In 2009, in the wake of the Global Financial Crisis (GFC), we penned a newsletter setting out our observations on the GFC's impact on the hotel industry. In a few short months, COVID-19, seemingly out of nowhere, has had a profound impact on the world in general and the hotel industry in particular. Globally, more than 100 million hospitality workers have lost their jobs. Until an effective vaccine is made available to the general population, the hotel industry will have to be agile and innovative to adjust to the new normal. While governments act to contain the spread of the virus through quarantine, lockdowns and other forms of restrictions, the hotel industry will be in a state of constant flux, adjusting to the changing legislative and economic environment.

Like many other industries, the virus hits at the heart of the hotel industry's business model — the concentration of large numbers of people in confined spaces, the delivery systems (such as the airline industry) which transport the business to the hotels and the precious guest experience which is being battered in the wake of social distancing protocols and other requirements. The virus will have profound impacts for owners, operators and financiers and of course the leisure and business guest.

Over the last few months, we have spoken to numerous senior hospitality executives comprising owners, operators, financiers, brokers, investment bankers and asset managers including those who have lived through past pandemics and recessions. In this article, we comment upon a number of trends that so far appear to have emerged out of the haze.

In more detail

1. How the impact of COVID-19 compares to the GFC

The impact of COVID-19 has deprived the hotel industry of income. The GFC deprived the industry of capital (i.e., equity and debt).

In a post COVID-19 world, legal restrictions, including social distancing, lockdowns and national and state-based border closures are preventing hotels from attracting and accepting both international and domestic guests.

For the time being in Australia, government support and trading bank benign lending practices are minimising the adverse impact of an income drought, but this will end sooner than anybody would like with unpredictable, potentially adverse, consequences.

 

2. Impact of devising a safe and readily available vaccine or antidote

The best way out of the current crisis is the emergence of an effective vaccine that provides immunity to the virus and allows people to travel freely, both domestically and internationally.

Current indications are positive that an effective vaccine is on the way and is only months away from being generally available in Australia.

In the absence of total immunity, it will be up to governments to determine what rules and regulations it needs to implement to contain the spread of the virus. To date, such rules and regulations have involved limiting the number of people allowed to gather at any one time and restricting movement across borders. This results in corresponding potential adverse economic impacts on the business community in general and the hotel industry in particular.

 

3. Franchising vs management

One potential consequence of a post COVID world is that hotel management companies may elect to alter their current business model to increase their focus on franchising as opposed to management.

In the short term, new management opportunities may be harder to secure than in the pre-COVID period. Franchising appeals to owner- operators and those owners with a preference for "white label" management (which is a management arrangement that is largely invisible to the public).

Greater interest may also be given to the "manchise concept" - a relationship between the owner and the operator which starts its life with the operator providing full management services with the prospect of a conversion (by an owner-exercisable option or otherwise) to a franchise arrangement.

 

4. Insurance considerations

For so long as COVID-19 remains a pandemic, then it is likely that travel insurance policies will exclude coverage for the consequences of contracting the virus.

This is a significant issue for the general travelling public but particularly for business travellers.

For example, an employer wishes for its employee to travel overseas. This raises the prospect that the employee may contract the virus and is to be admitted to a hospital, with a substantial bill for medical services provided thereafter. As between the employer and the employee (or perhaps one or more third parties that may have been responsible for the employee contracting the virus), who is responsible for that bill? Such uncertainty may impact the number and frequency of business travellers.

There is also the prospect that income protection and life insurance will contain COVID-19 exclusions in these circumstances.

 

5. Brand standards

In response to community concern, we are already seeing hotel operators imposing new stringent protocols to minimise the prospect that hotel guests, employees and other invitees will contract or spread the virus on hotel premises.

While the implementation of stringent protocols are necessary to ensure the safety of hotel guests, employees and other invitees, it does come at a substantial cost, which is ultimately borne by hotel owners.

It is clear that when a hotel guest is deciding where to stay, one enhanced factor will be the question — do I trust this hotel to take adequate and proper precautions to ensure that I am safe while on hotel premises?

 

6. The availability of debt

The availability of adequate and reasonably priced debt finance is fundamental to the ongoing viability of the hotel industry.

In the case of Australia and perhaps abroad, we are told that traditional financiers are showing signs of retreating from the industry. These financiers will have less capital to play with. Hence primary financiers will be more reluctant to maintain existing relationships and even more so to enter into new ones. If the financier is inclined to lend, then loan-to-value ratios will be significantly less than the percentages previously on offer.

This will mean that owners will need to work much harder to source mezzanine finance or be left with the prospect of contributing significantly greater amounts of equity. This will have a profound impact on hotel valuations, particularly if it is a trend largely specific to the hotel industry rather than being more widespread in its application to all real estate categories.

 

7. Valuations

Currently there is very little demand for valuations. This is a good thing because arguably, there has never been a time when it has been more difficult to undertake a meaningful valuation.

When undertaking a valuation, valuers seek to execute a detailed analysis of the discounted cash flow arising from hotel operations over an extended period. In the current environment, this is challenging to say the least. This analysis is then reality checked by reference to comparative recent sales. Once again, this is a significant challenge at the current climate.

As governments and regulators seek to return to normality and require regulated lenders to reactivate periodic reporting obligations, the demand for valuations will increase substantially. These valuations will drive behaviour and outcomes, especially if they produce hotel valuations substantially lower than previous valuations.

 

8. Impact on new hotel construction activity

Many hotel management agreements for new build hotels require owners to construct the hotel in accordance with strict construction milestones. If the owner is unable to access funding to construct with the prospect of not being able to comply with construction milestones, then what is the fate of new hotel construction activity? If the GFC is any indication, construction activity will return gradually and then accelerate dramatically.

 

9. Will hotel management agreements change?

The short answer is that it is too early to tell.

Some questions that are occupying the quiet moments of industry thought leaders are as follows:

  • Will the current paradigm for risk sharing between owners, operators and financiers change?
  • Will the universal approach to operator fees being a percentage of revenue and profit change?
  • Will owner construction obligations be relaxed in the face of increased uncertainty?
  • Will owner obligations in relation to its dealing with lenders need to become more flexible in the face of increased uncertainty as to who will lend and on what basis?
  • Will a world without an effective and generally available vaccine open up opportunities which hitherto were not available?

 

10.The potential economic consequences of the virus

Without an effective vaccine readily available, there will be an impact, perhaps severe, on domestic and international business travel demand, particularly by senior executives. This will be due to factors including willingness to travel and congregate with others, availability of sophisticated communication technologies like Zoom and the potential unavailability of readily accessible and reasonably priced travel insurance (which could be the real sleeper issue). COVID-19 exemptions to income protection and life insurance could also be an issue.

Enhanced dependence on a largely domestic leisure travel market will significantly impact luxury hotel rack rates, as leisure travel is a personal non-tax deductible cost.

 

Conclusion

It is often quipped that the most significant event which has occurred in the hotel industry in the last 50 years is that somebody decided to put a flap on the toilet roll.

Post-COVID-19, those days of static operating circumstances would be well and truly gone.

It is anybody's guess where this global disruption is going to take us. There will undoubtedly be winners and losers. Stay tuned for the next instalment.