Expert analysis of the impact of the COVID-19 crisis on the value of hotel real estate and the transaction market in Croatia
Transactions are mainly concentrated in prominent “sea” destinations such as Dubrovnik, Split, Opatija, Istria and the capital Zagreb; more than 80% relate to portfolios, with a limited number of cross-border investments. Cover photo: Photo by Eunice Stahl on Unsplash To investigate the potential range and degree of impact of the current recession on hotel values, Hotelis has created a specific model depending on the recovery of the tourism industry during 2020/2021 and the likelihood of hotels to realize high season business in 2020. In this sense, the analysis presents the case of a resort type hotel (4 *, 200 keys) with the assumption that it is the subject of interest of the international investment market. In 2019, the average achieved hotel price per key was EUR 101,000. The potential range and degree of impact of the current recession on hotel values is conceptualized on baseline scenario and three alternative scenarios. The COVID-19 pandemic and imposed travel restrictions along with redefining social contacts have a strong negative impact on the hospitality and hospitality industry. It is precisely the topic of the impact of the COVID-19 crisis on the value of hotel real estate and the transaction market in Croatia that she addressed through expert analysis. Silvija Ilišković Balagović MRICS, hotel consultant and business owner Hotels, independent consulting houses specializing in investments in the field of hospitality and tourism. Assessing the value of assets is particularly problematic in conditions of market uncertainty. The valuation of commercial real estate is based on their ability to generate a monetary return, which also applies to hotels. The approach to the valuation of hotels that is the standard of the profession includes projections of future cash flows for a certain period at the end of which the terminal value of the property is estimated and everything is discounted to the present value. The parameters used depend on the specific market framework and the prospects of the hotel market movement, which are identified at that time as the most expected. As one of the conclusions, Ilišković Balagović points out that currently the decline in the value of hotel real estate in Croatia is up to 40%, depending on the dynamics of the recovery of the tourism industry, while the value is expected to recover. But the main question is when and under what circumstances? More information will bring more certainty and opportunities to draw reliable conclusions. Scenarios and evaluation The model shows a baseline scenario and three alternative scenarios. BASIC SCENARIO – reflects the expected value of the hotel over time based on a stable market framework; this case assumes that the capital and market conditions of the hotel from January 2020 remain unchanged. Additional assumptions for each individual scenario are summarized as follows: As the hotel industry as well as the entire tourism industry is “on break” and EBITDA is expected to fall sharply, where the worst-case scenarios include the possibility of negative EBITDA in the medium term, lenders have stopped new financing and lower LTV ratios and increased interest rates are expected. rate. HOTEL VALUES AND TRANSACTION ACTIVITY IN 2020 The analysis is done from the perspective of a professional participant in the transaction market, and is based on the standard hotel valuation methodology (DCF method). Most of the realized transactions were made among local players, while pension funds became more active as customers, especially in cooperation with operators / hotel companies. Only part of the transactions can be characterized as “market-based”, while other cases are related to privatization, real estate in the banks’ portfolio, and the sale of obsolete and / or obsolete real estate, etc. The COVID-19 pandemic affects all aspects of our lives, both personally and in business. Tourism, and especially the hotel industry, is affected globally, which has a strong impact on the hotel real estate market. The hotel market in Croatia, compared to other Mediterranean destinations, is relatively small and of limited growth, emphasizes Ilišković Balagović. And to illustrate, according to the list of categorized facilities (MINT) at the end of 2019, Croatia had about 780 hotels with about 62 rooms, with a growth of only 000% in the number of hotel rooms over the past three years, while, for example, Italy has more than 6 30 hotels with over a million rooms. Furthermore, the hotel market in Croatia is characterized by a high level of spatial and ownership consolidation, seasonal operations and challenges related to the formation and management of products and the offer of destinations. Key issues and challenges related to the real estate aspect of the hotel business: BEST SCENARIO – Restrictions are expected to be lifted and hotels will benefit from the main season of 2020. This case assumes that hotels will open on July 1 and operate normally until the end of the year with an additional 20% revenue reduction with a recovery by 2023. Attachment: Silvija Ilišković Balagović, Hotel: The Impact of COVID-19 on Hotel Values and Transactions – Croatia Case THE WORST SCENARIO – Revenues are not expected in 2020 with a modest recovery from 2021, and normalization in 2025. All stakeholders in the industry are united in their efforts to better understand the impact of the crisis and find new innovative solutions and business models to apply to enable business conditions and job retention and ultimately mitigate the negative impact on operating cash flow (EBITDA). THE MOST LIKELY SCENARIO – It is assumed that during the months of the high 2020 season, restrictions will continue to apply and that hotels will open in the last quarter of 2020 with an additional 20% overall reduction. EBITDA is estimated to be negative in 2020, and a full recovery in revenue is projected in 2025. During the period from 2017 to 2019, 16 transactions were realized, which refers to 10.600 rooms, with a total transaction value of about 856 million Euros. TRevPAR (total revenue per available room): 32.000 EUREBITDA margin 35%Fixed cost share: 40%Allocation for investment maintenance: 3% of total revenues Assumptions for performing the baseline scenario: THE CASE OF CROATIA – POTENTIAL IMPACT ON HOTEL VALUE Market price versus the cost of building a new hotel – given the significant increase in construction costs in the last 4 years (up to 35%)The expected increase in value in the medium term will attract institutional investors with a greater risk appetite in the hotel industry.Property condition and capex requirements in the medium term – if the property is regularly maintained and it is possible to operate for the next 3 years without major investments, it will be more interesting to buyersBusiness model – it is assumed that brands will gain in importance due to the increased need for high health and hygiene standards, which is easier to introduce into an already standardized business, with the psychological effect of trust in hoteliers as a prerequisite for using accommodation. Additional aspects are the possibility of revising the contract terms and the quality of the owner / brand relationship.Availability of working capital for at least 12-18 months – a financial factor that affects the increase in indebtedness or reduction of internal reserves if the hotelier wants to keep ownership.Production and spatial concept of real estate – the ability to maintain a competitive position in the market, the relevance of the product and compliance with the product of the destination and the needs of modern touristsLocation, landmark status and other features that affect valuesAbility to overcome “operational issues” by changing standards, automating procedures and digitization, and business revitalization. Although there are different levels of impact on the value of hotel real estate, depending on the dynamics of recovery in the short and medium term, it in the worst case scenario falls by up to 37%. To investigate the potential range and degree of impact of the current recession on hotel values, Hotelis has created a specific model depending on the recovery of the tourism industry during 2020/2021 and the likelihood of hotels to realize high season business in 2020. It is expected that transaction activity will slow down in 2020, because values are falling, and owners are not inclined to sell property at a discount unless forced to do so, Ilišković Balagović points out, and asks key questions about the real estate aspect of the hotel business in the next challenging period. The following illustration shows the results of the model while the specific impact on a particular property depends on its physical characteristics, quality of management, market position and location. The high season generates 40% of the total annual revenue of the hotel (in July and August), while during the 4 months (from June to September) it generates about 70% of the total annual revenue in a typical seasonal 4 * hotel. “Many operational procedures must be invented to shape the new “rules of the game.” The manner and intensity of use of hotel public spaces will be redefined, which will also affect value. But hotels are expected to remain a desirable asset and a tool for diversifying their investment portfolio. ” emphasizes Ilišković Balagović and concludes that the next few years will be very exciting in the hotel industry. Hypothetically typical hotel The entire analysis of the impact of the COVID-19 crisis on the value of hotel real estate and the transaction market in Croatia, in the expert analysis of a consulting company specializing in investments in the field of hospitality and tourism Hotelis.com read in the attachment. The decline in value ranges, depending on the speed of recovery, from 17% in the best to 37% in the worst case scenario. Travel and hospitality as well as values are expected to fully recover by 2025. No one knows exactly in which direction the situation will develop and how the recovery will proceed, but one thing is for sure: hotel values are declining as the availability of funding and the ability to work decreases.