Faculty of Business and Law
THE IMPACT OF FOREIGN EXCHANGE VOLATILITY
ON THE FINANCIAL PERFORMANCE OF HOTEL
REAL ESTATE PRIVATE EQUITY INVESTMENTS
IN SWITZERLAND
Doctoral Dissertation Submitted by
Casper Studer, BBA(Hons) & MAS REM
In Partial Fulfilment of the Award
Doctor of Business Administration
Abstract
The shockwaves that hit financial markets amid the dawn of the global financial
crisis in late 2007 did not only send several equity markets into free-fall, but
simultaneously led to an increased level of volatility in global currency markets. One
of the main drivers of this volatility is believed to have been the product of the
so-called flight to safety, meaning that a large amount of capital was being shifted into
safe haven currencies. Given that the Swiss Franc belongs to the very inner circle of
these safe haven currencies, its value against several major international currencies
strengthened considerably. In fact, currencies such as the British Pound and the Euro
lost between 30-40% of their value against the Swiss Franc between 2007 and 2009.
As a natural consequence, Switzerland – although stable as an economy in itself –
was suddenly being exposed to severe economic pressures due to the mounting
strength of its currency versus several other currencies.
Given the structure, seasonality and dynamics of Switzerland’s hotel industry, the
risks of a strengthening currency and its potential negative implications for the
national hotel industry were soon conceived as a latent threat to its wellbeing. In fact,
it was not long until economic evidence came to suggest that a strong national
currency would not only lead to a reduction in demand for discretionary spending
among visiting guests, but naturally, also diminishing hotel revenue. Therefore, from
a hotel investor’s point of view, it became obvious that extraordinary measures
would be required in order to decrease, or at best, eliminate the vulnerability of hotel
investment(s) to negative economic exposure. Considering the vast heterogeneity of
Switzerland’s hotel industry, this study has found particular interest in identifying
whether the characteristics of an individual property or a set of properties reduce or
offset exposure to movements in certain currencies. More specifically, the study
focused on measuring to which extent Hotel Real Estate Private Equity (HREPE)
investors are able to reduce risk to Foreign Exchange (FX) exposure while at the
same time enhancing the Financial Performance (FP) of their investments.
The analysis and discussion that has taken place in this study has been subject to an
examination of financial and operational data from 76 resort properties located in 5
major tourism regions. Due to certain limitations with regards to data availability,
solely the performance of 3 and 4 star properties has been taken into consideration.
The timeframe in which the study takes place has been specified to be between
2007-2011 and the currency samples have been selected based on national tourism
demand: US Dollar, British Pound, Chinese Yuan, Russian Ruble, Indian Rupee,
Japanese Yen, Euro. Overall, one of the main aims of the study has been to measure
the relationship and impact movements in each of the above currencies have had on
the Financial Performance of the selected sample of properties between 2007-2011.
It has done so by applying a quantitative research approach.
even offset once active Financial Performance Management tools as well as Yield
and Revenue Management (YRM) systems have been put in place. It has also been
found that the exposure to certain currencies may be reduced according to the supply
structure of a property and the reduction in certain costs. Moreover, the study
suggests that Hotel Real Estate Private Equity investors have the ability to reduce
Foreign Exchange exposure by allocating their capital into distinct individual
properties or a portfolio of properties. Additionally, the study suggests that investors
have the ability to hedge their currency exposure and at the same time profit from the
upside potential a particular currency or set of currencies have to offer.
Certification of Dissertation
I declare that the work presented in the thesis is, to the best of my knowledge and
belief, original and my own work, except as acknowledged in the text, and that the
material has not been submitted, either in whole or in part, for a degree at this or any
other University.
………
………
Signature of Casper Studer
Date
ENDORSEMENT
………
………
Signature of Dr. Peter Phillips
Date
………
………
Signature of Dr. Max Gsell
Date
Dedication
I dedicate this work to my close circle of family members, especially to my parents,
Barbara and Andrew.
“Never give up on a dream just because of the time it will take to accomplish it. The
time will pass anyway.”
Acknowledgements
I would like to take this opportunity to express my infinite gratitude to my principal
supervisor, Dr. Peter Phillips, University of Southern Queensland, Australia, for
providing me with the best imaginable support, motivation and advice one could
wish for throughout the entire journey of this research project.
Special thanks also to my academic associate supervisors Dr. Taiji Watanabe,
University of Southern Queensland, and Dr. Max Gsell, for sharing their valuable
insight, experience and wisdom.
Further, I extend my praises to my employer, Dr. Hans Ueli Keller, for allowing me
to take on this challenge whilst being employed in his company. I am also greatly
indebted to Philippe Pasche and Pascal Leresche of the Swiss Society for Hotel
Credit, as well as Steve Hood and Duane Vinson of Smith Travel Research for their
trust and support.
I am especially grateful to my parents, Andrew and Barbara, for their constant love
and encouragement. Without them, this piece of work would have – by all means –
never come to life.
Zürich, 10 September 2013
Casper Studer
!
Table of Contents
CHAPTER 1 – INTRODUCTION ... 1
1.1 Introduction ... 1
1.2 Overview of the Chapter ... 2
1.3 Background of the Research ... 2
1.4 Research Problem ... 2
1.4.1 Research Objective ... 2
1.4.2 Research Question ... 3
1.4.3 Hypotheses ... 3
1.5 Methodology ... 3
1.6 Outline of the Study ... 4
1.7 Definitions ... 4
1.7.1 Hotel Real Estate Private Equity ... 4
1.7.2 Financial Performance Management ... 4
1.7.3 Foreign Exchange Rates ... 4
1.8 Delimination and Scope of Key Assumptions ... 5
1.9 Justification and Contribution of the Research ... 5
1.10 Conclusions ... 5
CHAPTER 2 – LITERATURE REVIEW ... 6
2.1 Introduction ... 6
2.2 The History of Hotel Real Estate Private Equity ... 6
2.3 Terminology and Focus of Hotel Real Estate Private Equity Investing ... 7
2.4 Legal Structure of Hotel Real Estate Private Equity Investing ... 8
2.5 Characteristics of Hotel Real Estate Private Equity Investing ... 9
2.6 Hotel Real Estate Private Equity in Switzerland ... 12
2.7 Characteristics of Hotels ... 12
2.8 Overview of the Swiss Hotel Market ... 13
2.9 Hotels and External Impacts ... 14
2.10 Foreign Exchange ... 16
2.10.1 Theoretical and Practical Concepts of Foreign Exchange ... 17
2.10.2 Foreign Exchange Impacts on the Property/Company Level ... 18
2.10.3 Foreign Exchange Volatility vs. the Swiss Franc ... 19
2.10.4 Foreign Exchange Hedging ... 21
2.11 Financial Performance Management ... 21
2.11.1 Hotel Performance Management ... 24
2.11.2 Yield and Revenue Management ... 27
2.11.3 Information Technology and Financial Performance ... 27
2.11.4 Benchmarking ... 29
2.12 Conclusion ... 30
CHAPTER 3 – RESEARCH METHODOLOGY ... 31
3.1 Introduction ... 31
3.2 Research Paradigm ... 31
3.3 Research Design ... 32
3.4 Research Methodology ... 33
3.5 Sampling Design, Data Collection ... 33
3.5.1 Sample Selection and Sample Size ... 33
3.5.3 Foreign Exchange ... 35
3.5.4 Hotels ... 36
3.6 Data Measurement Variables ... 37
3.6.1 GOP Beta Values ... 37
3.6.2 Data Measurement Codes ... 37
3.7 Data Measurement Process ... 40
3.7.1 Foreign Exchange ... 40
3.7.2 Financial Performance ... 42
3.8 Data Analysis Techniques ... 43
3.9 Data Validity and Reliability ... 44
3.9.1 Data Validity ... 44
3.9.2 Internal Validity ... 45
3.9.3 External Validity ... 46
3.9.4 Reliability ... 46
3.10 Limitations ... 47
3.10.1 Limitations of Dependent Variables ... 47
3.10.2 Limitations of Independent Variables ... 48
3.11 Conclusion ... 48
CHAPTER 4 – ANALYSIS OF RESULTS ... 49
4.1 Introduction ... 49
4.2 Data Collection and Consolidation Process ... 49
4.2.1 Hotel Data ... 49
4.2.2 Currency Data ... 50
4.2.3 Description of Consolidated Data ... 51
4.3 Identification of Missing Values ... 52
4.4 Year on Year Operational Developments ... 52
4.4.1 Cost of Goods Sold ... 53
4.4.2 Personnel Expenditure ... 54
4.4.3 Marketing Costs ... 55
4.4.4 Maintenance Costs ... 56
4.4.5 Gross Profit Margin ... 57
4.4.6 Revenue Per Available Room ... 58
4.5 Model 1: Results of Gross Operating Profit to Foreign Exchange Volatility .... 59
4.5.1 Results 4 Star Hotels Canton Graubünden ... 60
4.5.2 Results 3 Star Hotels Canton Graubünden ... 60
4.5.3 Results 4 Star Hotels Canton Wallis ... 61
4.5.4 Results 3 Star Hotels Canton Wallis ... 62
4.5.5 Results 4 Star Hotels Canton Bern ... 63
4.5.6 Results 3 Star Hotels Canton Bern ... 64
4.5.7 Results 3 Star Hotels Canton Ticino ... 65
4.5.8 Results 4 Star Hotels Central Switzerland ... 65
4.5.9 Results 3 Star Hotels Central Switzerland ... 66
4.6 Model 2: Linear Regression Analysis of Output from Model 1 ... 68
4.6.1 Output Model 2: US Dollar ... 69
4.6.2 Output Model 2: Japanese Yen ... 73
4.6.3 Output Model 2: Indian Rupee ... 76
4.6.4 Output Model 2: Euro ... 79
4.6.5 Output Model 2: British Pound ... 82
4.6.7 Output Model 2: Chinese Yuan ... 87
4.7 Model 2: Analysis of Histograms/P-P Plots ... 89
4.7.1 Analysis Output Histograms ... 89
4.7.2 Analysis Output P-P Plots ... 90
4.8 Conclusion ... 90
CHAPTER 5 – PRACTICAL APPLICATION ... 91
5.1 Introduction ... 91
5.2 Practical Matrix Application of Model 1 ... 92
5.2.1 Practical Matrix Application of Model 2 ... 94
5.3 Linkages to Modern Portfolio Theory ... 97
5.3.1 Exposure Model JPY ... 99
5.3.2 Exposure Model INR ... 100
5.3.3 Exposure Model EUR ... 102
5.3.4 Exposure Model GBP ... 103
5.3.5 Exposure Model RUB ... 104
5.3.6 Exposure Model CNY ... 105
5.3.7 Exposure Model USD ... 107
5.4 Conclusion ... 108
CHAPTER 6 – CONCLUSION ... 109
6.1 Introduction ... 109
6.2 Summary of Main Literature and Discussion Points ... 109
6.3 Summary of Main Results ... 110
6.3.1 Summary of Main Results for Model 1 ... 111
6.3.2 Summary of Main Results for Model 2 ... 112
6.3.3 Summary of Practical Application ... 114
6.3.4 Validation of Main Hypotheses ... 114
6.4 Implications for Sector and Practice ... 115
6.4.1 Risk Reduction ... 115
6.4.2 Cost/Revenue Management ... 115
6.4.3 Implications for Hotel Real Estate Private Equity Investing ... 116
6.5 Limitations and Suggestions for Future Research ... 117
6.6 Conclusion ... 118
CHAPTER 7 – REFERENCE LIST ... 119
APPENDICES ... 131
Appendix A Hotel Values Europe 2002-2011 ... 131
Appendix B
Currency Developments versus the Swiss Franc ... 132
Appendix C Balanced Scorecard Model ... 134
Appendix D Du Pont Model ... 134
Appendix E
Case Processing Summary ... 135
Appendix F
Regression Results Model 1 ... 136
Appendix G
Comparison of Average Daily Rates ... 151
Appendix H
Tourism Arrivals ... 152
Appendix I
Output Homo-/Heteroscedasticity ... 153
Appendix J
Output Histograms ... 155
Appendix K
Output P-P Plots ... 157
List of Figures and Tables
Figures
Figure 1 Sectoral Focus of Private Equity Investing ... 7
Figure 2 Limited Partnership Investment Structure ... 9
Figure 3 Private Equity Business Cycle ... 10
Figure 4 Manager Style Framework ... 11
Figure 5 Diamond of Competitive Advantage ... 13
Figure 6 The Impacts of Global Crises on Tourism ... 15
Figure 7 Hotel Demand Switzerland 1990-2014 ... 15
Figure 8 Influences on Price ... 17
Figure 9 External vs. Internal Forces ... 25
Figure 10 Typical Hotel PMS / POS System ... 28
Figure 11 Data Input / Output Flow ... 34
Figure 12 Selected Cantons ... 36
Figure 13 Static vs. Dynamic Variables ... 40
Figure 14 Cost of Goods Sold ... 52
Figure 15 Personnel Expenditure ... 54
Figure 16 Marketing Costs ... 55
Figure 17 Maintenance Costs ... 56
Figure 18 Gross Profit Margin ... 57
Figure 19 Revenue Per Available Room ... 58
Figure 20 Foreign Exchange Exposure Control Sheet/Matrix ... 93
Figure 21 Foreign Exchange Exposure on Variable Basis ... 96
Figure 22 Foreign Exchange Exposure Model Japanese Yen ... 99
Figure 23 Foreign Exchange Exposure Model Indian Rupee ... 100
Figure 24 Foreign Exchange Exposure Model Euro ... 102
Figure 25 Foreign Exchange Exposure Model British Pound ... 103
Figure 26 Foreign Exchange Exposure Model Russian Ruble ... 104
Figure 27 Foreign Exchange Exposure Model Chinese Yuan ... 105
Figure 28 Foreign Exchange Exposure Model US Dollar ... 107
Tables
Table 1 Geographic Origin of Hotel Guests ... 35
Table 2 Sample Data Measurement Variables ... 38
Table 3 Consolidated Dataset ... 51
Table 4 Results Model 1 ... 67
Table 5 Output Model 2: US Dollar ... 72
Table 6 Output Model 2: Japanese Yen ... 75
Table 7 Output Model 2: Indian Rupee ... 78
Table 8 Output Model 2: Euro ... 81
Table 9 Output Model 2: British Pound ... 83
Table 10 Output Model 2: Russian Ruble ... 86
Table 11 Output Model 2: Chinese Yuan ... 88
Table 12 Foreign Exchange Exposure Barometer ... 92
Table 13 Foreign Exchange Exposure Sample Matrix ... 95
List of Abbreviations
ARDC
American Research and Development Corporation
BE
Canton Bern
BFS
Swiss National Bureau of Statistics
CAPR
Capitalisation Rate
CHF
Swiss Franc
CI
Confidence Interval
CNY
Chinese Yuan
COGS
Cost of Goods Sold
DM
Deutsche Mark
DO
Days Open
EUR
Euro
EVA
Economic Value Added
FP
Financial Performance
FPM
Financial Performance Management
FX
Foreign Exchange
GARCH
Generalized Autoregressive Conditional Heteroscedasticity
GBP
British Pound
GDP
Gross Domestic Product
GFC
Global Financial Crisis
GOP
Gross Operating Profit
GOPAR
Gross Operating Profit Per Available Room
GP
General Partner
GPM
Gross Profit Margin
GR
Canton Graubünden
HR
Hotel Rating
HREPE
Hotel Real Estate Private Equity
INR
Indian Rupee
IRR
Internal Rate of Return
IT
Information Technology
KAG
Swiss Capital Investment Act
KB
Koenker-Basset Test
KPM
Key Performance Metrics
LOP
Law of One Price
LP
Limited Partnership
MC
Maintenance Costs
MKT
Marketing Costs
ML
Macro Location
MPT
Modern Portfolio Theory
NPM
Net Profit Margin
PE
Private Equity
PEX
Personnel Expenditure
PMS
Property Management Systems
POS
Point of Sales Systems
REPE
Real Estate Private Equity
REVPAC
Revenue Per Available Customer
REVPAR
Revenue Per Available Room
ROA
Return on Assets
ROIC
Return on Invested Capital
RUB
Russian Ruble
SECO
State Secretariat of Economic Affairs
SD
Standard Deviation
SER
Standard Error of Estimates
SGH
Swiss Society for Hotel Credit
SHA
Swiss Hotel Association
SNB
Swiss National Bank
TI
Canton Ticino
USD
US Dollar
VC
Venture Capital
VIF
Variance Inflation Factor
VS
Canton Wallis
1. Introduction
1.1 Introduction
Since the breakdown of the Bretton Woods system in the early 1970’s, the volatility
of currencies and its associated risks have become an increasingly important
component of financial management (Muller & Verschoor 2006). Foreign Exchange
(FX) volatility is known to have a strong effect on business sectors and firms with
national and international exposure. In the light of their often-complex operational
structures and broad international client base, hotels are considered to be particularly
vulnerable to movements in FX. Recent FX movements against the Swiss Franc have
not only impacted the demand for hotel bookings, but likewise the cost structure of a
hotel/investment. According to Choi & Prasad (1995) FX fluctuations can affect
operating cash flows and Financial Performance (FP) of a firm or investment
significantly.
Whilst filled with opportunities, Hotel Real Estate Private Equity (HREPE) investing
also bears potential downside risks. Due to its late introduction into the Swiss market
in 2007, HREPE is still in its early infancy, especially in comparison to mature
HREPE markets like the U.S and U.K. This study aims to identify the FX and
operational/financial risks associated with HREPE investing in Switzerland. It shall
also provide insight into how FP can be managed on a property specific level during
times of significant exposure to certain currencies. As discussed in the subsequent
sections, there is a vast amount of literature to be found in the area of FX and
Financial Performance Management (FPM), HREPE on the other hand, is a topic
which has not yet been given as much academic attention, particularly not in the
German speaking parts of Europe.
This study aims to identify and analyse the most significant factors affecting the
financial success of the underlying assets of HREPE investments in Switzerland. It
therefore tracks (back) FX volatility of the 7 most influential currencies against the
Gross Operating Profit (GOP) of a selected set of hotel properties between
2007-2011. This process allows an in-depth investigation of the FX exposure of HREPE
investments. The data that is captured in this study is linked to a selected set of key
operational and financial features, therefore allowing for identification of the
relationship between movements in FX and the FP of the associated sample of hotel
properties.
1.2 Overview of the Chapter
1.3 Background of the Research
The surge in the Swiss Franc against most of its global peers is believed to be a result
of the financial turmoil, which erupted in late 2007. Whilst the relatively safe and
stable characteristics of the Swiss Franc (CHF) have benefited foreign investors
seeking currency refuge, its strength has become a burden for many national
industries. One strongly affected industry has been tourism. This study focuses on a
sub-sector of the tourism industry, the hotel sector. Rather than limiting the study to
measuring only the external effects of FX volatility on a hotel property or a portfolio
of hotel properties, the research also identifies and measures the consequences of FX
volatility on GOP. Additionally, the relationship between FP and FX exposure of
operational and financial variables of hotel assets are being identified. This approach
shall guarantee that internal as well as external forces affecting the financial success
of a hotel’s operation during times of significant currency exposure can be
quantified.
Given the nature of financial volatility within the hospitality industry, hotel
investments generally have the reputation of being rather risky compared to other
asset classes within the Swiss investment market. According to Frehse (2007) hotel
investments are far more complex than ordinary real estate investments. The same
author argues that there is still a large gap between theoretical and practical
knowledge within the sector. The mixture between exposure to FX volatility and the
complexity of investing into hotels makes this niche market – albeit highly risky –
considerably lucrative for investors. It is this mixture between risk and opportunity
of HREPE investing that makes FX exposure play such a vital role in terms of capital
allocation.
This is certainly also the case because the financial revenue of a hotel/investment is
often strongly dependent on the geographic background of the client base it is
exposed to as well as their spending behaviour. Furthermore, it is also the cost
structure of a hotel that is exposed to FX volatility (i.e. via imported products).
Given the economic environment and the financial forces that national hotel
investments are exposed to, this study will contribute timely information helping to
advance the understanding of the relationship between FX exposure and FP of
HREPE investments. Its aim is also to bring forward solutions that will assist hotel
investors to actively manage (hedge) exposure to movements in FX whilst at the
same time benefiting from certain upside potentials FX movements offer.
1.4 Research Problem
1.4.1 Research Objective
1.4.2 Research Question
As mentioned previously, hotels are known to have a particularly strong exposure to
economic events that are often and in a large part reflected in FX volatility. Since
HREPE investments are multi facetted, this study focuses solely on what are
believed to be the most significant factors affecting a hotel’s FP based on movements
in FX. While discussions among politicians, the Swiss National Bank, tourism
officials and hotel-/investment managers regarding the impact of the strong Swiss
Franc on the profitability and wellbeing of the national hotel industry have
intensified since late 2007, this leads us to the following research question:
“To what extent do Foreign Exchange movements affect the Financial
Performance of underlying assets of Hotel Real Estate Private Equity investments
in Switzerland?”
1.4.3 Hypotheses
The stated research question provides the basis of the main research hypotheses,
which are as follows:
Hypothesis 1
The FP of a hotel investment is largely dependent on exposure to movements in FX.
Hypothesis 2
The FX exposure of HREPE investments is determined by various factors such as:
property location, cost and profit structures of hotel assets.
Hypothesis 3
FX exposure of HREPE investments can be reduced or eliminated when putting
appropriate FPM systems in place.
1.5 Methodology
1.6 Outline of the Study
The structure of this dissertation is based on the nature of scientific inquiry, which
suggests the following five steps as being typical for its character (Ary et al. 2010):
1.
Identification of a problem
2.
Statement of the problem
3.
Formulation of hypothesis
4.
Prediction of consequences
5.
Testing of hypothesis
In particular, this study aims to explain phenomena by collecting numerical data that
are analysed using mathematically based models such as described by Aliaga and
Gunderson (in Mujis 2011). The study is based on a six-chapter structure, which
covers all of the relevant topics of discussion.
1.7 Definitions
This section reveals the most frequently used definitions in the chapters to come. A
brief introduction and description of each definition is provided, aiming to facilitate a
smooth transition into the main chapters of this study.
1.7.1 Hotel Real Estate Private Equity
The practice of Private Equity (PE) focuses on creating value through the means of
strategic capital allocation and efficient operational and strategic management of a
single asset or a company (Roettke & Rebitzer 2006). HREPE investing targets the
identification and acquisition of underperforming hotel properties or portfolios with
the goal of turning them into more profitable assets (Frehse 2007).
1.7.2 Financial Performance Management
Financial
Performance is defined as the potential for future successful
implementation of actions in order to reach the objectives and targets and to avoid
unnecessary financial losses (Lebas 1995). Whether the activities of an enterprise are
financially efficient or not has direct influence on profitability, thereby potentially
threatening its survival (Feng & Wang 2000). There are several different approaches
towards measuring the FP of a business. The approaches used in the context of this
study will be defined in the subsequent sections.
1.7.3 Foreign Exchange Rates
significance of FX rates in relation to this study.
1.8 Delimination and Scope of Key Assumptions
This study dominantly focuses on resort hotels based in the German speaking part of
Switzerland. The core analysis and discussion that takes place in this dissertation is
built on the quantitative analysis of 76 individual properties based in 5 distinct
geographic regions and ranked within a 3-4 star hotel rating. FX rates have been
retrieved from the 7 most relevant and influential currencies based on national hotel
demand and extracted from the same source on a quarterly basis. All of the data
samples are based on the same time frame that has been specified to be 2007-2011.
The study does not take any political, social or environmental aspects into
consideration and although it makes reference to certain macroeconomic factors, it
does not measure for any such influences in relation to movements in FX and the FP
of HREPE investments.
Key assumptions of this study are that the national hotel market is highly
heterogeneous and that guest demand may be subject to qualitative (experience) as
well as quantitative (price) preferences. Geographic attributes are also believed to
influence guest demand. Consequently, the study presumes that both the income and
cost structure of a hotel is vastly dependent on overall global economic stability and
movements in FX. It also claims that a hotel’s operational and financial exposure to
undesirable movements in a particular currency may be reduced thanks to
operational hedging tactics. As such, the study assumes that an investor has the
possibility of building an optimal portfolio of hotel properties that provide a buffer
against movements in FX whilst increasing the profit potential of each property in
the presence of FX exposure.
1.9 Justification and Contribution of the Research
This study shall provide valuable insight into the effects that currency movements
are likely to have on hotel investments based in Switzerland. It shall give investors,
investment managers and operational decision makers a better understanding of how
they can manage their hotel investments more effectively during times of severe FX
pressures against the Swiss Franc (CHF). The study shall also assist in narrowing the
gap of academic literature in the field of HREPE and FX. Prior research has shown
that Switzerland has a vast amount of catching up to do in terms of HREPE
literature. The outcome of this study shall mainly benefit the academic as well as the
hotel investment and tourism community. Moreover, it shall reveal practical
solutions for reducing FX exposure while at the same time enhancing the FP of hotel
investments.
1.10 Conclusions
justification and academic contribution towards the practical field it focuses on.
Further, an overview of the methodology was provided, followed by an outline of the
study’s structure. Key definitions used in this dissertation were stated and a
delimination of the scope of the study took place. The following chapter is focused
on providing insight into the main areas of literature that the research topic is
affiliated with. It therefore offers insight into the history and background of Private
Equity and the overall structural features of HREPE investing. The chapter also
describes FX characteristics and their theoretical and practical concepts with respect
to this study. Additionally, FP related features are described and their qualities and
importance linked to hotel specific FP measurement tools/approaches discussed in
the subsequent chapters.
2. Literature Review & Scope
2.1 Introduction
While chapter one devoted itself to providing an overview of the scope, background
and theoretical foundations of the study, this chapter gives insight into relevant
previous research carried out within the chosen field of study. This chapter starts
with a brief history and an overview of the terminology and legal structure that
stands behind Hotel Real Estate Private Equity (HREPE). It then goes on to describe
the main characteristics of HREPE investing and aspects relating to the Swiss
HREPE market. Further, insight into the Swiss hotel market and potential internal
and external impacts affecting the success of a hotel property is provided. In a next
step, the chapter discusses Foreign Exchange (FX), along with its theoretical and
practical concepts and impacts on a company/property. Following this section, the
chapter gives insight into different aspects of Financial Performance Management
(FPM) within the hotel investment context, as well as Yield and Revenue
Management (YRM), benchmarking, and the influence of information technology on
the FP of HREPE investments. A summary of the key aspects covered in this study
takes place in the final section of this chapter.
2.2 The History of Hotel Real Estate Private Equity
favourable enough traits to allow for PE investing to attain broad acceptance among
investors. Succinctly, the initiation and promotion of PE investments proved to be
more challenging than anticipated.
According to several researchers such as Thum, Timmreck & Keul (2008) and
Davidson (2011), it wasn’t until the early 1970’s that, of what we know today as PE
investing, started gaining traction. In fact, the seeds of modern PE, Real Estate
Private Equity (REPE) and HREPE alike were planted by the inception of Limited
Partnership (LP) investment structures, which will be described in detail in the later
sections of this study. As Davidson (2011) suggests, it was the American real estate
market collapse of the late 1980’s and the debt financing shortages that led to a
significant increase in REPE investing. News about the benefits and success of
REPE investing soon reached the European continent. While the United Kingdom
can be counted as an early adopter of REPE investing, it yet took almost another
decade for other European countries to follow suit in what has become a multi
billion-dollar industry. In fact, PE investing in Switzerland has only been made
available in 2007 on the basis of a new investment law, which allows LP structure
investments.
2.3 Terminology and Focus of Hotel Real Estate Private Equity Investing
REPE is an expanded version of Private Equity. The practice of Private Equity
focuses on creating value through the means of strategic capital allocation and
efficient operational and financial management of a single asset or a company
(Roettke & Rebitzer 2006). As suggested by the term “Equity”, REPE focuses on
acquiring equity from financial sponsors with the goal of using this equity in order to
finance single real estate assets, real estate portfolios and/or real estate firms. HREPE
as such focuses solely on the financing of single hotel properties, a portfolio of hotel
properties or hotel companies. In summary, REPE and HREPE investing involves
the acquisition and management of actual physical properties, while PE follows a
less tangible investment approach (Garay 2009).
According to Thum, Timmreck & Keul (2008) the term REPE is associated with two
different types of investment strategies. One of the strategies focuses on the
financing of private – non market listed – businesses, the other focuses on the
financing of publicly listed companies through the means of private capital/equity.
Garay (2009) on the other hand, argues that PE exclusively involves investing into
non-market listed companies. In fact, this study will focus solely on non-market
listed businesses.
Essentially, REPE/HREPE seeks to implement successful operational and financial
strategies in businesses that are either (Rottke et al. 2006):
1.
Being sold at a discount
2.
Provide (re)development potential
3.
Leave room for operational and/or financial performance management
The bedrock of HREPE investing as such is the identification and acquisition of
underperforming hotel properties or portfolios with the goal of turning them into
more profitable assets (Frehse 2007). During an envisaged holding period of 5 to 8
years, HREPE investors implement operational and financial measures that increase
the cash flow of the acquired hotels. In order to fund acquisitions, HREPE investors
often seek funding from the following sources:
• Insurance
• Pension Funds
• Trusts
• High Net-Worth Individuals
2.4 Legal Structure of Hotel Real Estate Private Equity Investing
[image:21.595.111.525.147.387.2]
(22)alignment of interests that makes HREPE investing so unique and successful.
Figure 2: Limited Partnership Investment Structure
Source: Aigner et al. (2008)
2.5 Characteristics of Hotel Real Estate Private Equity Investing
Real estate has historically been – and still is – viewed as a local phenomenon
(Bardhan et al. 2008). Although, from a physical point of view, there are a number of
parallels between hotels and pure real estate assets, what separates REPE from
HREPE investment strategies is the nature of their underlying income streams and
the structure of their client base. The return generating function of a pure real estate
asset remains very much tied to the local economy (Hoesli & Lekander 2008).
While this is the case for real estate assets, the profitability of a hotel is dependent on
its demand for short-term accommodation. Beals (cited in Brotherton & Wood 2008,
p. 361) states that while an investor in an office complex or a multi family building
can obviate the danger of numerous disruptions by passing risks on to tenants, hotels’
short leases leave them vulnerable to weather, economic impacts, air and ground
transportation as well as various other factors.
On the other hand, ‘…hotels appear to be the most effective inflation hedge as
compared to other property sectors, as they can adjust their ‘leases’ on a daily basis
by altering their room rental rates to anticipate increases in inflation. As such, they
do not suffer from the ‘rental rate inertia’ which encumbers property sectors with
long-term leases (Petersen, Singh & Sheel 2004, p. 167).’ Frehse (2007) argues that
as opposed to most other real estate categories, hotels have some very unique
features and are thus more complex than ordinary real estate investments. He further
suggests that the potential risk of investing into specialised real estate such as hotels
is likely to be coupled with an expectation of returns well above market average. In
fact, according to Cline (2000, p. 1) ‘…the complex nature of hospitality
General Partner (Manager)
Limited Partnership
(Fund) Target
(Property/Portfolio)
Limited Partner (Investor)
Investments Gross Distributions
Net Distributions
Drawdowns
Management Fees
Carried Interest GP Commitment
organisations has tended to create hurdles for accessing capital.’ What HREPE does
is seek to eliminate these hurdles by raising capital/equity in order to turn
unprofitable hotels into profitable investments, thus generating value for an entire
business/economic sector.
Corgel (2008) argues that in a mature hotel industry it is not difficult to comprehend
that highly able HREPE investors/managers identify inefficiencies in hotels that were
overlooked by their ownership. ‘…The upside HREPE investors seek might be
realised through various exercises, including renovation, re-positioning, re-branding,
the installation of new management or cost containment (Beals 2006, p. 306).’ In the
best-case scenario a property acquisition will be made during a market downturn and
financial performance increased and stabilized before the hotel transactions market
reaches its next momentary peak. In the time between acquisition and sale HREPE
investments can produce hedge fund like levered total annual returns from 20-30 per
cent to ownership (Beals 2006).
With hotel management moving out of the real estate business, investment vehicles
are gaining increased importance (Bardhan et al. 2008). Among other factors,
changes in ownership structures offer new opportunities for HREPE investors
(O’Roarty 2009). Beals (2006) further argues that as hotel and real estate markets
become more transparent due to the increasing availability and sophistication of data,
investors will seek ways to participate in ownership. An enhanced market
transparency is believed to open new opportunities for private and institutional
investors to successfully allocate funds into the national hotel market. As such, hotel
investors would be able to diversify their investments based on property type,
geographic factors, investment manager/style and the business cycle of a particular
portfolio or individual property.
[image:22.595.83.472.529.742.2]According to (Thum, Timmreck & Keul 2008) HREPE investments generate value in
one, a few or all of the following business phases:
Figure 3: Private Equity Business Cycle
Source: Adapted from Thum, Timmreck & Keul (2008)
Expansion Bridge Buyout Turnaround
C
om
p
an
y L
ife
C
yc
le
[image:23.595.113.527.351.594.2]
(24)According to O’Roarty (2009) the application of professional asset management
expertise and financial management/restructuring allows to release latent value from
an asset in each of the illustrated life cycles. Beals (cited in Brotherton & Wood
2008, p. 362) argues that maximum returns from hotels are realised only by
unlocking their appreciated value. While the highest return will usually be generated
in the turnaround phase of a property or a portfolio, the other three business phases
may be just as attractive for an investor from a profit point of view. What makes
hotels so unique as an investment class is that their profits do not only depend on the
cyclicality of the tourism market but also on the cycles of the real estate market. The
lag between tourism demand signals and the building process is only one example of
how important it is to get the timing right within each of the different life cycles of
HREPE investing. Besides the consideration of investment cycles, HREPE investing
is also divided into different investment manager styles as depicted below in Figure
4. According to Raitio (cited in Roettke & Rebitzer 2006, p. 90) ‘… one of the most
important ways of differentiating between non-listed real estate investments is their
investment manager or style.’
Figure 4: Manager Style Framework
Source: Adapted from INREV (2011)
The main investment styles are divided into three categories. While so-called “Core”
investment strategies tend to follow a more risk-averse investment approach by using
less financial leverage and investing into relatively “safe” assets, “Value Added” and
particularly “Opportunity” investors seek to use a high amount of financial leverage
and invest into riskier assets. Naturally, these investors will seek to be compensated
for their risk by above average returns. The choice of investment style and strategy
strongly depends on the underlying market conditions and overall economic
situation. From an investor’s point of view, each investment style provides unique
!
!
!
!
!
!
!
!
!
!
Core Value Added Opportunity
0
100
0
30
Fi
na
n
ci
al
L
ev
er
ag
e
Int
er
n
al
Ra
te
of
R
et
u
opportunities in changing market and business cycles.
2.6 Hotel Real Estate Private Equity in Switzerland
In terms of academically published literature, HREPE investing is non-existent in
Switzerland. Frehse (2007) underscores this statement by arguing that in the entire
HREPE field theory based models and defining approaches are lagging behind
considerably. Below the surface, however, HREPE investing is slowly but surely
gaining more interest among national investment professionals. This interest is in
part driven by the compressed cap rates that are leading to a shortage of entry
positions into high yielding real estate investments. Further, there is a general
sentiment that the strength of the national currency will impose long-term effects on
the wellbeing of the hotel industry, particularly in tourism resorts. Despite the
introduction of the amended Swiss Capital Investment Act (KAG) in 2007,
Switzerland has to this date still not witnessed the launch of HREPE investment
fund. In comparison to other countries, Switzerland is in its early infancy in terms of
available hotel investment vehicles. By lacking new and innovative ways to raise
capital, the national hotel industry is likely to lose its competitive advantage over
other major global tourism destinations and hotel players.
2.7 Characteristics of Hotels
[image:25.595.122.518.112.392.2]
(26)Figure 5: Diamond of Competitive Advantage
Source: Adapted from Cardoso, Vaughan & Edwards (2010)
Porter’s diamond model suggests that the national business environment is
influenced by three distinctive external dimensions/perspectives. The incorporated
sub-levels define the proximity of each dimension in relation to the operational asset.
The further away each level is from the core (the operation), the less it can be
influenced by the owner and/or operator. From an investment point of view, hotels
hold a number of particularities, which are – even for investors with previous hotel
investment experience – at times cumbersome to comprehend. What makes hotels so
unique and risky as an investment is the perishability of their product (rooms, food &
beverage). Burgess (2010) further adds that hotels vary in size and may operate with
complex units, with many operating and support departments, making them even
more vulnerable to unforseen impacts. As well as being the most closely linked
property sector to economic conditions and external events, hotels tend to hold
several other characteristics that distinguish them from conventional real estate assets
(Newell & Seabrook 2006).
2.8 Overview of the Swiss Hotel Market
According to the latest information from the National Bureau of Statistics (BFS),
revenue from tourism accounts for approximately 2,9% of the annual Gross
Domestic Product (GDP) of Switzerland’s economy. In 2011, Switzerland counted a
Business Perspective
In
du
str
y
Pe
rsp
ect
ive
N
at
ion
al
P
er
sp
ec
tive
!!
!!
Na tiona l E co nom y National E nviro nmen t Tourism Sector Su pp lie rs, N
ew E
ntran ts, B
uy ers Hote
l Ind ustry
Env ironm
ent
Industry Competitors, Substitute Products Oper
atio nal E
nviro nmen t Support Activities Pr im ary A
cti vities
total of 5,396 hotels and resorts (BFS). This amounts to approximately 1 hotel for
every 10 square kilometres. In 2011 a total of 35,5 million lodging nights were
counted in Switzerland. According to the Swiss Hotel Association (SHA) 46% of
these lodging nights were spent in hotels and resorts in mountain regions, 26,6% in
larger cities, 17,6% in smaller cities and 9,9% in rural areas.
The 2011 SHA market report, which took into consideration data of 2,174 (40% of
BFS total) properties, provides a valuable overview of the overall structure and
condition of the Swiss hotel market. According to this report, the 3 star property
category represents the largest market share (20,3%) in mountain regions, followed
by 4 star properties (7,9%). Although 1, 2 and 5 star properties are not subject to
further research, it is nevertheless valuable to mention that these categories represent
only 0,7%, respectively, 5,5% and 1,4% of the total market for mountain resorts in
Switzerland. Another aspect that deserves special mention is that 57% of properties
located in mountain regions are not classified, i.e., assigned to a particular lodging
segment.
For sampling purposes, SHA conducts a yearly survey of key operational and
financial figures of 160 properties. Whilst the output of this survey cannot be used as
a benchmark for this study, it is nevertheless worth mentioning a limited range of its
key figures. One of these figures is Revenue Per Available Room (REVPAR), which
according to the Swiss Society of Hotel Credit (SGH) survey stood at approx. 134.-
Swiss Francs for 3 star and approx. 179.- Swiss Francs for 4 star mountain resort
properties. Another noteworthy figure is the Gross Profit Margin (GPM), which
stood at 13,2% for 3 star, 15,8% for 4 star and 17,4% for 5 star resort hotels. Detailed
reference to key operational and financial figures will be made in the latter sections
of this study.
2.9 Hotels and External Impacts
!
15
Figure 6: The Impacts of Global Crises on Tourism
Source: Adapted from Arthur D Little (2009)
From a global perspective, the high-end business travel market was one of the first
hotel market segments to be hit during the early stages of the GFC. Soon after, both
high- and also low-end leisure travel started to slow down. This came to no surprise
since spending on leisure and hotels is naturally closely related to economic
wellbeing. During tough economic times, people may prefer to keep their cash for
the essentials of life rather than spend it for discretionary items (Papatheodorou,
Rosselló & Xiao 2010)
. As a part of discretionary spending, tourism tends to –
although somewhat lagged due to advanced bookings – be one of the most strongly
exposed sectors to global economic volatility (Dwyer, Forsyth & Dwyer 2010).
Figure 7: Hotel Demand Switzerland 1990-2014
Source: Swiss Department of Economics (2012)
0 100 200 300 400 500 600 700 800 9001996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Asian Crisis 9/11 SARS
Tsunami
Financial Crisis
Oktober 2011 Prognosen für den Schweizer Tourismus
Prognosen Wintersaison 2011/12
Für den kommenden Winter (November 2011 bis April 2012) erwartet
BAKBASEL gegenüber der Vorjahresperiode einen kräftigen Rückgang der
Zahl der Hotelübernachtungen um rund 2.6 Prozent. Neben dem starken
Franken als Hauptursache für den Abschwung tritt als zusätzlicher
Belas-tungsfaktor die deutlich langsamere Gangart der weltweiten Konjunktur auf.
Die Aussichten für den privaten Konsum sind in etlichen wichtigen
Herkunfts-märkten aufgrund hoher Arbeitslosigkeit und privater Verschuldung weiterhin
bescheiden.
Der Binnennachfrage wird in der anstehenden Wintersaison eine
stabilisie-rende Wirkung zukommen. Während die Auslandsnachfrage voraussichtlich
einen Rückgang um rund 4.2 Prozent verzeichnen wird, dürfte die
Binnen-nachfrage nur leicht zurückgehen (-0.4%). Schweizerinnen und Schweizer
bleiben ihrer Hotellerie treu, obwohl auch für sie Ferien im Ausland relativ
ge-sehen deutlich günstiger wären. Einen positiven Beitrag an die
Binnennach-frage leistet dabei nicht zuletzt die Zuwanderung.
Entwicklung der Hotelübernachtungen in der Wintersaison
85 90 95 100 105 110 115 120
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Inländer
Ausländer
Total
Index, Winterhalbjahr 1989/90 = 100 Quelle: BFS, BAKBASEL
Bei der Auslandsnachfrage sind im kommenden Winter kaum Lichtblicke
aus-zumachen. Für alle wichtigen Herkunftsmärkte wird im kommenden Winter
eine negative Entwicklung erwartet. Besonders deutlich dürften die
Rückgän-ge bei der NachfraRückgän-ge aus Westeuropa ausfallen. Die Zahl der
Hotelübernach-tungen von Gästen aus Westeuropa wird voraussichtlich um rund 7 Prozent
zurückgehen. Kaum besser dürfte sich der US-Markt zeigen. Einziger
Hoff-nungsschimmer ist der asiatische Raum. Allerdings fällt im Winter die
stabili-sierende Wirkung dieser neuen Märkte aufgrund des geringeren Marktanteils
deutlich bescheidener aus als im Sommer.
Zwar werden im kommenden Winter fast alle Schweizer Tourismusregionen
von Nachfragerückgängen betroffen sein, in Bezug auf das Ausmass der
Be-troffenheit sind aber grosse Unterschiede auszumachen. Die noch günstigsten
Aussichten ergeben sich für die «Grossen Städte». Zwar ziehen auch beim
stark konjunkturabhängigen Geschäftstourismus als Folge der allgemeinen
konjunkturellen Abkühlung dunkle Wolken auf, dennoch beträgt der
prognosti-zierte Logiernächterückgang bei den «Grossen Städten» dank einer
dynami-Kräftiger Einbruch
der
Tourismusnach-frage in der
anste-henden
Wintersai-son
Stabilisierende
Bin-nennachfrage
Nachfrage aus
Westeuropa und den
USA stark rückläufig
The trend towards reduced discretionary spending soon also became apparent in
Switzerland. Besides having to deal with the impacts of a highly volatile global
economy, Switzerland soon had another challenge, namely the increasing strength of
its national currency. According to the latest joint-study published by the Swiss
Society for Hotel Credit (SGH) and the SHA, the national hotel market is becoming
more and more challenged by the ever-increasing strength of the Swiss Franc against
most global currencies. Especially tourism demand from the Eurozone and England
has been affected by the recent strength of the Swiss Franc. Between 2007-2011 the
Swiss Franc strengthened by around 30% against the Euro and has gained almost
50% against the British pound. In fact, on the 9
thof August 2011 the Swiss Franc and
the Euro were trading at parity. Enough reason to cause for extreme unease within
the national tourism community. Since the Gross Domestic Product (GDP) of
Switzerland is strongly dependent on exports, immediate action had to be taken by
the Swiss National Bank (SNB) to protect the Swiss export industry from the effects
of an ever-strengthening currency. To protect and stabilise the national economy
from a long lasting dilemma, the Swiss Franc was officially pegged against the Euro
on the 6
thof September 2011.
Based on hotel values, Switzerland belongs to a minority of Continental European
markets to have witnessed an increase in the overall market prices of its hotel
properties. As can be viewed in
Appendix A,
hotel property values in Zürich, for
example, have increased by 6,4% in nominal and around 20% in real terms against
the Euro between 2007–2011. In Geneva, hotel market values have increased by
around 5% in nominal terms. This increase in property values, however, is mainly
reflected by the recent strength of the Swiss Franc, as well as low interest rates, and
does not mirror the individual operational performance of each hotel. From a hotel
investors point, it is hence important to differentiate between macroeconomic and
operational factors affecting the value of his asset(s). Although an investor may not
be able to directly influence macroeconomic forces, it is assumed that operational
and financial performance measures will allow one to anticipate financial risks and
hence manage investments more successfully.
2.10 Foreign Exchange
Since the abolition of the fixed exchange rate system of Bretton Woods in 1971, the
international economic environment has been characterised by substantial exchange
rate volatility (Williamson 2001; El-Masry & Abdel-Salam 2007). Muller &
Verschoor (2006) argue that the volatility of FX rates and its associated risks have
become an increasingly important component of international financial management.
‘…Given the globalization of many industries, FX fluctuations are a source of
uncertainty for many corporations (Söhnke, Brown & Minton 2010, p. 148).’
Although there are various theories that focus on identifying the origin and impact of
movements in FX rates, it is extremely hard to make clear sense of the behaviour and
dynamics of currencies. Various studies by Stockman (1980), Svensson (1985) and
Krugman (1987) focus on identifying the relationship between currencies, supply,
demand, interest rates and other factors.
generally accepted theory of exchange rate determination that gives precise guidance
for judging the economically appropriate values of exchange rates. What we do
know, however, is that FX movements have been and still are a major concern for
investors, managers and analysts alike (El-Masry & Abdel-Salam 2007).
‘…Volatility is definitely an important financial phenomenon which needs to be
addressed (Malik 2005, p. 188).’ Particularly because changes in exchange rates have
important implications for financial decision-making and the profitability of firms
(Dominguez & Tesar 2006). According to Choi & Prasad (1995) exchange rate
fluctuations affect a firm’s success and firm value through the translation, transaction
and economic effects of FX exposure.
2.10.1 Theoretical and Practical Concepts of Foreign Exchange
[image:29.595.134.527.487.749.2]The theoretical FX exposure literature supports the common belief that exchange rate
changes should impact firms through various mechanisms (Doidge, Griffin &
Williamson 2006). Although FX volatility may be extremely difficult – if not almost
impossible – to anticipate, there are several theories which help to understand the
roots of FX fluctuations and hence to manage FX exposure in an attentive and
efficient manner. One of the most relevant theories in terms of assessing the impact
of FX volatility on hotel demand and revenue is the theory of Law of One Price
(LOP). The theoretical foundation of LOP states that sellers of a product or service
will seek to sell at the highest price, while buyers are eager to find the best product or
service at the lowest possible price. In today’s ever more transparent global hotel
market, clients possess the ability to seek for the best possible value for their money.
Hence, their wishes and needs will dictate the price they are willing to pay for a
service or product.
Figure 8: Influences on Price
Adapted from Iten et al. (2003)
Price
Consumer Perspective Related Production Costs
(Labour, Food etc.) Competition Product & Service Characteristics
Supply
!
Demand
Value for Client Price Elasticity
