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Investing in Irish hotel assets
The following article, written by Mairea Doyle Balfe, an industry specialist with our hotel, tourism and leisure team, appeared in May 2019’s issue of Hotel & Catering magazine.
Over the past decade the Irish hotel sector has experienced a prolonged period of financial growth. This growth comes off the back of a positive global and domestic economy and strong demand from growing visitor numbers. International tourists have grown from 7.6m in 2014 to 10.6m in 2018 and in 2018, many Irish hotels will have achieved some of their strongest business KPIs. Average Room Rate in 2018 for Dublin hotels, for example, was at an all-time high of €131. (Source: STR)
However, it should be noted that while the Irish hotel sector is currently in a good place, it has come at a price. In the early 2000s, the availability of an accelerated capital allowance scheme fuelled expansion, development and growth in the hotel sector in Ireland. While tourist numbers were growing and the economy doing well, the financial feasibility of some of the hotel developments during this time was questionable.
The subsequent downturn in the economy meant declining revenues and profits in the sector. Hotel values declined, cash flow was reduced and banks/NAMA took possession of hotel assets to resell them at prices well below their replacement value. During this period of restructuring, there was almost no reinvestment and many hotels became tired and out of date.
As the economy recovered and the landscape improved, foreign investors purchased Irish assets, and began upgrading these properties. This reinvestment in the sector enabled hotels to yield a higher average room rate at a time when demand was also growing. This can be seen with the five-star Ashford Castle, for example, which has had a reported €50m-plus investment allowing the hotel to not only compete on a national level, but also on the international stage with other five star hotels and resorts.
A shortage of new supply, coupled with growing demand against a backdrop of a robust national and international economy, has meant that Irish hotels have achieved a higher return on their investment. However, while there has been strong capital appreciation over the last number of years, hoteliers are cautious about the future. Questions over whether we are at the top of the market coupled with the recent increase in the VAT rate and with Brexit looming, are making hotels naturally more nervous about further capital investment into their properties.
When exploring an expansion or a possible refurbishment, hoteliers need to determine what the optimum level of spend is and what will be the likely return on investment. Feasibility analysis and a review of the business will be key to determining the level and approach to investment and refinancing.
At Crowe we help hoteliers review the feasibility of projects. A comprehensive supply and demand analysis will include a full competitive assessment, reviewing facilities, pricing, perceptions and operating details. For example, if a hotel is looking to upgrade from a three star to a four star, it is important to look at who their new competitors will be and review their prices, the quality of their product and most importantly, how the upgraded hotel will compete for market share.
In preparing financial projections for a hotel, it is important to review what could be achieved, with and without the proposed investment, over the next three to five years. A project of demand is important here, with data from sources such as Fáilte Ireland and the CSO alongside a hotel’s own projections and knowledge of trends within their local market.
A hotel’s projected net profit/EBITDA (Earnings Before Interest Tax Depreciation Amortization) will need to demonstrate sufficient return to justify the project and cover the cost of capital – whether equity or debt. If a hotel’s EBITDA was €23k per available room and their investment €250k per available room, the ROI is 9%. It is important though, to ensure viability within the market that the property is in as the ROI of a hotel varies across regions and hotel class.
Hotels are trading assets and thus are susceptible to economic cycles, so it is important to consider what the return will be in the medium- to long-term, particularly if the project is an extension to an older asset. Preparing a sensitivity analysis can show available cashflow during periods of declining revenues/profits. Scenario analysis is also useful to help decision making as to whether to invest or not and where the investment will deliver the best return.
If demand is consistent, such as in Dublin, a hotel can have a more secure investment strategy. This can be more challenging for a seasonal hotel, which relies on its peak seasonal trade to make its returns and generate cash. Revenue management has played a key role for seasonal hotels, with discounting and special offers aimed at key markets who have time and money to stay off-season.
The level of RevPAR/EBITDA needed for a hotel to expand its footprint is dependent on a number of factors. Construction costs will be dependent on the site layout and how and where the rooms will be added. If the hotel already has a sufficient ground floor, then extending bedrooms solely will be more cost-effective.
Take the following example of an 80-bed regional hotel adding 20 guestrooms. With adding the extension, the hotel gains efficiencies in fixed payroll and some other operating costs, which enables the property to increase the EBITDA percentage. A higher or lower Internal Rate of Return (IRR) requirement would impact the investment spend on the extension.
In looking to refinance, whether to complete an extension or otherwise, the lender requirements and offerings of multiples, interest rates and repayment schedules vary on a project by project basis, with different funders having varying offerings. A capex provision of say 3% may be a requirement to ensure continuous upgrading of FF&E (Fixtures, Fittings & Equipment). The cash available for debt service, along with other director’s loans/outstanding liabilities, may impact the payment schedule.
Hotels in Ireland are being refinanced with both equity and debt. The location, facilities offered, financial performance and quality of a property will impact the loan available. In refinancing your hotel, it is important to have good management information and a good understanding of where you see your business in the short- to medium-term.
For more information about how Crowe’s dedicated hotel, tourism and leisure group can assist you contact a member of our hotel, tourism and leisure team.
Hotel Tourism and Leisure services
Hotel Tourism and Leisure services