Search

×

Seeing red? Horwath weighs in on activity in China

Is the bloom off the rose that is hotel development in China? The stock market was going through a serious correction the past few months, investors have been looking outward to markets like New York and into Europe for hotel acquisitions and, generally speaking, the real estate market in the world’s fastest-growing economy over the last decade has been slowing down.

HOTELS’ Investment Outlook reached out to Horwath HTL’s Asia-based team for their points of view on the current and near-term state of hotel development and M&A. Beijing-based Senior Consultant Li Wen was the point person and author of the responses.

HOTELS’ Investment Outlook: Has the devaluation of the stock market in China put a damper on hotel development, and has it further impacted slowing performance?

Horwath HTL: We believe that the major impacts on the China hotel industry development come from the slowing down of the real estate market. We haven’t seen much evidence showing that the devaluation of the stock market has any impact on hotel development.

However, the recent turbulence in the stock market has affected the performance of hotels whose major clients are finance-related companies as their meeting, banqueting and food and beverage consumptions were reduced under the tough stock market circumstance. According to the most recent China Hotel Market Sentiment Survey in May 2015, the performance of local or global stock markets was viewed as a factor that would slightly negatively impact hotels’ performance.

HIO: Where is there hotel industry strength and weakness in China?

H: Let’s break this out by market, by segment and by developer type:

Market: Primary cities and leading secondary cities have continued to exhibit strong performance, including Beijing, Shanghai, Guangzhou, Shenzhen, Sanya and Wuhan. Tertiary cities face intense challenges, especially the ones with oversupply issues like Tianjin, Chengdu, Qingdao, Dalian and Xi’an.

Segment: In terms of nationality, the share of international demand is likely to continue to drop. Domestic demand becomes increasingly dominant. In terms of demand segment, domestic corporate and leisure FIT demand are on the rise, while large scaled MICE demand from state-owned companies has decreased significantly. Shanghai stands out as an international MICE destination in the private sector.

Developer type: The types of hotel developers are more diversified than ever. While some real estate developers continue to include hotel components in their mixed-use developments, other types of investors have stepped into the hotel development market such as architects, media companies, Internet technology companies, funds, insurance companies and P2P (peer-to-peer) financial institutions.

HIO: How are deal terms evolving as a result of weaker economic conditions?

H: The numbers of deals (excluding economy brands) signed decreased by 3% to 4% year-to-year from 2013 to mid-2015. Meanwhile, the share of luxury and upper-upscale brands among all the brands (excluding economy brands) decreased continuously (49%, 42%, 40%, 36% respectively in 2012, 2013, 2014 and Q1-Q2 2015).

Given the expected decrease in deals signed, there have been intentional compromises on certain commercial terms by some global hotel management companies. A few management companies have started to open up the franchise option for selected brands such as Courtyard by Marriott, Holiday Inn Express and Hampton by Hilton. Comparatively, domestic hotel management companies are more flexible on deal terms, including critical ones like the contract term and management fees.

HIO: Government officials stated in late July that they expect 7% GDP growth for the next few years. What is your response to that?

H: The central government of China usually will ensure the realization of the expected goal, judged by previous experience. The current administration is also known for its focus on sustainable GDP growth.

HIO: There is a perception there are empty hotels littering the Chinese landscape. How realistic is this view? How long before they are operating at a profitable or even near profitable level?

H: Based on YTD May 2015 data from STR, the average occupancy of the China hotel market in 2014 achieved over 65% despite an approximate 5% supply increase.

We believe that the China hotel market has substantial demand even though the present spending power of the mainstream of demand is relatively low compared to other leading global regions. Currently, the major challenge for the China hotel market comes from the continued decrease in ADR that was not strong to begin with. As such, the investment return of hotel development in China is far from being satisfactory, especially for those heavily invested in upscale and above hotels.

HIO: Is the Chinese economy truly evolving toward a service-based economy, and if so, what is or will be the impact on hotel development and performance?

H: The high-speed development of the Internet economy has facilitated the development of the service industry in China. However, there hasn’t been significant growth in the high-end professional service sector that could generate strong demand for the hotel industry.

Dynamics, outlook for investment in China

Based on the YTD May 2015 pipeline data from STR Global, there were 806 upscale and above hotels under active planning/construction in Mainland China. However, new hotel development has slowed since mid-2014. Many new hotel openings have also been delayed.

The main cause is slower real estate market and residential sales, which used to fund hotel development. Given that real estate developers are still the major hotel investors in China, Horwath HTL says the current static development market is likely to continue.

As for the outlook on future development trend, Horwath summarizes a number of key points:

Future investors are likely to include more market/return-driven capital.

Future hotel products will focus more on the select-service and mid-tier categories.

Suburban resorts, theme parks and hotels are likely to be the investment focus.

Ski resort development is likely to be another hotspot for investors after China officially beat Kasakhstan to host the 2022 Winter Olympic Games.

Outbound investment has been very active since 2014, marked by a number of significant deals made by AB Insurance and Wanda Group.

Restructuring of hotel management companies is growing increasingly active.

Comment