African Hotel Development – Great potential returns for investors

African Hotel Development – Great potential returns for investors

Hotel Partners Africa Tourism Leave a Comment

Head of Property Services Hotel Partners Africa Head of Property Services Hotel Partners Africa

Everyone knows about Africa’s potential, created by the population explosion, the demographic profile of the population and the commodities “lottery win”. However, the shortage of hotel bedrooms provides one of the best opportunities for traditional property investors anywhere in the world. What are the benefits for the host country ? And how to minimise the impact of the key obstacles to successful development ?

In 2015 the latest of the biannual reports by Hotel Partners Africa outlined the huge opportunity that was available for hotel investors in sub-Saharan Africa, echoing many earlier reports by a whole series of academic and professional luminaries. Everyone knows about Africa’s potential, created by the population explosion, the demographic profile of the population and the commodities “lottery win”. However, the shortage of hotel bedrooms provides one of the best opportunities for traditional property investors anywhere in the world. To set this opportunity into context, it is useful to look at some of the key facts. In the USA, one of the most mature hotel markets in the world, there are approximately 15,000 branded hotel bedrooms per million people in the population. Across sub-Saharan Africa there are only 89 bedrooms per million population. That is 168 times less; purely in terms of supply, the opportunities are huge.

There are only 89 bedrooms per million across sub-Saharan Africa, 168 times less than the USA.

However, that is not the only reason why hotel development can provide such a great opportunity for investors. Many governments throughout sub-Saharan Africa are extremely keen to see to hotel development, and some commentators have questioned this almost instinctive desire to help such developments happen as not always in the best interest of the country. I would argue however, that hotel development is extremely good for an emerging economy, as it brings many tangible as well as intangible benefits to a country.

Attractiveness, employments, training…

One of the easiest to understand, but least considered benefits that international class hotels bring is the very facilities they offer. Having a well-known international branded hotel encourages international investors to visit a country and look at the investment opportunities in all sectors of the market. Without a quality hotel, it is extremely difficult to persuade an investor to come and visit a country, and without personal due diligence of opportunities, inward investment tends to be limited. It is often stated that when the Tanzanian government invested in the Kempinski hotel in Dar es Salaam, the inward investment in the country doubled after it opened compared with the year before.

Another big advantage of hotels is the amount, and type, of employment opportunities they provide. Hotels in Africa tend to employ somewhere between 1-5 staff for each bedroom, with higher employment in the smaller, more luxurious segments. Employment levels are typically higher in Africa compared with all other geographic regions, except for Asia. As such a single 200-bedroom hotel can typically employ 300-400 people directly, with countless other people employed in indirect services, for example taxi drivers or suppliers to the hotel.

A single 200-bedroom african hotel can employ 300 to 400 people directly, with countless indirect services.

However, a hotel is unique in taking staff with no training and providing training and then offering very real opportunities for personal (and therefore financial) improvement. A member of staff can start as a pot washer in the kitchen, but with the right attitude will get the opportunity to seek promotion, and can advance all the way to senior management. When education opportunities are not high in a developing country, this opportunity for the population is highly prized by local people, and quite rightly it is also highly prized by politicians, who are tasked with representing the people and their best wishes.

A high “multiplication factor” of money generated

For government to run a country effectively it needs to generate taxes. Of course, generating taxes does not mean that the money will be spent wisely, but if such taxes are not collected then there is no chance it can be used to enhance the lives of the population. Hotels offer fantastic opportunities for governments to raise revenues from a wide range of sources. Visa fees for hotel guests when they enter the country, income tax on all employees, taxes on imports required for the business operation, taxes on company profits, not to mention bedroom taxes and VAT. In addition, throughout the development process there are opportunities to charge fees during the planning process, for imports on the materials needed to build the property, as well as income tax on the construction crew and company tax on the profits of the construction company. With so many opportunities for raising taxes it is not surprising that some forward- thinking governments offer tax incentives for hotel developers, to ensure the development phase is profitable enough to see the initial investments made.

The travel and tourism industry has one the highest “multiplication factors” of money generated. One dollar earned in the industry turns into seven dollars, a higher rate than any other industry. The WTTC believe that for every direct dollar earned in the industry, 3.2 dollars are earned indirectly, through ancillary services.

In addition, the presence of a high class international hotel can enhance the view of country to foreigners bestowing a prestige not offered by any other type of commercial property. When the Sheraton in Addis Ababa was opened for example, it raised the profile of prestige of the city to unprecedented levels. The presence of well-known hotels will also attract tourists, whether business or leisure guests. “Build it and they will come” is a mantra within the hotel industry, not just in Hollywood movies about baseball stadia.

Long and costly delays

So what are the obstacles? Why are so few hotels developed each year, even though the opportunities are seemingly boundless? In 2016 there were 248 branded hotel developments officially under construction, yet of the planned openings in sub-Saharan Africa due for that year only 18.7% had actually opened on time.

In a piece of research Hotel Partners Africa carried out earlier this year on actual hotel developments in key cities, it was shown that the typical delay in hotel openings was around 4 years across sub-Saharan Africa, with Lagos showing an average delay of 7 years, Accra and Dar es Salaam showing 3 years, Addis Ababa, Kigali and Kampala showing a 4-year delay, Lusaka showing a 5-year delay, and Nairobi and Abidjan showing and average delay of 2 years. These delays cost money – the returns on a development diminish rapidly if there are delays, and in one project the IRR dropped from an ungeared 15% to less than 7% on the back of a 4-year delay. There are a number of factors causing these delays, including planning issues, difficulties in procurement, hold-ups at port, and issues with finding sufficient trained sub-contractors. There is absolutely no substitute for having an experienced team in the development process if such potential delays are to be minimised or indeed removed altogether. The problem is that the unskilled and inexperienced are usually offering a cheaper service, and short-sighted investors are attracted by these offers, not knowing it will cost them much more in the long run. Companies like HotelSpec will happily work with developer’s, acting as the owner’s representatives, ensuring that the projects are developed on time and on budget, whilst also offering a procurement service that takes the risk out of the development phase of the project.

It was shown that the typical delay in hotel openings was around 4 years across sub-Saharan Africa

The feasibility study : a helpful spending

Another key issue is the lack of focus and due diligence given to a project. A feasibility study is essential, not just to raise funding or to attract a good operator, but also to ensure the site is being used to its optimum potential. There is no point in building a 400-bedroom luxury hotel, if the market requires a 200-bedroom mid-market property and the returns on such are much higher. The cost of a feasibility study, somewhere between $30,000 – $40,000, will usually help stop expensive mistakes. W Hospitality Group worked on one project, where development costs were cut by 30%, yet the end value was increased by an impressive $20m, enhancing the investors returns to 40% on a geared basis. Such advice always ends up cheap, even when it says “don’t do the project at all”.

However, the single biggest cause of delays is the lack of money. Many projects are delayed because the owner simply does not have enough funds at hand to develop the project. Debt for development projects has traditionally been difficult to come by. Typically expensive, with short terms available, it is very important that a developer knows how best to attract affordable debt funding, if the loan terms are not to reduce the profitability of the project. There are a number of reliable funding sources for new developments, including Proparco, IDC, DEG, and other DFIs to name but a few. It is possible, if the funders are approached properly, for the terms to be favourable enough to enhance the development profitability. Talk to the lender, find out what they need to take the project forward (usually a good feasibility study and a hotel management agreement with a respected operator at the least), ensure you present the project and the team involved in the most favourable light (and by this we mean use the presentation method that bank favours, not hide the truth!), and ensure you are extremely transparent on all issues, especially risks involved, so the bank knows you are being realistic. No development project has no risks – if you cannot identify those risks the funder will not think you are credible as an investor/developer.

Hotel development across sub-Saharan Africa offers great potential returns for investors, as long as they avoid the many pitfalls that befall many developers. Since such developments usually meet the requirements of local and national politicians, such developments are likely to be favourably regarded, so it is essential all potential hurdles are avoided to ensure that all the benefits of hotel development, investment returns, employment, tax revenues and prestige are all maximised.

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