Location, location, location — it’s not just key to landing good real estate, it’s also an important factor in finance. By their very nature, hotel investments are risky to varying degrees, but these days they are particularly precarious due to the volatility of several economic factors, including the low price of oil, interest rate cuts and the strength of the U.S. dollar.
The price of oil, which declined from US$107 a barrel last June to US$42 this past March, is starting to have a very severe impact on those regions reliant on oil revenue — Alberta, Saskatchewan, Newfoundland and even some pockets of northeastern B.C. — says Himalaya Jain, director and portfolio manager at ScotiaMcLeod in Toronto. “When the energy sector is booming, there is a lot of travel associated with that, whether it’s workers coming in from out of town, contractors or consultants,” he says. “So generally when the oil sector has been doing well the lodging industry in Alberta specifically has been doing fairly well. I would bet occupancies and rental rates would have been benefiting for the last few years, as oil prices have been very high. So a pull-back in activity, because of the magnitude of reductions we’ve seen … would result in lower occupancies.”
Indeed, in the first quarter of 2015 overall occupancy, ADR and RevPAR rates for Alberta lagged well behind Ontario due to a decline in business traffic and consumer confidence, plus work camps closing down, according to the “Canadian Hotel Brief” by CBRE Hotels, based in Toronto. Hotel occupancy dropped by 8.4 per cent in Alberta, compared to a 0.3-per-cent drop in Ontario; ADR was up an incidental 0.6 per cent in Alberta, compared to a 3.0-per-cent increase in Ontario; and RevPAR was down 7.9 per cent in Alberta but up 2.6 per cent in Ontario.
Oil prices have fluctuated for decades, so analysts don’t expect the price to remain this low indefinitely. However, the recovery will be more gradual than we’ve seen in other commodity cycles, says Jain.
Strategic investors looking to put capital into Alberta speculate about the upsides as well as taking calculated risks. “Alberta had robust rates and occupancy over the last couple of years but limited additions to supply as far as new hotels,” notes Steve Giblin, president and CEO of Vancouver-based SilverBirch Hotels & Resorts, which operates several hotels in the oil-rich province, among others. “Here’s a very gutsy call for the strategic investor: is it a good time to build a hotel in downtown Calgary?” Giblin would say, yes. “You’re going to open three years from now, and it could be a different economic environment, [and] you could build that hotel for substantially less than it was priced just a few months ago.”
In response to the drastic decline in oil prices, the Bank of Canada unexpectedly lowered interest rates by 25 per cent, down to 75 basis points, in January. The move subsequently weakened the loonie, which dropped 1.5 cents to close at 81.07 cents U.S.; at press time, it sat at 81.77 cents U.S.
The low cost of credit also makes real-estate investment appealing right now, notes Jain. “We’re sitting at very low financing rates that should be encouraging investment, because the yields you can get … are fairly attractive. So, generally investment in particular regions would be looking quite interesting.”
The low dollar, low-interest rates and financing rates may just be the catalyst needed to spur investments in commodity-based regions such as Alberta. “One of the issues with Alberta up until recently was that even though the economy is strong and the lodging industry has been doing fairly well, new development has been tough, because the cost of labour has been so high,” Jain explains. “You’re competing with the oil industry when you think about construction, so investors that have a longer term view may take advantage of this down trend to get projects started.”
Demand for real estate hasn’t waned over the last 12 to 36 months, according to reports from CBRE Hotels. Total hotel investment volume for 2014 was $1.3 billion — with 56 per cent of total volume in Central Canada, 39 per cent in Western Canada and five per cent in the Atlantic region. Notable transactions include the Fairmont Royal York (a joint venture) and Hyatt Regency Vancouver, which were purchased by Mississauga, Ont.-based InnVest REIT.
In any given year, transaction volume has ranged between $1 billion and $1.3 billion, but the commercial real-estate firm is forecasting total volume ranging between $1.5 billion and $2 billion in 2015. There are many drivers, says Bill Stone, EVP and broker, at CBRE Hotels in Toronto. “We’re seeing non-Canadian entities disposing of hotel real estate. We’re seeing some of the major institutions restructuring and culling their portfolios. You’ve got product, you’ve got a strong operating environment on a national basis, so it’s making underwriting a lot easier. And then you have plentiful and inexpensive debt, so people finance these acquisitions a lot more easily today than they would have three or four years ago.” Key transactions in early 2015 include the Hotel Bonaventure in Montreal, which was purchased by Montreal-based Kejja Group in February; the Best Western Primrose Hotel in downtown Toronto, which was purchased by Toronto-based Knightstone Capital Management in February; and Bethesda, Md.-based Marriott International, which completed the acquisition of Toronto’s Delta Hotels & Resorts in April.
Major urban markets, such as Vancouver, Toronto and Montreal, are tempting to would-be investors because of their diverse economic base, long-term depth and appeal to international travellers. Toronto and Vancouver are particularly attractive to SilverBirch’s Giblin. He’s seen Americans travelling to Vancouver and Victoria in a big way and thinks this will trickle into the rest of the country. “We anticipate this summer to be one of the best summers ever in Vancouver,” he says. “It’s always been attractive because of the weather, and the U.S. traveller and international traveller see it as great value.” Conversely, places such as New York City are substantially down in the first quarter of this year compared to last year, because the U.S. dollar is so strong, he adds. International travellers can’t afford to go there anymore, so Canada provides a good alternative.
Giblin also believes the absorption of Toronto’s condo supply is an indicator of the city’s strength and viability. “Everybody thought there was a bubble developing within Toronto with all the building of condos, yet [the city seems] to absorb them,” he notes. “That tells me the market is really hot and experiencing tremendous growth. Also … it’s not so much like the Vancouver story — where there’s a lot of offshore investment from Asia — where people are parking money in the condos. People are living in them, so job creation has to be strong. Generally, when that happens there’s a need for more hotels.”
Secondary markets can also make a lot of sense for investors wanting to buy more efficiently. CBRE’s Stone says when the shipbuilding contract kicks into high gear, it will be a boon for the Halifax market. However, all investments hold inherent risk, particularly those relying on fewer business sectors to drive demand. “If you’re in a logging community, and that company closes down, that has a direct impact, and there’s nothing else to support it,” explains Stone. “That’s where these [markets] are susceptible, but the buyers today are very diligent; they do lots of research before they acquire.”
Regardless of location, investors should do their due diligence before submitting any bids. Stone says this includes examining environmental assessments, operating performance, rebranding opportunities, ability to finance and a host of other factors.
At the end of the day, investing can be more of an art than a science. “My advice would be review your assumptions, your risks and your risk appetite,” Giblin cautions. “And, if you’re comfortable with those risks, and you can afford [them], it’s a good time to invest.”
I’m glad you pointed out that investing in a hotel really comes down to a personal decision about understanding and being comfortable with the risks. My husband and I want to diversify our finances, so I’ve been doing some research about investing in hotels. I learned a lot of info that I think will be valuable as we make our decision, so thanks for sharing!