Safer with the sovereign - financing in Middle Eastern hospitality

The low price of oil was the defining business news story last year, and it seems that the perpetually low price of Brent crude isn’t going to change dramatically anytime soon. The impact is even being felt in the most gilded corners of the Gulf: state-backed sovereign wealth investment funds (SWFs) that for decades have been dependent on high oil prices to fuel spending.

SWFs have always played a significant role in the Gulf Cooperation Council’s (GCC) hotel financing environment, acting as guardians of their nations’ oil wealth with a state-backed mandate to “safeguard the manna”, as Chiheb Ben-Mahmoud, head of hotels and hospitality, Middle East and Africa at Jones Lang LaSalle, puts it.

“Governments have always supported and led, to some extent, hotel development,” he says. “There’s continuity here, and the question will be why SWFs are still investing in hotels.”

These days, however, SWFs are cutting costs, and many worry that funds for lavish hospitality projects could be drying up. In November last year, Jones Lang LaSalle released a report predicting that SWFs would have to scale down in 2016, cut back on investment overseas and focus on essential spending closer to home.

The same month saw the Saudi Arabian Monetary Authority withdraw tens of billions of dollars’ worth of investments, much of it in hospitality, as the kingdom’s reserves slumped by about $73 billion in a year – a drop a fund manager described as “our Black Monday” to the Financial Times.

It was not the first sign of slowing down either. In October last year, the Qatar Investment Authority (QIA) sold a 10% stake in Hochtief, a major German construction company. It was yet another sale in three months, after QIA offloaded its stakes in construction conglomerate Vinci and two London office buildings.

Tightening liquidity

“Low oil prices are directly contributing to a tightening of liquidity,” says Philip Shepherd, a partner at PWC’s Middle East hospitality and leisure division. “And money being repatriated is likely to focus on essential spending such as infrastructure, healthcare and education.”

SWFs are a key pillar of hospitality across the region, providing much-needed capital for ambitious projects and acquisition deals, and to “fill a gap or fill a role,” as Mahmoud says. But it’s important not to overstate the impact that SWFs expenditure revisions will have on the broader sector.

“The role they play is really the tip of the iceberg,” Mahmoud says. “It is what’s most talked about, but it is not what is defining the momentum or the reality of the sector. Because SWFs are usually from the Middle East and target trophy assets – properties that are highly visible – they make the news.”

This is not to say that SWFs can’t have a big impact. In 2014 and 2015, the Investment Corporation of Dubai (ICD), the SWF of the emirate, played a significant role in the acquisition of the Atlantis, the Palm Hotel and the development of multiple, large, mixed-use projects.

Struggling oil prices are impacting ongoing plans. While not necessarily leading to the cancellation of projects, which usually stems from a desire not to lose face, funding streams have slowed down, according to Nigel Teasdale, a partner at Arc Consulting.

“A number of government hotel projects are all being stalled,” he says. “Key markets in the leisure segment are being challenged. We all know that these are short-term issues, but they do influence decisions; they create an atmosphere of caution.

“With any projects moving ahead, funding will be slow, so the opening date can be pushed further out. We’re seeing that happen a lot.”

Hospitality investment is in a safer position, however, when it’s part of a broader and more profitable offering. Dubai, for example, has spent much of the last decade building a strong tourism product, and transforming the once oil-dependent state into a thriving holiday destination. The country attracts 14 million visitors a year, a buffer against the market uncertainty caused by low oil prices. It is this diversity that is partially to thank for ICD’s profits rising by 62% last year.

“This is certainly because there’s a more diversified economy, and in the hospitality segments the demand is much broader, so you know the leisure segment is maybe 50% in Dubai,” Teasdale says. “It is only 20–30% in Abu Dhabi or other Gulf states.

“Dubai can recover in a way that other Gulf States will struggle to emulate; it’s now a global tourism brand. You can’t say the same for Kuwait or Saudi Arabia, or even Qatar, despite all of its sporting events.”

A low oil price isn’t the only thing impacting the use of SWFs in hotel investments, especially those in markets that are heavily dependent on international corporate business.

“There are cutbacks combined with the Russian market, challenges with the euro-based markets because of dollar strength,” Teasdale says. “The Chinese market is equally challenged at the moment, because the currency exchange is not good; so all of the key markets in the leisure segment are challenged. We all know that those are short-term issues, but they influence decisions.”

Events in the broader region have also impacted the investment climate. “In some countries, particularly Egypt and the Levant, recent security issues have had a significant impact on tourism and, thus, the financing of hospitality assets,” says Shepherd.

So how good an investment is Middle Eastern hospitality still thought to be? Mahmoud is certain that despite turbulence in capital and the decline of oil prices, access to financing remains strong and the outlook of bankers and financiers has remained positive. But investors need to be cognisant of the sensitivity to volatility, Teasdale says. It’s impossible to avoid the fact that sentiments will be influenced by the instability of the broader geography.

“The picture will be mixed across the region,” Shepherd says. “The substantial investment in infrastructure, leisure and cultural attractions in UAE will support continued growth in tourism. The Kingdom of Saudi Arabia is making substantial investments in infrastructure in Mecca and Medina to support the continued high growth in visitors and, thus, new hotel supply will be required. Investors will be cautious about Egypt and Levant until there is greater stability.”

The region recovered quicker from the impact of the 2008 financial crisis than most, largely thanks to economies buoyed by oil profits and diversified SWF investments, many in hospitality. The recent slump combined with instability has made things more uncertain.

“There have been headwinds since, with the oil price causing concerns and tightening liquidity in the last few quarters, as the oil-producing countries fund budget deficits,” says Shepherd. “In addition, many regional banks are nearing full capacity with their real estate portfolios, and the recent softening of ADRs is also impacting sentiment.”

While there’s not necessarily a massive shift from SWFs as drivers of investment, they’re certainly shoring up bets. In the past, where they might have put the majority of equity into a project, SWFs are now looking for others to share the liability. This can be good news for wealth funds: it frees up capital for other projects and helps absorb the impact of low oil prices for the time being.

“We’re not seeing a move away from them as investors,” says Teasdale. “We’re seeing them trying to limit their exposure, involving third-party commercial investors or asking brands to take a share of the equity.”

These changes aren’t set to make a big difference to the consumer, but the shift will impact the dynamics of development. With operators having more say, situations where projects might be delayed may become less commonplace.

“Because they’ll be bringing investors of their own, they’re going to want projects to open on time,” says Teasdale.

While a lot is uncertain, SWFs and their partners are lucky to have safeguards that many don’t. Unlike the Eurozone or some OPEC Nations, GCC states have little debt, hefty assets and significant access to financing help. Those looking to develop or acquire new projects have plenty of options – it’ll be about finding the right project.