Hotels as an Alternative Property Investment Asset Class and its Funding Challenges in South Africa

Abstract

Institutional investors and corporates are constantly looking to achieve double digit yields in relation to investments in traditional real estate assets. With retail, office and residential property under pressure the study set out to determine how hotels perform compared to traditional property investment asset classes in terms of investment yields during different stages of the property cycle, and whether investors (property developers and institutional investment funds) are considering the hospitality sector for investment or diversification of current portfolios. Furthermore, to determine how aligned the commercial banks, Development Funding Institutions (DFI) and Section 12J funds are with funding single hotel assets versus portfolio lending, and what their requirements are.

As an exploratory study, interviews were conducted to obtain in- depth and rich information from purposively selected respondents with experience in the sector after completing a preparatory questionnaire. Respondents included property developers, investors, financiers, tour operators and hotel operators. Results confirmed that both developers and investment funds are indeed considering hotels as an alternative investment since the yields are favourable when compared to other asset classes, yet with a longer investment horizon. Hotels required time to stabilise and at this point an expected yield should be higher than 12.5% which is higher than initial yields for traditional commercial properties. Historically, hotels investors were very specific in their investment asset classes and usually purely focused on hospitality assets (specialist investors). This has now changed with an increase in generalist investors coming to the market with exposure in a diversity of asset classes including the hospitality sector.

Funding challenges, due to the operational risk associated with Hotel Management Agreements (HMA) is perceived by both financiers and developers or investors. Leases are the preferred income model but are seldom available in the hospitality sector and often those that are made available, may not provide the strong covenants required by financiers and developers/investors. Alternative funding is available in the form of Section 12J VCC’s or from DFI’s but both have their limitations as became apparent in the results. Recommendations for further research include funding challenges for a development or acquisition strategy at a single asset and portfolio level, and expansion to Sub-Saharan Africa as it impacts many investors and international hotels brands with exposure in these regions.