Hospitality Report FAX: Winter 1999

Current Opportunities For Hospitality Industry in Asia

Hospitality Outlook in Europe

Current Developments in Latin America

CURRENT OPPORTUNITIES FOR HOSPITALITY INDUSTRY IN ASIA
John H. Steed

The Asian economic crisis that began last fall, as well as Japan's lingering economic stagnation following collapse of the asset-inflation "bubble" in 1991, have caused the worlds' political and economic leaders substantial anxiety due to the immense influence which that region has come to have over the world economy. While the current situation in Indonesia remains very volatile, it appears that South Korea and the other countries in the region affected by the crisis have been able to restore political stability, and are making strides on the long road toward economic recovery. Japan's leaders, facing intense international pressure to keep the region's largest economy from contracting sharply, have committed substantial resources toward immediate "pump priming" public works projects and appear to be dealing earnestly to solve the structural defects in Japan's highly regulated financial sector and to boost domestic demand.

Among the consequences of the turmoil and uncertainty prevailing in the region is the appearance of sophisticated international investors. They see the situation in Asia as a rare opportunity to acquire assets at a fraction of their peak prices in economies whose long-term potential -- far above average growth -- remains bright. In a remarkable turnabout from the late 1980s, U.S. and European investment banks, hedge funds, and opportunity fund investors are descending upon Tokyo in what has been described as a "feeding frenzy," to purchase non-performing loan portfolios secured by Japanese real estate and other Japanese real estate assets. Although no "landmark properties" (such as Rockefeller Center or Pebble Beach) have yet been acquired by foreigners, the Japanese press is beginning to complain of the "foreign invasion" being mounted by these investors.

What are the implications of the current situation in Asia for the hospitality industry, particularly for industry participants from outside the region? The following list outlines some of the more significant implications and opportunities we see for the hospitality industry in Asia today. We've separated our list into two sections -- Japan and the rest of Asia -- since the underlying strength and size of Japan's economy and financial resources put it into a category of its own.

Current Hospitality Opportunities in Japan

Compared to the environment of just a few years ago, Japanese consumers have become very conservative in their purchases of all types of goods and services. While personal income has actually continued to increase modestly over the post-bubble period of economic stagnation, the mood of consumers in Japan is one of uncertainty about the future. Accordingly, consumers have moderated their expenditures on foreign travel/luxury brand goods, and instead are spending their money closer to home on more affordable travel and entertainment. Despite staying home, the Japanese consumer's appetite for the "American lifestyle" appears strong. Tokyo Disneyland's remarkable and virtually uninterrupted economic performance is evidence of this trend and Disney, with its Japanese partners, has recently announced yet another huge expansion of their operations near Tokyo to include a marine theme park. Starbuck's Coffee is undergoing rapid expansion in the Tokyo metropolitan area, and retailers such as Eddie Bauer are enjoying great success in marketing the American look in clothing and accessories.

Given the steep decline in real estate prices from their "bubble-inflated" peaks (prime commercial properties in Tokyo are reported to have declined by 70-80 percent from their peak values), and the fall in the value of the yen vis-a-vis the U.S. dollar (roughly 30 percent over the past 18 months), foreign companies involved in the hospitality industry are finding it a good time to invest in assets and to start up or enhance operations in Japan. In a bid to boost domestic demand, the Japanese government has announced a plan to adjust national holidays to provide more three-day weekends, believing that Japanese families will take the opportunity provided to travel more within Japan. There is currently a surplus of unsold condominium units in many of Japan's prime winter and summer resort locations; condos that were planned and built during the "bubble" era for sale to the affluent but space-limited urban middle class remain unoccupied. The cost of carrying and maintaining partially occupied condo buildings is straining their developers. This combination of factors point logically to the development, over time, of a time share or "vacation club" industry in Japan, an industry that to date has been virtually non-existent in Japan, but that has flourished in the U.S. and done well in Europe.

Except for the influx in foreign investment bankers and investors interested in exploiting the current lack of liquidity in the Japanese real estate market, as well as opportunities anticipated to result from Japan's "big-bang" financial sector liberalization, the hotel sector in Japan is suffering. Business visitors from other Asian countries have declined, and occupancy rates at first class hotels in Tokyo are reportedly hovering below 70 percent, making it difficult for hotels to raise room rates despite the decline in the value of the yen against the dollar. Likewise, fewer Japanese are taking vacations to upscale resorts throughout the region, meaning that the hospitality business in Australia, Thailand, Malaysia, Indonesia and the Philippines (not to mention Hawaii) is suffering.

Opportunities in Asia Outside Japan

For investors with a long-term strategic perspective, the opportunity exists to acquire assets (such as condominium projects in Thailand) at prices substantially below replacement cost. Whether such assets can be successfully managed over the near term to justify their acquisition is a tough question, and careful analysis is required to determine the actual economic value of available assets. Acquisitions of significant interests in operating companies may be a feasible way of taking advantage of the current economic dislocation but once again, the prospects of such companies to "weather the storm" over the near to mid-term, must be carefully examined. In all cases, it seems prudent to seek the advice of knowledgeable and reliable local advisors and/or partners before entering into any transaction in the region, particularly if the deal looks, from a U.S. perspective, "too good to be true." The legal systems of countries throughout the region are in various states of development, and many changes have either recently been implemented (due to IMF requirements) or are under consideration.

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HOSPITALITY OUTLOOK IN EUROPE
Keith T. Ott & W. Andrew Scott

The hospitality industry in Europe represents significant business opportunities in many segments of the economy. Current favorable trends in supply and demand, and equity markets are expected to continue, but much of the development in the hospitality industry in Europe may come from corporate growth, rather than franchised operations.

European equity market performance has been improving steadily in the recent past. Dollar volume of equity capital markets in western Europe in the hospitality industry has risen significantly from 1992 to 1997. The growth in equity assets under management in Europe has risen from approximately $2 trillion in 1994 to more than $3 trillion in 1996. Expectations are there will be sustained long-term growth in the hotel industry driven by significant liquidity in the equity markets.

Key factors in future development of the hotel industry are general liquidity, supply and demand and the establishment of the European Monetary Union. The western European hotel sector has been extremely attractive from an investment standpoint because of a relative lack of supply in relation to increasing desire for travel and vacation lodging. The growth in the hotel industry is generally also seen as bright because of the establishment of the European Monetary Union and the issuance of Euro currency. Last month the European Union Summit selected Austria, Belgium, Finland, France, Germany, Holland, Ireland, Italy, Luxemburg, Spain and Portugal for the first wave of the European Monetary Union. Also, exchange rates between Euro and national currencies will be fixed, the European Central Bank will begin its operations and all prices must be displayed in Euro and national currencies. During the year 2002, Euro coins and notes will be put into circulation and traditional currencies will disappear.

Because of the single monetary union, and due to increased demand for lodging, expectations are occupancy rates will continue to rise steadily as they have since 1993. Room occupancy will follow the trend established since 1993, for increases in most, if not all, countries of Europe, and average room rates should improve as well.

Many European hospitality companies are publicly traded and quoted. The U.K. and its equity markets lead Europe in the hospitality industry because a history of high and volatile inflation rates make bonds less attractive and the U.K. has a strong culture of equity ownership, especially through U.K. company pension schemes. Europe has lagged the U.K. somewhat in its emphasis on equity financing, relying more heavily on bond financing because of lower inflation rates and less of a culture of equity investment generally. On the other hand, it is anticipated that the emphasis by significant hotel chains in worldwide development and general interest in equity financing may improve capital markets for Europe. In addition, indications are that REITs may be looking at Europe for attractive investment opportunities, as they are currently in the United States.

Franchising as a vehicle for development of hospitality investment may develop more slowly in Europe. The lack of space and zoning restrictions may limit the development of branded new build operations. In addition, hotels willing to convert to branded operations may not be entirely suitable for franchised operations. Many existing European hotels have a unique character, and it may be difficult or impossible for such hotels to meet the standards of branded operations entirely, if at all. In addition, smaller European hotels may be unwilling to change their character to comply with such standards. To the extent that larger branded operations will move into European operations on a conversion basis, expectations are that a form of dual branding, using the franchisor's brand in connection with the original hotel brand, may be the most attractive avenue and would allow the original operation to retain its name and character.

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CURRENT DEVELOPMENTS IN LATIN AMERICA
Michael L. Owen

In recent years, foreign investor interest in Mexican real estate has focused on hotels in the many beach resorts attracting hard currency bookings, principally from the United States and Canada, and on premier office buildings attracting foreign tenants with leases in dollars. Many of these opportunities remain, but investors are beginning to recognize that domestic demand is increasing as the Mexican economy rebounds from the disastrous 1994 peso devaluation and resulting recession. Numerous opportunities exist for construction or renovation of hotels, office buildings, and shopping centers located in commercial centers in the interior away from the principal attractions of Mexico, D.F. and Monterrey.

The importance of the recovering Mexican economy cannot be overstated. It unleashes pent-up Mexican demand and makes domestic capital sources available for joint venture development opportunities.

All of this comes at a time when Mexico has made substantial strides to change its Foreign Investment Law, and to a much more limited extent, its legal structure and bureaucracy to encourage and facilitate foreign investment. Foreigners are permitted to own real estate anywhere in Mexico, except in the "forbidden zone" which is anywhere 50 kilometers from the coast or 100 kilometers from its border with a foreign country. Recognizing the depressant this constitutional limitation imposes on foreign investment and the resulting employment for its citizens in this "forbidden zone" which contains many of the country's most attractive tourism sites, Mexico in the 1960s created a statutory trust mechanism (fideicomiso), that allows Mexican banks as trustee to hold title to the Mexican real estate for the benefit of the foreign investor. The main drawback of the trusts has been their cost, with fees to the Mexican trustee averaging 0.25 to 3.0 percent per year, depending on the value of the property in the trust.

Recently, Mexico has changed its laws to permit a Mexican corporation with up to 100 percent foreign ownership to acquire real estate in the "forbidden zone" so long as such real estate is not being acquired for residential purposes. Mexican corporate income taxes are 34 percent; unlike the United States, however, Mexico does not impose double taxation on corporate income, i.e., so long as the corporation pays its taxes, the dividends are not taxed to the shareholders.

The cost of acquisition can be significantly more than a foreign investor may be accustomed to in his or her own country. Notarial fees can be substantial, although they will vary significantly depending on the locale and the willingness of the notary to negotiate. Subject to negotiating, these fees are often split between the buyer and the seller. Although the notarial fees are substantial it should be remembered that the notary in Mexico serves the role of escrow agent and guarantor of title. Despite that the notary is responsible for assuring title, many United States investors and lenders are obtaining title insurance for Mexican properties issued by, or reinsured by, United States title insurance companies. Acquisition costs in Mexico are also inflated by a two percent transfer tax, that is customarily paid by the purchaser, and registration fees, that often run between .25 to 10.0 percent of the appraised value of the property, although Mexico, D.F. has placed a Ps5,045 cap on such registration fees.

For lenders on Mexican real estate, underwriting the credit risk requires considerably more flexibility than what is often required in the United States. Although the traditional means of securing a real estate loan through a recorded mortgage is similar to the procedure in the United States (aside from the cost aspect described above), the differences are encountered in obtaining security interests in related personal property (e.g., FF&E, accounts receivable) and in enforcing the lender's interest in the real estate or the personal property. Mexico's constitution has been interpreted to prohibit the creditors exercising self-help as they are accustomed to doing in the United States; instead, creditors must seek court orders to enforce their interest in real or personal collateral. Even with the best of documentation taking advantage of those aspects of Mexican laws assisting the creditor, if the borrower resists, the process can take more than one year.

The traditional approach is often supplemented with use of a special purpose vehicle to own the property and a pledge of its shares. Once the loan has been made, the shareholders of the pledged shares can authorize the lender in writing to foreclose on those shares in the future without going to court; obtaining such written authorization is a fairly customary procedure in Mexico.

In recent years a new use of the Mexican trust mechanism has come into vogue as a vehicle to reduce the enforcement risk. The real property and personal property are transferred to a Mexican bank as trustee and the grantor-borrower and the beneficiary-lender agree in the trust agreement to the nature and mechanism of remedies (including foreclosure) to be taken by the trustee in the event of a default. This use of the Mexican trust mechanism to avoid having to seek a court order for enforcement has been challenged in court as an evasion of the Constitutional prohibition on self help, but it has generally been upheld.

The opportunities in Mexican real estate are numerous and the environment in Mexico is more encouraging than ever. Coordination with experienced cross-border and Mexican counsel can go far to reduce the risks of the differing legal environment in Mexico.

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