Wayne Godwin, Vice President, Hotels & Hospitality Group (SSA) at JLL, talks to how the averting credit downgrade and subsequent increase in business confidence has ushered renewed optimism for the hotel sector
The timing of South Africa’s political changes in late 2017 and into early 2018 could not have come at a better time for the South African hotel market. Averting a further credit downgrade, and the subsequent increase in business confidence has ushered renewed optimism for a sector after several years of muted growth and tight liquidity. While the tough trading conditions have continued into the first part of 2018, it is not uncommon to see increased corporate travel activity lag renewed business confidence, and we expect to see stronger demand in the latter part of 2018 and into 2019.
This comes at a time when the South African hotel sector has seen a somewhat delayed supply cycle. The previous supply, or development cycle, preceded the 2010 FIFA World Cup, off the back of strong domestic economic conditions. The timing, unfortunately, corresponded with the onset of the Global Financial Crisis and the oversupply effects were pronounced. The market emerged from the oversupply period as early as 2013 but has since been plagued by low demand growth that has failed to provide the requisite growth impetus to spur the next supply cycle. Despite these muted demand conditions, there has fortunately been limited supply growth and the next supply cycle is now well underway in Cape Town, with approximately 1,000 rooms opening in the second half of 2017. Johannesburg and Durban are following close behind, with developers and brands considering new opportunities across the country. However, the improved demand fundamentals will mean little if there is no liquidity, so it is worth considering how prepared the various owners of hotels are for the upcoming cycle.
The largest owners of South African hotels are owner operators. Many of these groups have adopted African expansion strategies in recent years, and have found entry into new frontiers difficult, compounded by challenging trading conditions in the region. We are unlikely to see any of these groups abandoning their African expansion strategies, however, we do expect to see many of them looking to consolidate their dominant position at home. This group of owners is well capitalised and well placed to increase their share of hotel real estate in the coming few years and we expect to see this group of owners driving the majority of development activity in South Africa.
The next largest groups of owners consist of REITs and pension funds. Globally, institutional investors own the significant majority of hotel real estate. However, institutional capital has generally lagged owner operator investment in the asset class locally. This group of owners is considering investment cautiously, with the oversupply conditions post 2010 still fresh in their memory. We expect to see this group of owners trail owner operators in terms of new developments, with an initial focus on acquiring existing assets as opposed to developing new hotels. Institutional investors are likely to watch the sector carefully to regain comfort in the income profile of the asset class.
The final group of owners consists of private companies and high-net-worth-individuals. The previous supply cycle saw the proliferation of this ownership group, with the increased focus from global brands offering owners an attractive entry vehicle into the hotel sector without investing in the operating platform. One of the key challenges that this sector faces is access to funding, with commercial banks still cautious to lend to hotel promoters without a broader balance sheet. Despite this, this group of owners is well placed for the upcoming supply cycle, with various government support programs and funding from institutions such as the IDC and NEF, while Section 12J of the Income Tax act offers some attractive incentives for owners to raise capital in less conventional forms.
The various owners of hotels in South Africa are therefore well positioned for the upcoming supply cycle from a liquidity perspective. We expect it to be a more protracted cycle, with supply focused on major metropolitan markets that offer more depth. The pace and extent of the supply cycle will depend a lot on momentum in the economy, with domestic corporate activity needing to drive the demand growth that will ultimately provide attractive income growth that owners desire.