Australia
Scarcity sees Sydney five-star hotel room values soar

Scarcity sees Sydney five-star hotel room values soar

The rarer a commodity, the higher its price. Strong investor demand combined with a lack of stock, very limited supply growth and sustained outperformance have created a perfect storm for Sydney’s five-star hotel market. And now, the old metrics no longer apply.

The effects on the luxury hotels market

Sydney’s five-star CBD properties have been by far the strongest performers across the Australian hotel market for the past few years and there are extremely limited opportunities to get a piece of the action.

As a result, we now believe the next sale of a luxury property in the Sydney CBD could see investment yields fall below 5% and the per room price well exceed $1 million.

Analysis of key sales results over the past five years – a period when there were just a handful of transactions – shows how dramatically the value of Sydney’s five-star hotels has escalated in recent times.

When the signs first appeared

Old metrics still applied in 2013 when the Four Seasons Sydney went on the market, eventually selling for $340 million at $606,000 a room on a relatively high yield of 6.6%. 

At that point the cash rate was 2.5% and the international inbound tourism surge had just begun. 

In transaction terms, the game changed the following November 2014 when there was intense competition for the 557-room freehold Sheraton on the Park.

A Chinese investor emerged as the successful bidder, paying an Australian record total price of $463 million for the landmark property, which came with an obligation to spend a further $40 million on property improvement capex.

That total equated to more than $900,000 a room, almost 40% more than the Four Seasons had sold for just 14 months earlier.

The Sheraton on the Park result really created a stir – some people at the time thought it was an overly aggressive price, but history now shows it was an astute purchase.

This was vividly illustrated with the sale of the Westin Sydney a few months later when the mythical million-dollar barrier on a large format five-star property was cleared for the first time in Sydney with the buyer paying $445 million ($1.07 million per room). 

A new benchmark had been set but perhaps more importantly the Westin sale was crucial in demonstrating what an incredible investment a Sydney CBD five-star can be.

The seller, GIC, the Singapore sovereign wealth fund, bought the Westin in 2002 for just $160 million, meaning that on the sale price of $445 million, its investment had returned 21% a year based on capital appreciation alone. Obviously GIC also enjoyed strong income during its holding period.

The high-end price tags are justified 

These seemingly high prices were more than justified given the high level of revenue and profitability that a well-run five-star property can generate in the right hands and even since 2015 operating metrics have improved significantly.

The cash rate has fallen from 2.5% to 1.5% and Sydney five-star occupancies are regularly 90% or above.

For the six months to June 2018, STR recorded market-wide luxury daily rates at just under $370, though a select group of high-end properties routinely achieve average rates of more than $400 a night.

While margins vary according to the hotel operator, we estimate that the average net profit per room for the top Sydney CBD five-star hotels, including food and beverage profit, is more than $55,000 a year.

On this basis, a five-star Sydney hotel bought for $1 million a room would generate a net operating yield of at least 5.5%.

$1 million a room is just the beginning

We believe that if a quality property did come onto the market, $1 million a room would simply become a starting point.

Given the historical scarcity of central Sydney five-star product and long-term market outperformance, purchase yields could tighten to 4.75% or even 4.5%, pushing the price per room to well above the $1 million mark.

Sydney is the hotel investment market’s version of a high growth stock – high barriers to entry, low supply growth, consistent domestic and international demand and consistently improving earnings.

That’s why investors are prepared to pay higher ‘price to earnings’ multiples. Even at these higher price metrics, Sydney five-star hotels still represent an excellent long-term investment opportunity. 

History shows that Sydney five-star hotels are a blue-chip investment and reward those with a long-term perspective. It’s like Mayfair on the Monopoly board – the cost of entry is very high but more than justified by the returns.

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Michael Simpson

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