Lotte City Hotel in Mapo, Seoul

Increasing Chinese tourists make Korea's market remain promising

By JoAnn Hong

Driven by strong underlying market fundamentals and a lack of stable investment opportunities in the office market, the Seoul hotel market has attracted heightened investor interest over the past 12 months. However, despite this strong interest very few transactions have occurred. Why is this?

Reasons for high occupancy

Since 2007, all grades of hotel have benefited from annual increases in occupancy. In 2010, the average occupancy rose to 81 percent. This surge in occupancy has been matched by sustained increases in the Average Daily Rate (ADR). In 2010, 5-star hotel ADR reached 200,000 won, while for 4-star and 3-star hotels it improved to 110,000 won and 85,000 won respectively.

As 80 percent of Seoul hotel rooms are occupied by foreigners, the hotel market is benefiting from record inbound tourist numbers. In 2010, visitor numbers to Korea reached 8.8 million, a 12.5 percent annual increase which followed a 13.5 percent increase in 2009.

Korea’s nearest neighbors, Japan and China, account for the largest share of visitor arrivals comprising 34 percent and 21 percent respectively. The most significant tourism trend is the ongoing growth in Chinese visitors with arrivals surging from just over 700,000 in 2005 to nearly 1.9 million in 2010. This strong growth pattern was driven by the “Korean Wave” and is set to continue for the foreseeable future as Chinese outbound tourist numbers are forecast to double to 100 million by 2020. Chinese tourists are particularly important to the Korean hotel market and local economy in general as they stay longer and spend more money per trip than their Japanese counterparts.



Hotel transactions in 2011

Despite heightened investor interest, no transactions of established hotels have occurred in Seoul during the past 18 months.
Instead investor activity has focused on the acquisition of dated commercial buildings in prime locations for conversion to hotel accommodation. In CBD, this trend has been aided by a perceived oversupply of new office accommodation which has made some older commercial stock uncompetitive.

Conversion activity has been particularly prevalent within Myeongdong, where several transactions have occurred. JR No. 5 K-REIT acquired the Wise Building, which was remodeled, and Invesco purchased M-Plaza with plans to convert the office component of the building to hotel accommodation. A number of other buildings in the area, including the Migliore retail complex and Cheongbang Building are also slated for conversion.


Risks in hotel investment

During the next 18 months 1,200 4-star and 5-star rooms will be completed, representing a 6.5 percent increase in existing 4-star and 5-star room stock. In addition to this, a number of lower grade hotels are also being developed with more planned, however the actual amount of supply which will come to fruition remains to be seen.

Over the medium term it is anticipated that the current supply-demand imbalance in the local market will be rectified which will lead to occupancy rates and ADR growth levels returning to historic norms. Therefore while poorly managed hotels may still be able to survive over the short term, over the longer term the importance of quality management to achieving investment returns will be emphasized.

In Seoul, the hotel market is roughly divided into two groups — full-service hotels led by global operators or Korean conglomerates and limited-service budget hotels run by small local operators.

As a result, investors seeking global management standards are faced with significant barriers to entry due to the higher construction cost, longer development period and lack of operational knowledge, however benefit from international brand power and a stable income stream.

Conversely, lower grade locally managed hotels present lower entry barriers however are likely to experience greater volatility in returns.

Outlook

The outlook for the Seoul hotel market is positive considering the forecast for strong growth in outbound Chinese tourist numbers which will lead to a corresponding increase in Chinese visitors to Seoul and hotel room demand.

With limited supply forecast over the next 18 months, existing market players will continue to benefit from high occupancy rates and increasing ADRs.

However for investors seeking to enter the hotel market for the first time, we cannot overemphasize the importance of selecting the right consulting partner who understands the local hotel market as well as the future supply and demand and hotel operations, in order to maximize long term investment returns.