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The Obstacles to Making New Hotels Feasible

The crisis is behind us, but there are still many obstacles to opening new hotels. When you identify a good opportunity, don’t let it slip out of your grasp.
Cristiano Vasques

Starting in the second half of 2009, there were increasingly signs that the economic crisis was being overcome in Brazil. Indicators of consumption, employment, tax revenue, and occupancy levels, among others, showed results that were different from those found at the beginning of the year. Some indicators that had been registering decline began to point toward stabilization, while others showed considerable recovery.

The beginning of 2010 allowed for the onset of a sort of euphoric climate in the country, with predicted economic growth rates above 6 percent, large new public investments, expectations of relatively stable inflation, recovery of the stock exchanges and of IPOs, and the resumption of international investment in Brazil.

A large part of this climate is based on relatively solid and consistent structural elements. However, for the hotel market, this still does not mean that we will see a “boom” in investment in new hotels. In fact, from the various opportunities that clients and partners have brought to HVS, it seems clear that there are some obstacles, among them:

  • Recovery of the hotel markets
  • Land prices
  • Soil occupation and environmental licensing
  • Construction costs
  • Access to financial capital

Recovery of the hotel markets

Most of the Brazilian hotel markets are recovering, but they still have low ADR that is insufficient for generating a positive yield outlook.

In some cities, especially the main capitals, the hotel over-supply crisis of the beginning of the previous decade has still not been completely overcome. In other cities – mainly those of medium size – there has been significant growth, but it has still been insufficient for making the economies robust and diversified enough to allow occupancy rates and ADR that would reward investment in a new hotel.

In fact, of every 10 localities that HVS analyzed in recent years, 7 had RevPAR below that which would justify the opening of a new hotel.

Land prices

Good plots of land are rare and expensive. Moreover, land prices are a sizable portion of the cost of opening a new hotel. As the residential and commercial real estate market has undergone strong growth over the past few years, land prices have reached never-before-seen levels. Considering this variable alone, opening a new hotel today is already more expensive than it was a few years ago. This means that, under normal circumstances, the necessary RevPAR is currently higher than it was in the past.

One of the reasons for the increase in land prices is that on the heels of macroeconomic stability, interest rates fell and inflation became more predictable, thereby allowing real estate financing to take off. As a result, the incorporation and civil construction sector also grew. At the same time, the positive outlook for the Brazilian stock market allowed companies in this sector to come to market with IPOs. Once capitalized, they drove up land prices considerably.

In addition, in most cases a hotel project competes with other residential or commercial projects for the use of a given plot of land. As these markets are very strong, they generate greater economic value. Accordingly, they can be more profitable than hotels despite paying higher prices for land.

Soil occupation and environmental licensing

Over the past several years, since the implementation of the City Statute – a 2001 Brazilian law pertaining to urban development – medium-sized and large cities have been required to make or update their urban master plans. In general terms, the new legislation meant more restrictions on soil use and occupation. In São Paulo, for example, before the changes in the urban master plan, it was possible to build on up to 4 times the area of one plot. Today, the most common rule is 2 or 2.5 times the area of one plot, unless special permission is obtained through an onerous process.

The process of environmental licensing of an area has also become slower. As the contractors' cost of capital is quite high (between 20 and 25 percent per year), delays and unexpected issues significantly impact implementation costs.

Construction costs

The process of economic growth has had a strong impact on civil construction, driving up the prices of other important raw materials, such as cement, steel, and finishing materials. There have also been more complaints by construction companies about the lack of qualified workers for construction sites.

Over the past several years there has been a real increase in construction costs. The cost estimates for opening new economy hotels, which had been about R$ 1,250 per square meter just a few years ago, today are not less than R$ 1,800 per square meter, which represents between 50 and 60 percent of the total implementation costs. Even if this tendency is controlled or reduced, it is reasonable to expect real cost increases over the next several years.

Access to financial capital

Access to credit or to investor capital is still limited in Brazil. The new lines of credit offered by the Brazilian Development Bank (BNDES) and Banco do Nordeste are much better then previous ones, with longer terms and lower costs.

However, loan collaterals of 130 percent are still a major hurdle to most potential hotel contractors. At the same time, the low RevPAR values observed in most of the markets implies a sharp limitation on the amount that can be obtained, given that the projected EBITDA should be at least 1.3 times greater than the amount of the installment.

Private equity funds or institutional investors tend to be rather selective, giving preference to large partners or first-rate markets (neighborhoods or cities). In addition, they often require an equity yield of 20 percent per year, which is a difficult level to reach even with financial leveraging.

Do not waste a good opportunity

The euphoria with respect to the country's growth is very well-founded and should generate major investment opportunities. On the other hand, as this article points out, there is a series of real obstacles to investments for the opening of new hotels. Contractors and investors should spend a good amount of time prospecting and identifying the best alternatives. One thing is certain: when you encounter them, these obstacles will become barriers to entry for competitors and will work in your favor.

Cristiano has more than 15 years of experience in the Hotel, Tourism, and Real-Estate industry, conducting and supervising more than 250 studies for hotels and resorts throughout South America, Trinidad & Tobago, Angola, and Portugal. He worked for four years on tourism projects for HVS, coordinating the elaboration of regional tourism development plans financed by the Inter-American Development Bank (IADB). He is a permanent columnist for Hotelnews magazine and he has also published several reports on the tourism-real estate market and co-written the Brazilian Hotel Market Overview (HotelInvest / HVS). Cristiano owns the MRICS title from the Royal Institution of Chartered Surveyors (RICS), world leader entity in real state professionals qualification and has a Production Engineering degree from the Polytechnic School of the University of Sao Paulo (POLI-USP) and a post-graduate degree in Tourism and Hospitality Management from the Getúlio Vargas Foundation (FGV) and has also completed a Real Estate-Hotel Finance course at Cornell University. For more information contact Cristiano at cvasques@hvs.com.

2 Comments

  1. Pierre RicordJul 19, 2010

    Hi Cristiano, Very interesting overview, good read. Thank you

    • Thanks, Pierre. Hope it is useful as a guide for investors getting to know the Brazilian hotel market. Regards, Cristiano

  2. Javier NavarroMar 26, 2012

    Good evening I am looking for information concerning construction costs for new hotels in Central America. Could you help me with some information? Thanks

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