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Hotels in MENA: How Much Can You Invest?

We attempt to provide a guideline of “maximum supportable hotel investments” across Middle East and North Africa, reflecting current hotel market dynamics for the cities addressed.
Hala Matar Choufany

With the cost of raw materials fluctuating and with global economic conditions shifting the types and patterns of demand, developers are becoming sceptical about when to build, what to build and whether to commit to construction contracts. Therefore, in this article we have taken into consideration the current demand characteristics of each market and have derived the maximum supportable investment for the development of a certain hotel asset in a certain market. We illustrate our findings for 12 markets in the MENA region across the following four hotel asset classes.

  • Five-star – with three food and beverage (F&B) outlets and around 800 m² of meeting space;
  • Four-star – with two F&B outlets and around 500 m² of meeting space;
  • Three-star – with one F&B outlets;
  • Two-star – with one restaurant/bar and no room service.

We note that although we were in the past accustomed to seeing five-star hotels costing US$500,000 to US$800,000 a room in Dubai, for example, current economic conditions globally, and hotel market realignments regionally, would make such investments non-viable for a few years to come. Our estimates of maximum supportable investment aim to test the investment tolerance in the prevailing conditions.

Methodology

In deriving the maximum supportable investment, our starting point was our estimate of the stabilised performance of each hotel category in each market. The estimates made are based on our industry and market experience, the proposed pipeline for each market and, where applicable, imposed cartel agreements and rate caps. We assumed typical operations in each market, the typical facilities listed above and used the financing terms currently available to a developer. Therefore, when a proposed property is designed differently from what we have described, or when a developer enjoys preferred borrowing terms, or both, the maximum supportable investment would drift away from what we derive. The estimates we present are indicative averages only.

  1. Stabilised occupancy and average rate in each market and in each hotel asset class are projected, reflecting current market dynamics.
  2. Rooms revenue is assigned as a proportion of total revenue, as is typical for each asset class in each market.
  3. The percentage of gross operating profit (GOP) is assigned to each market.
  4. Net operating income is derived from Steps 2 and 3.
  5. Applying equity yields of 17-19% – the actual figure depends on the market and asset class – we calculate the required free cash flow to equity.
  6. Assuming a loan to cost ratio of 60% with interest rates of 7-8% – the rate depends on the market – we calculate the average interest expense a year.
  7. Having identified the debt/equity split we can calculate the maximum supportable investment per room that would provide investors with acceptable returns. We note that the scale of the investment is a function of occupancy and average rate and thus varies across markets and asset classes accordingly.

We present in Table 1 our derived maximum supportable investments by asset class across the markets, and compare these to the respective RevPAR that would result from our projections of occupancy and average rate. RevPAR would be a direct indicator of current hotel market realignments. If we were to rank these investments, we would note a misalignment between a city’s ranking according to its maximum supportable investment and its ranking by RevPAR. This misalignment is a result of the different rooms to revenue ratio that the different markets enjoy; therefore, RevPAR could be misleading were it to be used as a basis for deciding on where to invest.

Although GOPPAR would be the preferred profitability indicator, the revenue mix, departmental expenses and undistributed expenses could change after an operator’s reactive strategy to the crisis. Such changes cannot yet be determined and are likely to be temporary: a short-term tactic adopted to weather the storm. Operational norms are likely to be restored as markets stabilise again. Consequently, we have adopted RevPAR instead of GOPPAR.

On account of its high average rate and high F&B revenue contribution Doha commands the highest investment among five-star properties, and Damascus the lowest. The average supportable investment for a five-star hotel for this set of cities is US$330,833 a room. However, Damascus has the second-lowest RevPAR, just ahead of Cairo, which has a RevPAR of US$117. Abu Dhabi has the highest RevPAR, of US$215, and Dubai the second-highest (US$192).

The three most expensive markets in which to develop a four-star hotel (Abu Dhabi, Dubai and Doha) and the three least expensive (Damascus, Amman and Cairo) are the same as they are for the five-star market. There is some variation among the remaining markets. There is a wider variation in RevPAR in the four-star market, yet Damascus has the joint-lowest RevPAR and Doha the highest, in keeping with their rankings in terms of supportable investment.

The wide range of minimum and maximum supportable investments across the asset classes would force a developer to make a compromise between its class of property and its market. For example, an investment of US$150,000 a room would allow the development of a four-star hotel in Damascus but would be absorbed by a two-star property in Doha.

The three-star category has the widest range of maximum supportable investment per room primarily because most markets witness a huge gap in average rate among this class when compared to the four-star standing. Both two-star and three-star classifications are relatively new, as most markets are used to positioning themselves as luxury destinations, leaving the budget hotel concept to local management companies. However, changing financial times are working in favour of international budget and economy brands which, once inserted in the markets, would raise marketwide average rate.

Moreover, as the MENA region opens up to international investors and businesses, and with intra-regional travel on the rise, we can assume that some convergence in average rate is bound to happen; the relatively cheap destinations of today will be able to retain more of the international traveller’s willingness to pay, and presently expensive destinations will have to cut room rates as the competition among cities in the MENA region grows. Therefore, long-term investors developing a hotel today in Damascus, Amman or Cairo will reap the rewards in due course.

Third party consultants should be consulted before undertaking any investment decision. For questions or enquiries about this article please contact HVS Dubai or the authors.

Hala Matar Choufany is the Managing Partner of HVS Dubai and is responsible for the firm's valuation and consulting work in the Middle East and Africa. She has worked on several mixed use developments and conducted numerous valuations, feasibility studies, operator searches, operational assessments, strategy advice in Europe, the Middle East, Africa and Asia. Hala has in-depth expertise in regional hotel markets and a broad exposure to international markets and maintains excellent contacts with developers, owners, operators, investment institutions and government entities. Before joining HVS International, Hala had several years of operational and managerial hotel industry experience. Hala is an official Member of the Royal Institution of Chartered Surveyors (MRICS) and also holds an MPhil from Leeds University U.K., an MBA in Finance and Strategy from IMHI (Essec-Cornell) University, Paris, France. For more information contact, hchoufany@hvs.com

7 Comments

  1. Veno NathrajFeb 20, 2010

    I am interested in learning more about the South African market

    • We unfortunately have not covered South Africa but other offices may in the future do so. We can include you in our mailing list to receive our news and updates

  2. Georg SchlegelFeb 22, 2010

    Could you let me know on which product/brand(s) you have evaluated the construction cost per room for the 2 and 3 Star Segment? - As you have stated in your article, the number of well developed and branded hotels in that category was very limited in the last couple of yours and many hotels are unbranded and/or below international standards. Overall my guts feelins is that you have taken into account Express by Hi, Premier Inn, Ibis etc. because the construction cost are in general in line with Europe. Thanks!

    • Thank you for your feedback. The figures in Table 1 are not budgeted or actual construction costs. Rather, they are the maximum an investor should spend per asset class given the foreseeable performance in the respective markets. While investing less than what is presented would be feasible, exceeding these figures would yield less than the 17-19% we indicated.

  3. Georg SchlegelFeb 22, 2010

    Thanks understood! Any insides on real construction cost versus your recommended investment, especially for the 2 - 3 Star Segment in those countries?

    • Cost figures for projects currently under construction are slightly higher than our estimates. While this can be explained on the cost side by higher contracting costs at the time of sub contracting, hotel markets were also in a better shape and were projected to more than compensate for the increasing costs. However, it is not the case anymore and we are saying that the ceilings investors put for themselves should be lowered now in response to revised market dynamics, to what we estimate in Table 1. Luckily, costs happen to be also going down somewhat.

  4. Ghassan AtigaFeb 22, 2010

    Interesting report, thanks. However, from reading the title (Hotels in MENA) I was expecting reading about hotels in Libya, Tunisia, Algeria and Morocco as well. would you consider that in the future?

    • You are right. We did not cover all the cities that should be covered in MENA but yes, hopefully they will be included in the future...Thanks

  5. is the land cost applied in the construction ratio?

  6. saad sobhyFeb 28, 2010

    1. Would like to know if the same principals apply to other markets and other locations? i.e. beach front vs. downtown, in Latin America? 2. Would like to contact you re: advice/loan for a five star hotel in Latin America.

    • Thank you for your note which we have now forwarded to HVS Buenos Aires. They will be contacting you shortly.

  7. Great article! Have you taken inflation into account? If yes, at what percent? Thanks!

    • Thank you for your kind feedback. Average room rates do not necessarily increase in line with inflation. Our average rate projections are based on dynamics of market demand growth and proposed hotel supply for the period at hand.

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