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Heartbreak Hotel: the sharing economy and the hotel sector: part 2


In this second part we explore the impact of this phenomenon on the real estate sector so self-managed super fund (SMSF) investors can incorporate this thinking into their views of investment markets.


 

The rise of online lodging portals such as Airbnb has prompted new and unusual challenges for traditional hotel businesses. This is the second in a two-part article series that explores how the hotel sector is responding to threat that are emerging from the sharing economy.

In this second part we explore the impact of this phenomenon on the real estate sector so self-managed super fund (SMSF) investors can incorporate this thinking into their views of investment markets.

Globally, the lodging sector accounts for 3.4 per cent of the FTSE EPRA NAREIT Developed Global Index of which almost 3% comes from US companies.

An opportunity exists to generate meaningful relative performance for investors who can identify companies with the most attractive business characteristics that account for the risks created by new technologies.

Taking into consideration the motivations for technology – that is, to maximise utility from fixed travel budgets – and the resultant increase in the elasticity of supply and demand, investors should identify desirable characteristics for potential lodging investments and seek to appropriately reflect this in the relative attractiveness of investment options.

Diversification

Companies with concentrated portfolios that are exposed to markets with a high degree of sharing economy penetration should be penalised so as to reflect the potential reduction in pricing power and impacts on occupancy.

Lower operating leverage

Given potentially lower pricing power and the downward pressure on revenues resulting from an increasingly cost conscious customer set, companies with lower operating leverage should trade at a premium through cycle to reflect more attractive risk/return characteristics. On this basis, the hotel businesses are seen as relatively more attractive than the lodging real estate investment trusts (REITs).

Product differentiation

Commodity-like lodging offerings with lower levels of amenities and reduced service will face the most intense competition from the sharing economy and are most at risk of price competition, loss of market share and the resultant impacts on profitability. The REITs are well placed to control the physical quality of their properties but this may manifest in a higher capex load.

Ability to control their own destiny

The ability to react and respond to the threats posed by technology should command a premium. This slightly favours the hotel companies over the REITs as they can adjust many aspects of the lodging experience including booking terms and conditions, branding and marketing, loyalty program benefits, and brand standards/product offering.

Low financial leverage

In an environment of variable supply and lower pricing power, it is not unreasonable to expect a higher level of volatility in occupancy and rate growth. Consequently, revenue growth will also be more variable, and companies that maintain a lower level of financial leverage should command a valuation premium.

Conclusion

In an environment where corporate profitability has been under pressure and consumers have become more cost conscious, it is evident that technology will play an increasingly important role in helping customers stretch their travel budgets. On the supply side, technologies like those that facilitate the sharing economy have given rise to cost-effective alternatives to traditional lodging and will put downward pressure on pricing power in the lodging sector.

It will be important for hotel owners to be proactive and nimble in order to stay ahead of technological progress. Companies that are slow to react may be shocked at how quickly they can lose market share either to new alternatives or to their competitors.

Technology has helped increase elasticity on both the supply side and the demand side, suggesting it will be imperative for hotel owners to differentiate their offering and to be able to demonstrate the value in hospitality. Similarly, hotel owners will have to be aware of the impacts of higher price elasticity, and take that into consideration when assessing their outlook for the marketplace, and what that means for their ability to bear financial risk at this late point in the cycle.

As a cyclical sector, lodging will always have a role in a global real estate portfolio. The ability to re-price rents daily means that lodging names can take advantage of changing economic conditions immediately. The ability to take active positions in names with exposure to specific geographies or market segments can lead to opportunities to generate significant alpha through the cycle.

Combining a local presence with a global vantage can help identify the best opportunities as regions are never perfectly in synch from an economic perspective. In times like the present, where growth in the lodging sector is anaemic but still positive, one must be mindful of the multitude of factors that can impact lodging company profitability, whether they be macroeconomic in nature or longer term changes in industry structure, and position accordingly.

 

Funds related to this article: Wholesale Australian Property Fund

An income focused fund providing exposure to a diversified commercial property portfolio of high quality Australian office, retail and industrial properties often only available to institutional investors.

The Fund’s key aim is to provide investors with reliable income and long term capital growth.

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