It has been more than two months since I last posted on my blog. I promise I wasn't being lazy. I was in the process of finishing an article about how to profit from the upcoming changes in the yield curve. However, during the completion of that article, the Israel-Hamas conflict broke out, creating even more uncertainty about future interest rates and making me doubt the conclusions I had drawn in my article. So, I decided to put off the posting until I can convince myself that I was generally right.
In this article, rather than simply presenting current market data as I did for my previous post about London office market, I want to share an interesting discovery about London hotel sector. While other segments of the real estate industry continue to struggle, the hotel sector has made a swift recovery and has been delivering positive performance since 2021. This situation piqued my curiosity, leading me to wonder: Is the London hotel sector more resilient than I had thought?
To ensure that the rapid recovery is not merely an isolated or random event, I looked into the historical trend in RevPAR in London and delved into the relationship between RevPAR and significant events that could impact the sector.
Based on the graph above, we can easily see that the hotel sector is cyclical by nature, but it is also surprisingly resilient. Except for the 9/11 attack, it usually took only one year for the London hotel sector to return to the previous level every time after a significant event happened. The sector held up well compared to other industries during the financial crisis, and the Revenue per Available Room (RevPAR) recovered to the former level within a year after the UK recession. Additionally, the sector bounced back strongly post-Covid 19, with full recovery by 2021. But why? What makes the London hotel sector surprisingly resilient?
To answer this question, we need to look into the key driver of hotel revenues – tourism industry.
The tourism industry is intuitively linked to how wealthy people are feeling and how they perceive future levels of discretionary income. Surprisingly, though, data from the Office for National Statistics (ONS) indicates that even in cases when economies worsened, the tourist "spend" held up fairly well. Tourism's contribution to the UK economy proved to be "relatively resilient" in the wake of the 2008 financial crisis. Also, the spending of international visitors in London has been climbing from 2009 to 2017. Even though there were dips in 2018 and 2020, the spending bounced back quickly, showing the resilience embedded in this industry.
Besides the robust tourism market conditions, the ability to pass on the increased costs to consumers also makes this industry resilient. Unlike offices, which typically have long-term contracts with fixed leases, hotels can adjust their Average Daily Rate (ADR) flexibly to mitigate the impact of rising costs. Therefore, hotels can manage an environment of increasing rates better than offices.
However, the growing momentum is likely to stall in the next couple years due to the significant drops in UK hotel development pipeline and investment transaction volume. The heightened debt costs and tightening lending market push up the development cost and cause the mismatch in pricing expectations between buyers and sellers, which continues to impact the volume and timing of deals.
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