Hotel Market Performance Outlook ? August 2012

AHS Advisory has been producing hotel market outlook reports since 2002.? We have hosted many presentations and gatherings, with the objective of informing and educating hoteliers on the outlook for markets, and the potential opportunities that exist to maximise revenue growth for hotels.

There is no doubt that our forecasts and presentations are skewed towards the interests of hotel owners and operators. ?AHS Advisory has always aimed to support room rate growth through the timely recognition of market opportunity and by taking away fear of market setbacks, which all too often result in unnecessary discounting strategies to drive demand, even though we all recognise that that strategy doesn?t work in a market with a largely static demand base.? Unfortunately, it happens time after time and we see the results of that in this outlook yet again.

Our hope is always that hoteliers will make better decisions with more information at hand.? Hence, our projections tend towards optimism, in an effort to provide courage to embolden growth, rather than to cause angst and potentially create fear.

Reporting framework

Our analysis is based upon long-term performance time-series as reported by the Australian Bureau of Statistics (ABS), using their Survey of Tourist Accommodation (STA) data series.

The ABS has been progressively replacing the Australian Standard Geographical Classification (ASGC) with the new Australian Statistical Geography Standard (ASGS) as its geographic framework.? The ASGS is the framework for understanding and interpreting the geographical context of statistics published by the ABS. It brings all the regions for which the ABS publishes statistics within the one framework and will be used for the collection and dissemination of all geographically classified statistics. ?As a whole, the ASGS represents a more comprehensive, flexible and consistent way of defining Australia?s statistical geography than the ASGC. ?It addresses some of the shortcomings of the ASGC in that:

• it brings all the geographic regions used by the ABS into the one framework and now includes non-ABS structures (such as Tourism Regions) which are not defined by the ABS but which are important to users of ABS statistics;
• the ABS structures will remain stable between each cycle of the Census, although Tourism Regions will continue to be reviewed on an annual basis;
• the regions at each level of the ASGS ABS structures are more consistent in population size; and
• the regions at each level of the ASGS ABS structures are based on the idea of a functional area and are built around whole official gazetted localities.

All ABS collections are transitioning to the ASGS by 2013.? Under the ASGS, small area data will be produced at Statistical Area Level 2 (SA2) and will replace the Statistical Local Area (SLA) data used under the ASGC.

Tourism Regions (TRs) will change to be constructed from allocations of whole SA2s rather than whole SLAs.? Unlike SLAs which changed every year, SA2s will be reviewed only once every five years, therefore making these data more stable over time.? Furthermore, SA2s are in general smaller than SLAs and, as they represent functional areas of regional towns, the SA2 based TRs are a better geographical representation of underlying social and economic interactions than the SLAs based TRs.? As TRs are defined each year by Tourism Research Australia (TRA) in consultation with State and Territory Tourism organisations, TR boundaries and names may still change each year as a result of this consultation.

Under the ASGC, Local Government Areas (LGAs) were made up of one or more SLAs.? As the lowest level of geography available for the STA under the ASGC was SLA, it was possible to produce LGA level data by aggregating selected SLAs.? Under the ASGS, a relationship does not exist between LGAs and SA2s.? As SA2 is the lowest level of geography now available for the STA, it is no longer possible to produce LGA level data.? As a result, the selected LGA data series which was produced for the STA will be discontinued.

To assist with this transition, there will be a dual release of small area data for the four quarters of 2012.? Data will be released at both the SLA level (using ASGC 2011) and at the SA2 level (ASGS). ?As back-casting of historical STA data onto the ASGS is not possible, the dual release will allow users to continue with an ASGC time series for a 12 month period, whilst beginning a new ASGS time series at the same time.

Implications for our forecasting reports

The implication of this change for our market forecasting reports is both a break in time-series, as well as the need for a shift in our forecasting analysis to redefined areas.? Whilst the new data should theoretically allow for a more precise sample set, it may also make analysis of certain areas impossible, as not enough data may be available for small areas to produce complete and continuous data sets.? Time will tell.

In anticipation of SLA data being completely phased out by 2013 and the inability to back-cast data, we have switched our forecasting reports to growth trends rather than absolute numbers.? We also believe this may actually help our readers, in that it will provide projections that can be applied to the particular performance of individual properties, rather than just provide broad market projections.? Our hope is that we will be able to align historic growth trends for SLA data with growth trends for SA2 data, and thus continue our projections based on long-term trend analysis.

Summary

In this first report in a modified format we are introducing several new graphs and formats.? In this summary section we look at comparative room occupancy, average room rate and revenue per available room (RevPAR) performance across Australia?s key cities and destinations, based on their actual performance for the year ending 2011 and our outlook for 2015.

Room Occupancy Comparison

Following a rapid recovery from the setback of the Global Financial Crisis (GFC), room occupancies in Sydney, Melbourne, Perth and Brisbane closed 2011 at record levels.? With a room occupancy of 85.8% for the year, Sydney just managed to stay ahead of Perth which recorded 85.1%.? Perth recorded by far the strongest growth however, coming from 82.3% in 2010.? This leaves little room for further growth with Sydney and Perth only showing minimal further growth, whilst Melbourne and Brisbane will also break 80%.

Darwin comes from behind with 71% in 2011 to potentially reach close to 78% by 2015.? Adelaide, Canberra and the Gold Coast all experienced occupancy declines in 2011 whilst TNQ saw the beginning of a badly needed recovery, but still only reached 57% for the year.

Average Room Rate Comparison

In previous forecasts we have been bullish on our outlook for average room rate growth, expecting that hoteliers would seize the opportunity to make up lost ground on the back of world-beating room occupancy levels, especially in Sydney, Melbourne and Perth.? However, it seems only Perth hoteliers have grabbed that bull by the horns and ran with it, recording almost 13% rate growth in 2011.

Our hope for Sydney was close to double digit figures and we are disappointed that Sydney hoteliers achieved only 6.8% growth in 2011.? Melbourne did even worse, barely beating inflation with 2.7% rate growth, despite room occupancy in excess of 80%.? This leaves Sydney still with the highest rates in the country, at $188 across the city, closely followed by Melbourne and Perth with $178 and $177 respectively.? But not for long.

The room rate ranking will have changed dramatically by 2015, when Perth will be Australia?s most expensive city by quite some distance, unless the penny starts dropping in Sydney and Melbourne.? Double digit growth for the next few years will drop back to 6% by 2015 as rates in Perth shoot towards $260, with Sydney languishing at $220 and Melbourne at $200.? Brisbane seems more aggressive and by 2015 could outperform Melbourne with a city-wide room rate of $206.

Only in TNQ have rates declined in 2011 in a push to drive room occupancies.? This will hopefully have changed by 2015, with room rates matching at least inflationary growth.

Revenue per Available Room Comparison

RevPAR performance sees a clear winner in 2011: Perth achieved an astounding 17% growth to record just over $150 across the city, ahead of Melbourne with $143 and hot on the heels of Sydney with $161.? Whilst this phenomenal growth is unlikely to be maintained for many years, we expect Perth to record similar growth in 2012 before slowing to more modest single digit growth.? Still, RevPAR by 2015 will be well ahead of all other cities, with increasingly dated stock and only limited new supply entering the market.? Guests may complain, hoteliers will not.

On the other side of the scale, Adelaide and the Gold Coast experienced a RevPAR decline in 2011, owing to poor occupancy performance. ?TNQ did manage to achieve RevPAR growth through rate discounting, but only because this is a ?discretionary? market that can effectively induce demand through attractive pricing.? We strongly caution against this strategy for ?mandatory? city markets that have a much more finite demand base that cannot be stimulated as much through discounting policies; it will only damage long-term rate potential!

Australia

Our performance projections for each hotel market is driven by a correlation analysis between economic indicators as reported by Deloitte Access Economics (DAE) in their quarterly Business Outlook publication, and the actual demand for accommodation facilities, as reported by the ABS.? This methodology is explained in the following section, covering the overall Australia accommodation market.

The following chart depicts the change in five key economic indicators that relate to the demand for accommodation facilities.

• The variation in supply is estimated by AHS Advisory based on historic precedent and our view on the country-wide development pipeline.? New supply will invariably drive new demand, or divert potentially frustrated existing demand from fringe locations back into town.
• The prediction for international arrivals influences demand from corporate and leisure segments and also reflects the impact of foreign exchange rates.
• Employment figures reflect corporate activity and are a practical indicator for the domestic corporate segment.
• Retail spend reflects disposable household income and as such is a useful indicator for the domestic leisure segment.
• Economic Demand represents the sum of consumption and investment spending by the public and private sectors, and as such is an effective measure of overall economic activity.

The variation in occupied rooms is the last variable, as reported by the ABS. ?In attempting to correlate this variable with the fluctuations in the set economic indicators, we have created the Accommodation Demand Index:

??????????? I? =? ??D+ ??R + ??E + ??A + ??S

??????????????????????? ??????????? ??????? V

• ? ?I? ????? = Accommodation Demand Index
• ??D???? = weighted change in economic Demand
• ??R???? = weighted change in Retail spend
• ??E????? = weighted change in Employment
• ??A????? = weighted change in international Arrivals
• ??S????? = weighted change in the Supply of hotel rooms
• ? V ?????? = Volatility index

The correlation is established by creating a weighted basket of indicators, the mix and weighting of which is different for each market.

For example, a corporate market will be more heavily influenced by employment and economic demand, whilst a predominantly leisure-oriented market will have a stronger correlation with retail spend.

Based on a strong correlation between the Accommodation Demand Index and the variation in demand for transient accommodation, a projection for future accommodation demand can be made when this correlation is extended against future projections for economic activity.

By matching the resultant future demand against the expected future availability of rooms, taking into consideration the anticipated growth of accommodation supply, a projection for room occupancy can be made.

Our projections are prepared on a quarterly basis and then aggregated to a rolling annual forecast, extended for three to four years.? We do not believe it meaningful to extend our projections beyond this point as the anticipated changes in accommodation supply become increasingly difficult to ascertain, and any predictions are thus increasingly unreliable.

For the overall Australian market, demand can be correlated closely with the economic indicators, resulting in a room occupancy outlook that suggests continued growth to a stabilised room occupancy performance around 66-67%.? This performance level represents a blend of high occupancies in the key cities of 80% and above, combined with much lower occupancy levels in leisure and regional destinations.? The graph demonstrates that this is actually higher than the previous peak achieved in 2007, and we believe this represents the cap for country-wide room occupancy performance.

In the final step, room occupancy rates are compared to the variation in average room rates.? As room occupancy improves room rates can be increased, and the propensity to push rate growth increases as room occupancy climbs.? In a corporate market where demand is mandatory regardless of price, room rate growth can be significant as room occupancies escalate.? On the other hand, in a leisure destination demand can be stimulated by aggressive pricing strategies and the opposite trend might be true.

Whilst historic room rate growth has shown potential for healthy increases of up to 7% at times of peak occupancy, the GFC seems to have triggered a much more cautious pricing behaviour which, combined with the increasing pressure from online distribution platforms, has reduced rate growth potential by 2%-3% country wide, and significantly more in the cities.? This has resulted in an actual slowing of growth to about 3% at present, following a ?spurt? of 4% to recover from a 2% decline during the GFC.

Given the all-time high room occupancy performance in several key cities, our expectations for room rate growth across Australia are for a modest increase to slightly outperform inflationary growth by about 1%, to stabilise at a longer term growth rate of close to 4%, until such time when significant new supply will emerge.

The combined room occupancy and average room rate outlook produce a RevPAR projection for Australia that shows a steady growth on the same track as experienced since 2002, barring the ?bump? from 2006-07 and the subsequent ?slump? from 2008-09.? However, as the base for this growth steadily increases, the actual growth rate declines, from 5-6% to 3-4%, due to the increasingly limited room occupancy growth opportunity and increasing reluctance to aggressively grow room rates.

The impact of this slowdown in growth rates is stagnation in real growth when an adjustment for inflation is made, with country-wide RevPAR poised to remain at around $100 in 2012 values, which it already achieved in 2008, and significantly exceeded in the late 1990s!

Our final graph depicts the combined growth rates for room occupancies and average room rates, as well as the resultant RevPAR growth (being the sum of these two).

The following sections discuss the outlook for individual markets across Australia.? Whilst we only display the final growth chart with growth forecasts, they each follow the same methodology, based on State-specific economic indicators, a market specific supply outlook, and a uniquely weighted basket of indicators for the Accommodation Index.

Sydney

Of all Australian markets, Sydney is the largest market and also the most volatile.? It currently achieves the highest room occupancies in the country, as well as the highest room rates.? It was also subject to the most severe discounting practices during the GFC, and of the four largest city markets is again displaying the lowest room rate growth rates, despite the record occupancy performance.

Based on historic precedent we had hoped for a continuation of the enthusiastic recovery of the GFC, with room rate growing at close to 10% in the March 2011 quarter, only to see growth slow very rapidly to 2.8% in the March Quarter 2012.? The reason for this lacklustre performance is a market that is ?spooked? by an occupancy setback of as much as 2%, from a world-record 89.2% in the March Quarter 2011 to a (still world-record) 87.2% in the same quarter in 2012.? We think it will stay around the 86% mark for a little while longer.

Maybe it takes some time to get used to high occupancy levels; after all, in the 1990s room rate would grow by 10% with room occupancies in the high 70s rather than the high 80s, so this is highly unusual!? Even in the period 2004 to 2007 rate growth average 4% at sub 80% room occupancy.? So, we believe common sense will prevail and room rate growth will return to beat inflation by at least 1%, at 3-4% growth, and hopefully a bit more!? By the time we see new 5-star supply coming into the market, from 2016 onwards, this will hopefully help lifting rates a little more.

Melbourne

Whilst the absolute performance in Melbourne may not be as stellar as in Sydney, the highly diverse demand base in Melbourne makes it extremely resilient to both supply increases as well as demand fluctuations.? Between 2005 and 2010 the Melbourne CBD absorbed more than 2,000 new hotel rooms whilst continuing to grow room occupancies, barring a modest setback in 2009 during the GFC.? Whilst there are a number of hotel projects around town, only a select few seem to be materialising and this should keep room occupancies around the current 80% for the short term, with a potential left to 82% by 2015.

Similar to Sydney, however, room rate growth has come off the boil and to a complete standstill since late 2011.? With an expected strong finish of the year and annual demand levels holding steady, we expect room rate growth to return to at least CPI levels and more by the end of our forecasting period.? As occupancy growth is very limited, RevPAR growth is predominantly driven by rate growth and forecast to return to 3-5% from 2013.

Perth

Perth has demonstrated prior to the GFC that it is capable of extraordinary feats, when it achieved 34% RevPAR growth in the June Quarter 2008, on the back of 26% room rate hike.? Even more astounding, it maintained double digit RevPAR growth for four years, from the June Quarter 2005 until the March Quarter 2009.? The GFC caused a brief, modest, and arguably unnecessary setback, before RevPAR growth jumped right back to double digits from September 2010.

We don?t believe Perth can continue writing 2s in front like it did in the last three quarters, but double digits should be achievable until at least early 2014, when a new Holiday Inn Express will help alleviate a chronic shortage of rooms, with lower but no doubt still very high opening room rates.

Barring a significant slowdown in the resources sector, room occupancies will quickly climb back to the mid-80s, with midweek demand selling out virtually all rooms in town.? Longer term, a strong push to stimulate new hotel projects in Perth will hopefully see the delivery of additional accommodation facilities, but by that time Perth will have surpassed Sydney as the most expensive city in Australia with quite a margin.? Maybe we will also see some hotel managers transfer from Perth to Sydney and Melbourne, to teach their colleagues there how to keep their cool and continue rate growth during ?adverse? market conditions?

Brisbane

Brisbane is the ?industry barometer? and always seems to be ahead of the curve.? It was the first city market to see the impact of the GFC, and the first to recover as well.? Before the GFC Brisbane was furthest ahead with proposed new supply additions, and yet again there is quite a list of new projects on the blocks.? The timing of new supply remains uncertain however, as only few projects have actually commenced.

Our current outlook anticipates the first new rooms to hit the market towards the end of 2013, with ongoing further additions right through until 2015.? Assuming that new rooms are indeed being added to the market in an ?orderly fashion?, occupancy levels will remain relatively steady as the additional supply is being gradually absorbed by steadily increasing demand.? This should also see room rate growth being maintained at around 3-4%, following 6-7% growth in 2012-13.

The real threat is that new supply is being added in ?waves?, leading to temporary occupancy drops which are likely to trigger rate discounting strategies from hoteliers.? In other words, it is not the amount of new supply that is our biggest concern, but rather the timing of it.? For now, we expect RevPAR growth to stay around 8% until late 2013, dropping to negative 2% in 2014 before recovering to around 5% in 2015.? This scenario of course assumes that hoteliers do not hit the panic button when occupancy drops to a ?low? of 80% in 2014!

Adelaide

Adelaide must hold a magical appeal to developers as new projects keep emerging, even though hotel markets are performing well below other capital cities.? Having said that, the Crowne Plaza is the only new hotel being completed in many years, whilst other projects have been long announced but never commenced.? The supply outlook therefore remains the single biggest uncertainty in the Adelaide market, with the potential new additions being the Watson by the Art Series, the Mayfair in the CML Building, a new Ibis on Grenfell St and a hotel at Adelaide Airport.

With close to 700 rooms between these four projects, they have the potential to make a significant dent in city-wide room occupancies.? Based on our current outlook the new rooms will be added to supply in a staggered fashion during the course of 2014, but this is still expected to result in a 3% occupancy drop, from a comparatively low 76% to an even lower 73%.? Whilst Adelaide hoteliers are more accustomed to growing average room rates at lower room occupancy levels than their Sydney and Melbourne counterparts, this decline is still expected to unnerve operators and likely to result in marginal if any rate growth during 2014.? If multiple properties open at the same time, this may be exacerbated.

In summary, our current outlook expects RevPAR growth to continue until 2014, when supply pressure may cause a 4-5% RevPAR decline, which should be corrected in the following year.

Canberra

Canberra is a very difficult market to predict as demand fluctuates quite significantly, generated by government and corporate activity that produces peaks of occupancy during Parliamentary sitting weeks, and a secondary market generated by leisure tourism that produces a lower occupancy peak during holiday periods.

Over the past five years, Canberra?s hotel supply has declined slightly, with demand remaining relatively stable.? This has resulted in both room occupancy and average room rate growth, and a steady RevPAR increase.

The outlook for the Canberra hotel market is for softer demand levels during 2012, 2013 and 2014 with several additions to supply exacerbating an occupancy downturn to around 67% by end 2014.? Based on a historic propensity to maintain room rate growth even during slow occupancy periods, we are hopeful that average room rates will keep pace with inflation, however.? Based on this outlook, RevPAR will decline in 2013 before returning to modest growth from 2014 onwards, and picking up from 2015.

Darwin

With a strong demand outlook and very limited new supply on the horizon, the outlook for Darwin is promising.? Whilst strong seasonality holds back room occupancy levels in the wet season, room occupancies in the dry season are very high, creating the potential for healthy room rate growth as well.

Year-round room occupancy in Darwin has increased from a low of 69% as recent as September 2011, to 75% in mid-2012, with the dry season still to come.? We believe that by early 2013 annual room occupancy will reach 77% and stay there for the next few years.

In the wake of this rapid growth, average room rates have been growing nicely in the last few quarters, and we hope hoteliers can maintain this momentum and continue growth at 4-5% on average, to bring Darwin room rates closer to rates achieved in other capital cities by 2015.

RevPAR growth in Darwin has been driven by room occupancy growth in the last few quarters; we expect this to change to rate-driven growth averaging 5-6% over the next few years.

Gold Coast

The Gold Coast suffered a significant setback lasting well beyond the GFC, as both international and domestic visitation softened, whilst several new developments added significant new accommodation supply to the market, with a high product standard but at very affordable rates to draw demand.? Whilst this maintained the overall market rate, it did force the operators of existing accommodation properties into sometimes heavy discounting strategies to remain competitive.

Room occupancies should slowly return to the high 60s as market demand continues to strengthen.? At the same time we expect the newer properties to steadily push room rates up, driving the overall market rate up by 3-4%; we hope this will enable other properties to follow suit.

There are still a number of hotel projects on the cards, some of them very significant, which will help reinvigorating Destination Gold Coast and lift product standards and market recognition.? This will be matched with increased infrastructure investment leading up to the Commonwealth Games in 2018.

Our RevPAR outlook for the Gold Coast is thus becoming more optimistic, expecting up to 4-5% growth over the next few years.

Tropical North Queensland

Of all Australian key markets, THQ has by far gone through the deepest trough, with average annual room occupancy dropping as low as 55%.? Heavy discounting to drive demand resulted in RevPAR declines of 6.8% between 2008-2010, with occupancy growth from early 2011 driving a recovery, even though room rates are still declining.

Continued room occupancy growth on the back of strengthening demand should see room occupancies continue to improve steadily, reaching 63% on average by 2015.? In keeping with historic trends, room rates should return to growth when annual occupancy passes 60% which should be very soon.

With both room occupancies improving and average room rates keeping pace with inflation from 2014, RevPAR growth should steadily improve as well.

Disclaimer

Our projections are based on our best endeavours and insights at the time of publication of the forecasts.? However, hotel markets are fickle and performance fluctuations can be volatile.? As such, actual market performance is likely to differ from our projections, and this variation may be material, in particular towards the end of our forecasting period. ?Accordingly, the application of our projections is limited to use for informative purposes only

Nothing contained in this publication is to be construed as a representation or warranty of any kind. ?AHS Advisory is, by means of this publication, not rendering any professional advice or services. ?Before making any decision or taking any action that may affect you or your business you should consult a qualified professional adviser. ?AHS Advisory shall not be responsible for any loss whatsoever sustained by any person or entity who relies on this publication.

Throughout this report, ?AHS Advisory? refers to AHS Advisory Pty Limited, a company incorporated in Australia under NSW law.

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