Supply and demand: Hotel expansion drive makes for a very competitive market

Unlike many emerging markets, the cities of South Africa are not littered with the skeletons of half-finished high-rise towers. The 2010 FIFA football World Cup ensured that, despite the global financial crisis, buildings – particularly hotels – were finished on time and put to use. However, while much demand was created by the football tournament, the aftermath has been a struggle for hoteliers, competing in a market with significantly more hotels and significantly fewer tourists with cash to spend.

Indeed, consumers are spending and travelling less, which has hit South Africa’s hospitality sector hard. The average occupancy rate across the hotel sector for the first 11 months of 2011 stood at 50.3%, according to Statistics South Africa. While monthly figures were beginning to recover towards the end of the year (the rate in November reached 59%), for many months it was stuck stubbornly in the mid-40% range.

A SIMPLE EQUATION: As such, hoteliers are not optimistic about a quick recovery. According to Brian Davidson, the group sales and marketing director at Legacy Hotels and Resorts, “I do not see many opportunities to expand in South Africa. Occupancies are only just beginning to recover. There’s a long way to catch up with 2008 and 2009 when the occupancies were at 72%. Now they are in the mid-50s, leaving very little opportunity to increase rates.” While Johannesburg, Durban and Cape Town are very different markets, with different demand drivers, Davidson says this is a “national malaise”, with limited variation.

The equation is rather simple. Supply is running significantly ahead of demand. According to Davidson, “Cape Town no longer has a peak season. In February and March it used to have 90% occupancy but now it is 40-50%. There are simply 20% more rooms and not the same growth in the industry.” A similar situation exists in Johannesburg and the country’s other major urban centres. An excess of supply has driven down occupancy rates. In the Sandton/Rosebank node of Johannesburg, which caters largely to business travellers, the average occupancy rate for five-star hotels in 2011 was down to 55.2%.

EXCESS SUPPLY: While some hotels are keeping their heads above water, the environment is proving extremely challenging for most. The rapid increase in the inventory of rooms in the run-up to the World Cup has changed the dynamics of the industry. According to PwC, a global accountancy and professional services firm, the number of hotel rooms in the country rose by 1600 between 2005 and 2008, and then by a further 9700 rooms between 2008 and 2010 to reach a total of 58,800. This second rapid increase has boosted the accommodation capacity in the country by a massive 3.5m visitors annually.

The authorities recognise this problem, but have suggested that the country needs to adapt to the new realities of the market by diversifying the accommodation offering and creating greater segmentation in line with growing domestic travellers, as the volume of high-end, long-haul visitors declines.

“Many hotels came in at a very high grading level. At the time, we may have needed them, but now there may be too much capacity here,” said Thulani Nzima, the CEO of South African Tourism. “We are still seeing a very buoyant growth, but the prices that hotels had during the World Cup are not sustainable. If you do not change your business model, you have to close down your business,” Nzima added.

IMPACT ON RATES: The oversupply in the market has already led to aggressive competition on rates. According to Davidson, “You have the multinationals coming into South Africa. In the corporate segment, the new competition changed the perception of the market. It killed business for everybody. Now we are trading in the five-star market on four-star rates.” In the first three quarters of 2011, for example, the average income per room declined every single month, according to Statistics South Africa.

This combination of low occupancy, decreasing room rates and hence falling revenue per available room (revPAR) is clearly unsustainable. According to Andrew Rogers, the deputy CEO of the Hospitality Property Fund, a property loan stock company investing in the hospitality sector, revPAR is below the level needed for at least six new entrants to the South African market to turn a profit. “The revPAR being achieved in these new-build establishments is hardly able to cover the monthly overhead costs or the development costs,” Rogers said.

BUYERS’ MARKET: Such aggressive room rate policies have yet to claim significant casualties, but acquisitions and consolidation are not being ruled out. According to Allan Clingham, the general manager of the Crowne Plaza Rosebank in Johannesburg, deals are likely to take place going forward. “There are a few hotel groups out there looking for acquisitions. Small operations have struggled, but big hotels such as the Southern Sun have the muscle to ride it out. We will see a lot of big companies buying small hotels.”

The main issue for movers in the market will be their debt levels and ability to ride out the current conditions. According to Rogers, “Southern Sun is acquisitive because of the pot of money they are sitting on. I think there will be some consolidation amongst groups. A lot of companies tried to be asset-light and just went into management, but now this trend is reversing and companies want assets.”

Tsogo Sun Holdings, the group that owns the Southern Sun, has already made one acquisition, buying the Grace Hotel in Rosebank, Johannesburg for R85m ($10.4m) from Hyprop Investments in October 2011. The hotel is likely to reopen in the first half of 2012 as a boutique property that caters to corporate customers. The group owns 94 hotels in Africa and the Middle East, as well as gaming operations throughout South Africa. This reach has allowed it to invest during the downturn. Rogers of the Hospitality Property Fund argues that although there are distressed assets out there, they still remain too expensive to satisfy their yield expectations. “We look for property yields of around 9.5% to the 10% mark in the current market. These would be non-dilutionary as a fund, but currently the market is too expensive to invest,” he said. Rogers stated further that the environment is making development difficult for hoteliers.

“Access to financing is also challenging,” he added. “The development pipeline pre-World Cup was extremely aggressive. Many of the banks have been highly exposed to the hospitality sector and are loathe to invest in hospitality properties.”

Hospitality Property Fund knows all about the difficulty of the current market. The fund invests only in hotel and leisure properties, with a current portfolio of 26 hotel and resort properties in South Africa. However, the company was the worst performer on the Johannesburg Stock Exchange (JSE) in 2011. In January 2012 it was announced that the company was in discussions with Absa Bank about the refinancing of its R1.35bn ($165.24m) debt facility, which expired in February 2012. Any refinancing will likely require the company to undertake a rights offer to increase its capital and reduce its gearing level.

A CAUTIOUS APPROACH: Many hotels, companies and funds are now in survival mode and hope that the brief upturn in the market towards the end of 2011 turns into a full-scale recovery.

According to Clingham of the Crowne Plaza Rosebank in Johannesburg, “Coming through a recession, we were very rate- and revenue-driven, but now we have had to think outside the box and get creative.” For individual hotels, this has largely meant finding ways to control spiralling operational costs. With utility costs rising dramatically and labour regulations impinging on flexible hiring models, hoteliers are finding it more difficult to balance spending and revenue.

PUSHING FOR SAVINGS: This has driven many hotels to push for greater energy efficiency, as well as cut back on staffing numbers. However, the situation remains difficult, according to Davidson. “The cost of running a business now is disproportionate to our revenues and business profitability,” he told OBG.

In such an environment, strong management and a strong brand are highly sought after. Rogers said there has been an increase in management fees, especially from local brands. “Approximately 80% of the market is domestic here, so you want brands that work locally. International players may bring good loyalty schemes and other benefits, but they do not have the presence to gain traction here. Hotel management operators are starting to increase fees but it is gradual. It would be anywhere from 2.5% to 5% on revenue. Marketing would be around 3% of room revenue and incentive fees on a sliding scale would be anywhere from 8% to 15%,” he told OBG.

This suggests that not everybody is suffering in the current market. However, while management companies with a good track record may be able to boost their fees, revenues generally have been down. As such, the whole industry is hanging on and hoping that the slight upward trend in occupancy rates at the end of 2011 continues to gain momentum in 2012.