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Sun 25 Jan 2009 04:00 AM

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A New Year’s resolution?

In 2008, the financial crisis crept into the Middle East. In 2009, the economic stability of the region has been called into question. Lee Jamieson asks whether the New Year holds any resolution for hospitality investment and if a clearer picture is beginning to emerge.

In 2008, the financial crisis crept into the Middle East. In 2009, the economic stability of the region has been called into question. Lee Jamieson asks whether the New Year holds any resolution for hospitality investment and if a clearer picture is beginning to emerge.

If 2008 taught us one thing, it's that the Middle East is not impervious to the global economic slowdown.

In the latter half of last year, local stock indices tumbled by up to 45% in some countries, some property firms lost 80% of their share value, some governments placed guarantees on bank deposits while others injected cash directly into their banking systems. The GCC has seen the price of oil, its primary export commodity, more than half from record highs last year.

Conformation that the financial crisis was not a "western problem" came when Gulf Bank chairman Bassam Alghanim was forced to resign after announcing a loss of $800 million. Newspapers around the world billed Alghanim as the first Gulf billionaire to be claimed by the financial crisis.

So, where does this leave the estimated $2 trillion worth of planned and under way developments in the GCC? And more importantly, what does 2009 have in store for hospitality investors?

Storm clouds

"It's true that the Gulf is not invulnerable," says Viability partner and manager Guy Wilkinson. "It's obviously suffering to a lesser extent, but it's still suffering. I don't think we have a clear picture yet. A lot of people are saying that everything will become clearer in the first few months of this year when we start seeing performance figures - not so much from companies, but from the hotel industry."

Growth in the hospitality industry is closely correlated with the continued investment in new properties across the region. Some are concerned that the economic climate of 2009 could soften demand make it difficult to secure funding for new building projects and delay existing developments.

"2009 promises to be a difficult year wherever you are located," says Vision Hospitality Asset Management regional director for the Middle East, Nigel Teasdale.

"The Middle East will not be isolated. A reduction in both leisure and business travel from key source markets is likely to have an effect in the region and many holiday makers in Europe and the US, whose savings have been impacted by the global economic situation, will cut back their vacation spend. On the corporate front, companies are likely to cut back on non-essential business travel and conference attendance."

However, the Middle East's hospitality scene is in a fortunate position. If softening demand and slower construction proves to be a real threat this year, then the industry has lots of room to manoeuvre. According to the STR Global report, the Gulf has some of the highest average rates on record - Dubai is currently topping the list.

In the worst-case scenario hotels can discount their rates and still run profitable businesses. In turn, this will strengthen demand as the region becomes more affordable. Ultimately, this financial safety net gives Middle Eastern hoteliers a competitive edge over hotels operating in other countries.

"What we're talking about here is a phenomenal set of performance figures," explains Wilkinson.

"Last year, the 400 hotels and apartments market-wide achieved an average rate of about 90%. This is unheard of in most destinations - most places are happy with around 55%. So there's a long way for the sector to fall back and hotels will still be performing well by international standards."

The silver lining

Although the potential impact of the economic slowdown should not be underestimated, we should not forget that it is a natural part of the business cycle: it has happened before and it will happen again. As always, hotels need to monitor their positioning in a changing market and money needs to be invested accordingly.

From an investment point of view, these are ideal market conditions for acquiring valuable assets at a discounted price. Despite the financial crunch, there is still a great deal of liquidity in the Middle East which could lead to more interesting investments.

"Cash-rich developers are actually rubbing their hands together in glee at the prospect of these market conditions," says Wilkinson.

"They will have an advantage because they're cash rich. They can go ahead with projects when their competitors are unable to do so. They'll even be able to pick up ailing companies," he adds.

Major developers are therefore keeping a close watch on how the financial crisis unfolds in the region. Not only are they looking to protect their own assets, they are also looking to expand and diversify their portfolios.

"This year will bring significant opportunities alongside the more obvious challenges, and we are well-positioned to capitalise on these opportunities as and when they arise," explains Nakheel Hotels CEO Joe Sita.

"Our investment horizons are long-term and we hold a diversified portfolio across geographies and market segments, so we are well-positioned to ride out the short-term volatility that is occurring."

Diversification

As with any investment strategy, diversification is the best way to protect capital - for a hospitality investor this means incorporating a wider range of business models into each project.Mixed-use developments are therefore becoming extremely popular in the Middle East, incorporating private residences, condo apartments and retail units into the hotel development. The financial risk is therefore spread over a variety of different units, protecting the investor against any short-term volatility in the hotel trade.

"We are seeing more and more developers using integrated business models that include these residential or mixed-use developments," says Sita.

"If you can get the right mix of product, this model can work very well."

Even before the threat of economic slowdown, mixed-use developments were being employed by investors to off-set rising construction costs. Being able to sell some private units off-plan is an ideal way of securing funding in advance.

"Now, many hotels are getting into service departments," says Wilkinson, "but this has already grown to saturation point.

"Some hotels are interested in selling service departments to individual buyers on the residential property market and we're also seeing a timeshare market emerge. So, developers are finding more creative ways to make extra money from the same lettings unit - and it's getting very interesting. Already, there's an amazing variety."

Developers are also diversifying across the star rating, bucking the trend for high-end properties. Already, budget and mid-market brands like Premier Inn, Park Inn and Ibis are developing properties throughout the region, and this niche market is expected to expand rapidly. Here, investors can make money from an emerging trend in the long-term and also profit from the short-term economic volatility as travellers to the region seek out cheaper accommodation.

"If the financial crisis leads to a drop in demand, it could affect the top end first as business people trade down to three and four star properties," explains Fast Future Research CEO Rohit Talwar.

"This could be countered by price cuts in the five-star offerings, which could attract back some business visitors and generate increased demand amongst more bargain conscious leisure travellers."

Teasdale suggests that these budget and mid-market properties tend to be favoured by cautious investors because they are generally considered to be "more recession proof than upscale developments."

Down tools

Developers are preparing for a deceleration in construction rates. It is unlikely that this will affect hotels opening in 2009 because the necessary investment has already been made. In fact, operators will be looking at getting these new properties open as quickly as possible in the interests of future profitability.

Although cost efficiency may be a top priority for these new hotels, it is not expected that they will make any drastic alterations to their product to safe-guard against short-term volatility as they enter the marketplace.

"It would be difficult for hotels nearing completion to substantially alter the positioning of their product without undermining the feasibility of the project because the development costs have already been committed," explains Sita.

It is projects still in their planning stages that are most at risk. If cancelled, some pundits are concerned that this will cause a gap in the supply chain and hinder the future growth of the Middle East's tourism industry.

Others believe that the deceleration will allow the market to make a much needed correction. Amid concerns of over supply and softening demand, a deceleration in construction rates could well facilitate more sustainable growth in the future.

"In my view, there is going to be a slowdown in the construction of projects," says Wilkinson.

"We were seeing evidence of this even before the current economic situation arose. The events from the latter months of last year will probably decelerate the construction rates even further.

"But the hotel industry in the Middle East hasn't really seen a business cycle before - it's all been up and up! So, what we're going into now is a new thing for hospitality investment.

"In a way it's a healthy thing: the downward curve, the opening of new supply and deceleration are all signs of market stabilisation. It will allow supply to grow at a more reasonable rate and allow demand to fill up the newly opened hotels."

This year, investors will be carefully monitoring the economic climate of the Middle East and paying close attention to the performance figures of the hotel industry.

What investors should remember is that behind the "doom and gloom" stories peddled by the media, new and exciting hospitality investment opportunities exist.

Ultimately, the free market thrives on two essential ingredients: liquidity and confidence - both of which the Middle East has in abundance.

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