18/01/2012 - 09:59

Hoteliers’ confidence not matched by prospective developers or investors

18/01/2012 - 09:59

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Perth needs more hotels but it seems developers aren’t willing to wait for a return on investment, and current operators can’t afford to build.

Perth needs more hotels but it seems developers aren’t willing to wait for a return on investment, and current operators can’t afford to build.

THE Western Australian hotels industry is reaching a tipping point as strong demand for hotel rooms runs headlong into a lack of developments in the pipeline.

The state government has recognised the looming mismatch, and has moved to pull policy leavers to steer the market in the right direction.

But it remains a complicated sector fraught with issues that dissuade many developers from testing the waters.

On the surface, Perth’s high room and occupancy rates may seem like an incentive to build hotels, but high construction costs and operational and labour costs (see Costs a necessary evil) reduce the return on investment. Sensing there are better returns to be had elsewhere, developers turn their attention to the commercial or residential sectors instead.

Added to that is the widely held industry view that a hotel’s third owner is the first to turn a profit; hardly a ringing endorsement for a prospective developer.

Enter the state government.

Following talks with various tourism industry bodies, the state government recently announced it would release Crown land for hotel development, lease it on longer-term arrangements at a peppercorn rate and discount the land values on a case-by-case basis in order to encourage development, in the Perth CBD in particular.

“The severe shortage of hotel rooms in Perth in particular negatively impacts WA’s ability to successfully attract corporate and leisure visitors, major conferences and events, increase aviation capacity and disperse travellers throughout the state,” Tourism Minister Kim Hames said last October when he announced the incentives.

Market failure?

At a recent WA Business News boardroom forum, Tourism Council WA chief executive Evan Hall said market failure was to blame for the current situation.

“There has always been market failure in hotels, except for the point in time when a city is very young, land and labour are cheap so you can afford to build. Any sort of level of maturity and only certain markets pay off for developers,” Mr Hall told the roundtable.

AHS Advisory hotel consultant Rutger Smits said while the term ‘market failure’ didn’t quite fit the bill, demand and supply balance was the issue.    

“The demand for hotel rooms is far from failing; on the contrary in Perth you have more demand than anywhere else,” he said.

“I think the failure sits on the supply side, in that it is investment that is too expensive; or arguably the return side because room rates are not high enough.”

In that regard, it is considered a perfect storm for existing hotel operators.

For years large corporate clients have been aggressively negotiating prices for bulk room bookings, putting pressure on hotel owners to lower room rates.

In the current market, room occupancy rates are hovering around 80 per cent, while room rates are also at near-record rates, up 11 per cent in the past quarter and averaging $174.

“I don’t think there is an operator in WA or the world who wouldn’t be prepared to put a brand into a property in Perth,” Mr Hall said.

Hotel operators Pauline Tew, who owns Smiths Beach Resort and Injidup Spa Retreat under the My Hotels business, Hyatt general manager Adam Myott, and Pan Pacific general manager Grant Raubenheimer agreed.

So what explains the lack of interest in hotel development from owner-operators, investors in hotels and property developers?

Ms Tew puts it down to the construction costs.

“The old rule of thumb used to be that 10 per cent of the build cost was the room rate. If it cost you $250,000 to build that room, it cost you $250 for a room,” she said.

“Rooms now cost up to $760,000 to build, so you should really get $760, but you will never get that, so it goes down and down and that is where the problem is. Taking a building that you renovate that can sit in the price bracket of $147 to $246 [nightly room rate] is the only way it works.”

Ms Tew told the forum that when My Hotels had the Outram Street Hotel in its portfolio, she contemplated buying the land next door to the property and building it into a larger hotel but the room and occupancy rates of the time didn’t add up.

Instead, she renovated Outram Street Hotel so as not to overcapitalise.

“I took a small, boutique-style hotel, I put a five-star standard in it, I called it a club hotel and it was filled straight away in West Perth and it was up in 2005. I came out with a room rate of $268 and everyone said, ‘you’re crazy, no-one will pay it, no one will come’,” Ms Tew said. “They paid it, and they came.”

Others are currently taking this approach in Perth, with a 15-room boutique hotel currently under construction in the St Georges Terrace frontage of the Bishop’s See complex, and Mirvac Group’s development of The Old Treasury Building approved by the City of Perth (see Hotel developments can benefit from commercial connection).

Mr Raubenheimer said Pan Pacific considered Perth a hot spot for hotel development.

“Pan Pacific Hotel Group is looking to expand in the Pacific Rim,” he said of the Singaporean business.

“Since November last year to May next year we will have opened four new properties in Australia, four Park Royals and one Pan Pacific.

“We are looking to other properties now, whether it is a build or an old hotel property, residential conversion.”

Mr Raubenheimer said the land available in Perth didn’t lend itself to the right plot ratios for a hotel and that, because the business’ Pan Pacific brand already had a presence in Perth with the city’s largest hotel, he expected the business would be more likely to develop a second hotel in Perth under the higher star rated Park Royal brand.

“If you look at the Park Royal, it is family orientated and where would you build something like that?”

Policy intervention

The state government’s solution to the land issues the industry faces has been to open up Crown land to the market and offer peppercorn rents to hotel operators in order to improve the return on investment.

Mr Smits said this didn’t necessarily mean Crown land in the CBD – where it was needed most – would be released, however. 

Mr Smits believes a better solution is to mandate the development of hotels at new prime development sites, such as the Waterfront, Riverside and City Link.

“Frankly I don’t think the development authorities are going about it very smartly,” he said. “If you find a single developer for the entire site you end up with a developer who is trying to maximise the return on the real estate they develop on that site and the same principles apply.

“Returns on hotels are lower than anything else, so hotel development typically falls by the wayside, unless that hotel is mandated as part of the development plan in place.”

It is widely understood that Waterfront and City Link do not include mandated hotel development sites as yet, but that Riverside does.

Mr Smits suggested an extra step should be taken in attaching mandated hotel development lots to other commercial or residential lots to ensure the hotel sites were not left behind, which would provide another negative signal to prospective developers.

“If you look at Perth Waterfront, if government was smart it would say, ‘Ok we need more hotels, we need to mandate hotel development as part of the overall master plan’, and it would prescribe how many rooms and of what standard that needs to be,” Mr Smits said.

“If that means the hotel plot by itself becomes undevelopable because return on investment is not there, then that plot should be packaged up with surrounding plots or with the whole master plan if it is a single developer.”

However Committee for Perth chief executive Marion Fulker said the government should be wary of bundling large plots of land together for development by one proponent, for aesthetic reasons.

“We have Riverside, Northbridge Link and Perth Waterfront, which will be controlled by the state government in terms of land and tenure,” she said. 

“The model is very risk averse as far as I can see; let it go to one developer, the relationship is between the government and the developer to develop that site.

“Is Lend Lease invested in Perth? Does it understand the Perth market, is it going to produce something that has a Western Australian feel to it, or are we going to have a very sterile, cookie cutter model?”

That is the tack the state government took last year when it announced its decision to bundle five hectares of land together for the City Link project, to be managed by a single developer, and 4ha at Waterbank to Lend Lease.

The government came under fire from Australian Institute of Architects WA chapter president David Karotkin for that decision.

“Not only does this restrict developer access to this significant site, our view is that a single developer option will result in an homogeneous development outcome without genuine texture or soul,” Mr Karotkin said at the time.

“By handing over development control to a single entity, the government will not only deny many local and boutique developers access to this significant site, it will also lose flexibility to respond to evolving planning and development opportunities that will emerge over the timeframe that the site will be developed.”

Mr Smits stressed the case-specific feasibility of hotels and said strategies were needed to ensure the ‘right’ hotels were developed in the ‘right locations’.

“A limited-service, two-star hotel without restaurants right next to a convention centre probably doesn’t make sense. A full-service, luxury, five-star hotel in Fremantle probably doesn’t make sense either,” Mr Smits said.

“You have got to look at the market, the demand for accommodation product in that market and from there you determine what the best product is that suits that demand, and then you do your feasibility.”

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