What is that Hotel worth?

by Tony Karp, Executive Vice President

Hotel values in Asia are undergoing a metamorphosis as owners shift their perception of asset value from original cost to one that is income based. Owners have learnt from the experience of the Asian crisis when overvalued assets threatened owner's credit ratings and financial solvency.

Pre-crisis, during the regional economic boom of the early to mid-nineties and the resultant growth in tourism demand, one of the most attractive property assets in Asia was a hotel. As few acquisition opportunities arose over this period, the Asian hotel market was characterised by construction and development: anyone desiring a hotel would build it. Investment was typified by greenfield development and in South Korea, Indonesia, Thailand and Malaysia this growth was largely debt financed.

Development continued virtually uninterrupted for a decade on the expectation that prior tourism growth rates were sustainable on a long-term basis and the value of the hotel asset would increase with time, as did most forms of property pre-crisis. However, unlike residential and commercial investments, hotels are labour intensive, which means they are also capital intensive. When you invest in a hotel you invest in its business with a host of inherent risks.

The aftermath of the Asian crisis was an oft-promised period whereby property transactions would occur as debt-laden hotel owners became hard-pressed to maintain a positive cash flow amid plunging demand and room rates. Investors expected attractive pricing and came to the market with offers reflecting a consideration of the operating, economic, currency and political risk. The value dictated by the buyers was substantially lower, often 50-70% below the original costs or book values of the properties.

As such, owners could not afford to take their assets to market in fear of incurring a loss on the sale which may have triggered loan covenants or had the potential to effect the firm's credit rating. Instead, Asian owners tried to keep lenders at bay as long as possible in the hope of a recovery in value and hence the need for a lesser, or perhaps no, loan write down.

Owners had the local laws on their side. In a typical Western economy, if a borrower defaults on payment the lender has the right to seize the asset. This is not typically the case in Asia. In Thailand, for example, lenders do not have the right to pressure owners to sell their assets and borrowers avoided approaching lenders for debt-restructuring fearing loss of face or, potentially, bankruptcy reprisals.

As there was no pressure to sell, few properties were genuinely offered to the market and even less were transacted.

Now, having recently passed the third anniversary of the Asian economic downturn, hotel owners are realising their assets are overvalued on their books and acknowledge that value should relate to income. Having taken the experiences of the crisis on board, owners are now taking steps to value their assets downwards in line with the benchmarks being set by the market and comparable to other forms of investments including bonds, shares and property.

We are also witnessing a number of forward-thinking owners who are capitalising on the market's current position. With forecasters predicting a continuation of the limited, or no value growth, these owners are selling their assets in the current climate, in some cases accepting a small loss, in order to be cashed up for the next major downturn. They will then be in the position to take advantage of the better buying opportunities available, following in the footsteps of the few who sought to acquire the assets of their distressed countrymen in 1998, on the assumption that, eventually, there will be a massive shake up in the market.