inventory which will potentially put demand pressure on the 5-star sector as guests and tour operators look for better deals. In general terms, however, we are bullish about the market as a whole and its prospects over the next 5 years assuming there are no major “shocks” to the market. There are a number of initiatives being rolled out in the coming years which are designed to enhance and expand the broader tourism offering in Dubai and this hopefully has the effect of growing and supporting the demand. This will potentially alter the visitor profile to Dubai again supporting need for mid market accommodation options.

You recently spoke about the ‘new normal’ that hotel owners and operators need to accept in terms of performance i.e. basically 70 per cent average occupancy instead of 80. What are the reasons behind this?
There are some supply and demand challenges which will take some time to impact the market. The range of accommodation options is increasing, and with a general volume increase, could change the performance in the market as a whole. This is not necessarily a bad thing. At the moment the market is led by the supply side of the market. At occupancy levels where they have been over the last couple of years the hotels are able to dictate the pricing regime which is not a healthy situation for an extended period. Dubai is already getting close to one of the highest rate markets in the world and if the rate growth continues unabated, this has the potential of hurting the appeal of Dubai as a destination as people start to look for more attractively priced options. So if the planned growth in supply does indeed outpace demand growth, then the market wide occupancy will likely decline to levels of around 70% to 75%

How is investing in the hospitality sector in the UAE/Dubai different from investing in other real estate projects?
Location is always the dominant factor in any real estate investment and this is no different in the hospitality sector. Location is a key determinant of success for hotels but it is certainly not the only factor. Hotels are complex businesses that require experienced management to generate the appropriate levels of returns. Hotels in Dubai are heavily reliant on the strength of the economies in the source markets of their guests and market shocks can result in fluctuations in revenues from one year to the next. Residential real estate investment tends to be more simple to manage and returns tend to be more stable but at a lower long term return.

We all know the factors driving demand for mid-market and budget hotels but somehow the progress is slow. Why is it taking so long for investors to realise the potential of budget brands?
There is a lot of interest in the mid-market sector. The real problem with mid-market is that using tradition/typical construction methods, the cost to construct at present often makes the projects less attractive to investors. Then if you add the cost of land, the project then becomes unviable. Alternative construction methods have to be used to ensure the projects are viable and there needs to be some sort of intervention from government regarding land because in the areas where midmarket hotels need to be to attract patronage, land is typically prohibitively high. Another challenge is that Dubai has very high safety standards for construction of hotels. This is a good thing, but when it comes to new construction technologies, the process of approvals could take a long time and could become quite expensive for the investors.

What kind of investors are we looking at in the UAE hospitality sector?
Typical investors here are from local families and local real estate investment groups from the region. There is an interest from foreign investors too but on a much smaller scale. Generally speaking, foreign investors like to acquire properties rather than developing properties on their own. There is considerable cross border investment into the UAE market from Saudi Arabia, Qatar and Kuwait. Russian investors have slowed down a bit, however, interest from Indian and Chinese investors and developers remains strong.

How are regional hotel chains faring in comparison to big international brands?
Big brands and operators are often locked into relationships with the large developers. Smaller investors generally have to look at smaller operators and alternative brands. Whether those brands have value in the market remains to be seen..

What kind of ROE can an investor expect in budget segment?
Returns in the current ‘landscape’ are under pressure due to high land prices and rising construction costs. We tend to focus rather on internal rates of return (IRR) which could be somewhere in the region of 2 or 4 percentage points lower for mid-market properties. But the important fact is that such properties tend to be more resilient to market fluctuations in the long term.

What are the key challenges being faced by midmarket brands?
The mid-market brands are all keen to get involved in the market but probably the key issues for the mid-market brands are around brand consistency. There is an expectation in the region for brands to offer a higher level of service, luxury, facilities, etc. In many cases this challenges the brand expectations outside of this market. For example a typical 3-star brand in the US/Europe will tend to be positioned as a 4 star product in this market yet still be branded the same and will be sold as the same brand which can confuse the market.

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