COVID-19 IMPACT ON HOTEL VALUATION
ABOUT THIS PAPER The COVID-19 pandemic and resulting restrictions have many wondering about the fate of the hospitality sector. As such, banks and developers are pondering the extent of the impact on hospitality assets and how value will be determined in light of the increased uncertainty. Anticipating these concerns, we have calibrated our valuation reports to stay ahead of the market and provide a deeper analysis of the evolving situation. With the increased transparency and due diligence in our reports, we aim to better equip market participants to accurately assess the impact of COVID-19 on valuation figures. Changes include, along with reporting the Market Value, our unique scenario-based valuations, increased sensitivity analysis and commentary around forecasting to tackle the added uncertainty. Within the document, we will also highlight the likely impact on values based on the analysis we’ve undertaken since March. We hope you will find this document useful in assessing the impact of the current situation on your investments and that it gives an insight into how we can assist you in making an informed decision. Please get in touch to see how best we can help you with our services.
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COVID-19 IMPACT ON HOTEL VALUATION
CONTENTS 04
Material Uncertainty A Valuer’s Perspective
06
The Need For Reporting Change In Valuation Reports
07 04
Market Value During Uncertainty
08 04
Determining The Impact Of Covid-19 On Market Value
10
UAE 2020 Performance And Forecast
12
Scenario Based Valuations
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Resulting Impact Of Covid-19 On Market Values From 1 July 2020
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Forward Forecasting Future Prospects
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COVID-19 IMPACT ON HOTEL VALUATION
MATERIAL UNCERTAINTY A VALUER’S PERSPECTIVE The RICS Red Book Global Standards defines ‘material uncertainty’ as:
Where the degree of uncertainty in a valuation falls outside any parameters that might normally be expected and accepted.
Why is the current situation a material uncertainty? The outbreak of the Novel Coronavirus (COVID-19), declared by the World Health Organisation as a global pandemic on 11 March 2020, has impacted global economies and industry sectors. Travel restrictions have been imposed across countries, affecting global trade and disrupting financial markets. Indeed, the current response to COVID-19 means that we are faced with an unprecedented set of circumstances on which to base a judgement. We therefore have little doubt that the current market situation meets the definition of material uncertainty.
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COVID-19 IMPACT ON HOTEL VALUATION
Valuations reported on the basis of material valuation uncertainty relates to the valuation technical and performance standards reports (VPS 3) and the practical application of the material uncertainty as per Valuation Practice Guidance Applications (VPGA 10) of the RICS Red Book Global. Consequently, less certainty—and a higher degree of caution—is now prevalent than what would normally be the case. Whilst valuation reports account for and make reference to material uncertainty, Cavendish Maxwell has identified additional steps to address this. Additional due diligence is conducted to ensure the reader can make an informed decision based on the contents of our report.
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COVID-19 IMPACT ON HOTEL VALUATION
THE NEED FOR REPORTING CHANGE IN VALUATION REPORTS Valuation is the practice of estimating the price at which an asset would exchange hands at a specific date. The report, prepared by suitably qualified chartered surveyors, should provide an opinion of value based on Market Value as defined by the RICS and serve the intended purpose.
Market Value is defined in IVS 104 paragraph 30.1 as:
The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.
As part of the valuation process, the profits method is applied to hotel assets whose value is derived from the profitability of the businesses. Values are reported based on a ‘fully equipped operational entity’ and typically include the property interest, business or locational goodwill, fixtures and fittings, operating supplies and equipment in a single figure. The use of comparable information should be derived from a wide variety of sources beyond transactional evidence. Information may also be drawn from different operational entities with regard to the component parts of the profits valuation such as Average Daily Rates (ADR) or occupancy levels, cost and revenue benchmarks on a Per Occupied Room (POR) or Per Available Room (PAR) basis to arrive at an estimate of the hotel’s capital value. Since the outbreak of the COVID-19 pandemic, the comparable data is either unavailable, unreliable or outdated, and as such hinders the valuation process. An income and expenditure forecast based on all the evidence available is then capitalised using a discounted cash flow model and an opinion of value is derived. Valuations will always have a degree of uncertainty and it is the skill of the valuer to identify, quantify and disclose these uncertainties wherever possible. Our increased reporting standards aim to evaluate the potential impact of the current crisis on the property’s value, to enable the intended users to make a better-informed investment decision or assessment of their asset’s value.
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COVID-19 IMPACT ON HOTEL VALUATION
MARKET VALUE DURING UNCERTAINTY Determining a value within the definition of Market Value at a time of unprecedented uncertainty needs experienced specialists who operate in the local market. On the one hand, Market Value assumes a willing buyer. Given the reduced performance and loss of income, the market places power in the hands of buyers. On the other side of the definition is a willing seller. During times of uncertainly, owners willing to place assets on the market at buyers’ expectations are non-existent. If a hotel has short term liquidity issues, there is a risk it will become distressed, which would place it outside of the definition of Market Value. If there is a lack of willing sellers, there is an argument to say there is no market during these unprecedented times and any transactional activity is most likely forced. Therefore, determining an estimate of value needs to bridge the gap between buyer and seller expectations.
PROFITS METHOD 5-year forecast Fixed vs Variable cost analysis
COMPARABLE INFORMATION DISCOUNTED CASH FLOW
Average Daily Rates (ADR) Occupancy Per Occupied Room (POR) or Per Available Room (PAR)
Income and Expenditure Forecast capitalised
DEMAND SUPPLY ANALYSIS
INVESTMENT TRANSACTIONS
ELEMENTS OF A VALUATION
Known transactions are analysed on a rate per key and adjusted
Impact on current and future demand vs supply on forecasted rates and occupancies
REASONABLY EFFICIENT OPERATOR
YIELD AND DISCOUNT RATE ANALYSIS
Inefficiencies are brought in line with the market
Using most recent transactional evidence
SCENARIO BASED VALUATION Base Case Best Case Most Likely Case
MARKET VALUE ANALYSIS Weightage between cashflow and terminal value analysed
Worst Case
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COVID-19 IMPACT ON HOTEL VALUATION
DETERMINING THE IMPACT OF COVID-19 ON MARKET VALUE HIGH EXPOSURE OF HOSPITALITY SECTOR The hospitality market is responsive to demand changes and can adapt quicker than other sectors. To control the spread of COVID-19, travel bans and restrictions were imposed around the globe, directly impacting the hospitality sector. As a result, owners of hotels and resorts were hit by revenue losses that could not be recovered in the absence of government assistance. A recovery in the hospitality industry, though difficult to accurately project currently, is expected to be faster than traditional retail assets as it is more sensitive to changes in demand. Eventually, travel pattern will be easier to project, however, a larger concern is that the effects of the pandemic might alter travellers’ decision-making processes, potentially impacting complete recovery in the long run. During times of uncertainty, investors require a discount rate that accurately reflects the risk of a cashflow; therefore, upward pressure on discount rates is inevitable. However, we must hold true to the definition of Market Value and recognise that whilst the current environment can lead to assets being transferred under a restricted marketing period, or potential buyers speculatively registering offers of interest, higher yields and discount rates achieved in the short term do not necessarily reflect long-term expectations or trends. Therefore, a market-based approach using the most recent evidence may not lead to the best estimate of a Market Value. Real estate is generally less susceptible to market volatility than equities or certain other financial instruments. However, it is subject to similar business challenges as guest mindsets change over time.
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COVID-19 IMPACT ON HOTEL VALUATION
SOURCE MARKETS Valuers need to consider the hotel’s brand and positioning when forecasting demand. Some brands cater to certain source markets so care must be taken to consider the historical segment mix to advise on likely take-up levels. The travel and tourism industry accounted for 11.1% of UAE’s gross domestic product in 2018. To maintain this contribution and increase it, the UAE must witness a revival from its key source markets. For Abu Dhabi - India, China, UK, US and Egypt accounted for the top five source markets outside of the UAE, whilst for Dubai it was India, Saudi Arabia, UK, Oman and China. Interestingly, the UAE accounted for 40.3% of all guest nights in Abu Dhabi during 2019, leading to strong occupancy levels during Q2 2020. When preparing a valuation, key considerations must be made to the state of affairs in these source countries when forecasting. Also, it is imperative to understand the historical segments and nationality breakdown of guests to anticipate how certain brands and types of hotels will perform going forward.
EASING OF RESTRICTIONS KEY TO BREAK EVEN Strong demand from international arrivals is essential for hotels to break even. Since 19 Mar 2020, all UAE visitor visas on arrival were suspended. Currently this remains the case for all emirates with the exception of Dubai, which opened its borders to international tourism on 7 July 2020. Whilst the UAE has a healthy proportion of long-stay guests and staycation demand supporting occupancy levels at hotels still open for business, at the current average levels, the base demand is insufficient to allow the wider market to break even.
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COVID-19 IMPACT ON HOTEL VALUATION
UAE 2020 PERFORMANCE AND FORECAST Since the travel restrictions were put in place, hotels which remain open for business in the UAE sat at minimal occupancy levels. As of June 2020, 16% of hotels within the UAE tracked by AM:PM have closed their doors with many more operating at minimum capacity. It is likely that as we get further into the year, more hotels will follow suit. On a room basis, as of June 2020, the percentage of AM:PM tracked rooms currently closed within Dubai stood at 27% vs 8% for Abu Dhabi. As of June 2020, Dubai’s Revenue Per Available Room (RevPAR) fell 73.5% when compared with June 2019. Abu Dhabi City Hotels RevPAR is down 13.6% versus June 2019 and Abu Dhabi Resorts RevPAR declined 48%. Ras Al Khaimah and Fujairah stood at -32% and -42%, respectively. Using the latest information available, Cavendish Maxwell’s trend analysis estimates a Q3 2020 RevPAR decline of 65% for Dubai and 42% for Abu Dhabi Resorts. Abu Dhabi City Hotels RevPAR is forecast to move lower by just 17% with Ras Al Khaimah and Fujairah forecast to decline 36% and 43%, respectively, when compared with Q3 2019 performance. City hotels are expected to record improved performance once corporate and meetings, incentives, conferences and exhibitions (MICE) travel resumes but there will likely be a long-term reduction in occupancy as more businesses embrace video conferencing. From anecdotal research, a typical hotel needs to maintain around 40% occupancy to achieve break even. This will be the priority for hospitality operators over the short-term and is evidenced by our Most Likely Case scenario, which forecasts a 41.9% occupancy rate with a Gross Operating Profit (GOP) of 4.2% in the first year of the forecast, i.e. Jul 2020–Jul 2021.
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COVID-19 IMPACT ON HOTEL VALUATION
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COVID-19 IMPACT ON HOTEL VALUATION
SCENARIO BASED VALUATIONS To determine the likely impact of COVID-19 on hospitality assets, Cavendish Maxwell is conducting the following scenariobased valuations in its reports to assist the reader when making any financial decision.
The four scenarios
Base Case Using a historical demand
Best Case
and supply analysis,we
Using the Base Case, we
replicate how we expected
take average occupancy
the market to perform as
levels at the time of the
of the valuation date and
valuation and assume a
forecast forward, assuming
12-month growth phase to
zero impact for the
reach stabilisation.
disruption caused by the pandemic.
Most Likely Case Similar to the Best Case, we take average
Worst Case
occupancies at the time of
We assume a 21-month
the valuation. However, we
growth phase to reach
assume a 15-month growth
stabilisation.
phase.
In each scenario, year three of the forecast is assumed to mirror the base case. Recovery levels will vary significantly from one market to another as key decisions in each emirate and also the main source markets will affect how different types of hotels recover in the UAE. The shift in the Expo to 1 Oct 2021 - 31 Mar 2022 allows a more aggressive recovery multiplier when compared with main international markets. This contributing factor also allows us to justify maintaining performance from year three onwards as opposed to factoring in a longer-term reduction in occupancy levels relating to the global pandemic. The Most Likely Case detailed above would represent our opinion of Market Value. This scenario tries to establish a mid-point where an arms-length transaction can occur. Using the Base Case, adjustments to the first two years of the cashflow can include:
Reduced occupancy depending on scenario
Reduced ADR during the period of recovery
Per Occupied Room revenues adjusted to reflect loss of walk-in revenue
Fixed costs adjusted downwards to reflect cuts to workforces or costsaving negotiations
Revised fixed cost percentages adjusted upwards to reflect the loss of variable cost incurred Capitalisation rate range pushed outwards to reflect perceived additional risk of the asset
Discount rates temporarily pushed outwards during the recovery period, stabilised in line with the Base Case to reflect illiquidity and risks associated with the forecasts
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COVID-19 IMPACT ON HOTEL VALUATION
Along with this analysis, increased sensitivity is now essential. Effects on smaller shifts in key variables can now be produced to provide further transparency. Since the outbreak, our valuation models have been continually evolving and adapting to reflect the latest information and trends seen in the market. As of July, key revisions will be made to each valuation scenario that mirrors hotel performance seen during Q2 2020. Adjustments include:
Slower initial recovery to allow for source markets not resuming travel as expected
Higher food and beverage proportion to cater for quicker than expected take-up from UAE residents
Revisions to base occupancy levels seen to reflect Dubai opening its borders on 7 July
Increased reduction of the fixed cost as contracts continue to be negotiated at lowerthan-expected levels
RESULTING IMPACT OF COVID-19 ON MARKET VALUES FROM 1 JULY 2020 The resulting scenario-based valuations aim to demonstrate the impact of the global pandemic. It represents a typical 200key, leisure-focused hotel with standard F&B provisions operating within our expectation of a Reasonably Efficient Operator (REO).
BASE CASE SCENARIO
BEST CASE SCENARIO
Rate Per Key: AED 898,000
Rate Per Key: AED 834,000
Y1 ADR: AED 452 Y1 Occ: 79.8% Y1 GOP: 36.7% Yield: 8% Discount: 9.5%
Y1 ADR: AED 395 Y1 Occ: 47.2% Y1 GOP: 14.6% Yield: 8.25% Discount: 11% (Year 1 only)
WORST CASE SCENARIO
MOST LIKELY SCENARIO Rate Per Key: AED 819,000 Y1 ADR: AED 372 Y1 Occ: 41.9% Y1 GOP: 4.2% Yield: 8.25% Discount: 11% (Year 1 only)
DOWN 7.2%
DOWN 8.8%
Rate Per Key: AED 784,000 Y1 ADR: AED 350 Y1 Occ: 36.7% Y1 GOP: -9.4% Yield: 8.25% Discount: 11% (Year 1 only)
DOWN 12.7%
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COVID-19 IMPACT ON HOTEL VALUATION
FORWARD FORECASTING FUTURE PROSPECTS As the global lockdown eases, medium-term prospects for the hospitality sector are positive The hospitality industry, specialist in nature, applies a growth-explicit valuation model, focusing on a 5-year forecast. In contrast, other traditional sectors, including office and residential, use implicit models focusing on forecasting income and expenditure on a day one basis and applying growth implicit yields. The advantage to producing a 5-year forecast is that we can explicitly forecast forward. We can identify reasonable growth assumptions to define an opinion of Market Value whilst considering the current market situation. Hospitality assets are not transacted based on short-term performance, but investors must have a firm understanding of future forecasts and require reasonable returns to justify the risk of a stunted exit strategy. The impact of COVID-19 on the world will continue for the foreseeable future with a new ‘normal’ likely to take shape. Yet, the shorter-term impact on cashflows must be incorporated into the valuation. It is therefore highly recommended that valuation analysis is conducted on a more frequent basis as newer data is obtained. Yields and discount rates should shift but as evidenced by the financial crisis of 2008, there was a noticeable time lag between rising discount, and subsequently, changes to yield profiles. Even though it will not be a rapid recovery, hospitality performance is expected to recover faster than traditional sectors as occupancy and ADR are much quicker to react to changing market conditions. Countries which have been proactive and have overcome the pandemic relatively unscathed will be perceived to be a safer option for travel when the business and leisure sectors recover. According to the Deep Knowledge Group, as of June 2020, the UAE sat just outside the top 10 COVID-19 safe countries in the world. Given the sudden decline in hospitality performance and, in most cases, leading to numbers far from break even requires solutions. The UAE government has stepped in—the UAE Central Bank has issued guidance of economic support to the banks including zero-cost facilities, capital buffer relief and holiday payments until 15 September 2020, and an over AED 250 billion package to aid these measures. Whilst beneficial in the short-term, this will indirectly find its way back to banks and eventually, the customer. Given the relief measures introduced by the Central Bank, market activity will reflect yield and discount rates above historical averages, given the additional perceived risk or high level of uncertainty. As these measures are lifted we should see a shift towards lower leveraged, or even 100% cash transactions. We expect potential investors to take a longer-term view on hospitality assets. Once hotel performance begins to stabilise and assets are placed onto the market, buyers with higher levels of liquidity will be in a position to acquire assets at prices below both, replacement cost and recent norms. Irrespective of the downward trends associated with market performance, an opportunity for high returns will be created.
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COVID-19 IMPACT ON HOTEL VALUATION
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COVID-19 IMPACT ON HOTEL VALUATION
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COVID-19 IMPACT ON HOTEL VALUATION
COMMERCIAL VALUATION Cavendish Maxwell has one of the largest commercial valuation consultancy teams in the region, which includes eight fully qualified RICS registered valuers. Our commercial valuation team has the ability and experience to service large and complicated real estate portfolios and maintain the highest reporting standards. We interpret the latest data and incorporate independent and objective assessments to form our own market intelligence, which enables us to deliver clear and concise advice on properties across all sectors. During the past year, we have valued in excess of AED 130 billion worth of property and provided strategic advice to support financial and risk management decisions for a wide array of corporate clients across the Middle East and Africa.
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Daniel Harrison BSc (Hons), MRICS Associate Partner, Specialist Commercial Property Valuation dan.harrison@cavendishmaxwell.com DUBAI
ABU DHABI
SHARJAH
MUSCAT
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Al Sarooj
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United Arab Emirates
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Disclaimer: The information and analysis contained in this report is based on information from a variety of sources generally regarded to be reliable, and assumptions which are considered reasonable, and which was current at the time of undertaking market research, but no representation is made as to their accuracy or completeness. We reserve the right to vary our methodology and to edit or discontinue the indices at any time, for regulatory or other reasons. The report and analysis do not purport to represent a formal valuation of any property interest and must not be construed as such. Such analyses, including forward-looking statements are opinions and estimates only, and are based on a wide range of variables which may not be capable of being determined with accuracy. Variation in any one of these indicators can have a material impact on the analysis and we draw your attention to this. Cavendish Maxwell does not accept any liability in negligence or otherwise for any loss or damage suffered by any party resulting from reliance on this report.