I just saw the news about Jazz Hotel in Penang closing down its business after operating for just over a year. Honestly, I’m not surprised at all because somehow expected that since the first time I saw it. Well, I do not mean to be rubbing salt on the wound at this critical point in time when the whole hotel industry is facing an unprecedented crisis. The thing is, I struggle to think of a justification for its feasibility and the same goes for a lot of other similar hotels in other locations.

I’m not from Penang but my wife is, and because of that I have been travelling quite a bit to Penang since we got married. Her house is located in Tanjung Bungah which is fairly close to Jazz Hotel in Tajong Tokong and I regularly pass by this property. The doubts I have are quite straightforward:

1. It does not have access to the beach.
2. It’s so far away from the George Town’s tourist attractions and not near enough to Batu Ferringhi. Besides that, Batu Ferringhi has so many hotels providing better options to tourists.
3. It’s surrounded by residential area which adds little value.
4. It’s not accessible to any vibrant commercial or industrial areas, except Straits Quay which looks more like a glorified recreational park for the locals.
5. I don’t see what’s the attraction for the MICE (Meetings, Incentives, Conferences & Exhibitions) market. Being near the marina? How many visitors come in yachts? I jest.

Therefore it’s not fair to say that Covid-19 has killed the business because it has simply succumbed to the basic perils in business 101. In fact, its management has announced that the business has been suffering losses for months even before the virus outbreak. I don’t know what was the rationale for putting up a hotel there but I suspect it may be a trophy asset collection exercise.

The truth is, our market is full of similar examples. Owning a hotel, especially one managed by famous operator like Hilton or any of the Starwood brands, does give you lot of bragging rights. To a certain extent, the more expensive the price tag, the more face value you get. That is why a lot of developers love to put a hotel in their mixed development irrespective of the business sense because they can call themselves hoteliers during black-tie dinners before flipping it eventually. Whoever buys it is banking on another greater fool that appears later while enjoying the same bragging rights.

Does it really make money running a hotel? Yes and no. I think those budget/boutique hotels which focus more on cost efficiency and provide excellent customer service will generally be fine. Branded five-star hotels? I’m not that optimistic. I used to have a preliminary discussion with the senior management of Accor Hotel and found out that the capital expenditure (excluding building cost) for a five-star hotel is around US$180-200k per room and you are expected to recover that cost in 8-10 years. By the time you go past the fifth year, be ready for major repairs and refurbishment and that will add a few more years to your payback period. In short, most people who own assets like this don’t expect to make operating profits because they focus on capital gain. You better have a rock solid holding power in this case. Don’t believe me? Take a look at Hilton KL which was sold to Le Meridien in 2017 and the owner has accumulated RM46mil of losses and RM275mil of liabilities before the sale.

To own an asset that gives you massive negative cash flow over the years, you need to be rich to start off with. Another key factor in the whole mathematics is debt, without which the return doesn’t make any sense. I’ve always said that developers always build according to the availability of credit rather than actual demand because the brick and mortar is the banks’ favourite asset class. Whatever problems that come next, they can always refinance their way out of it. I personally think that there has been too much credit dished out to hotel builders in the past and this is a crisis waiting to unfold. Try driving around Klang Valley and you can easily see many hotels being built in questionable locations. Some were built as service apartments which were subsequently converted to hotels after failing to achieve meaningful property sales. Many of them are attached to an existing mixed development which I suspect were put together to spice up their funding proposal in the first place. All the recurring income thesis and glorified GRR schemes can easily make the bankers head spin in ecstasy. We all know how it’s done.

Covid-19 is a black swan event which is sweeping the entire industry like a tsunami. Like what Warren Buffett said, “Only when the tide goes out do you discover who has been swimming naked”. As demand is not expected to recover immediately, watch out for those hotels in lousy location and those who have their balance sheet supercharged with debts.

Just to give you some perspective before I end this. Some time beginning of last year, there has been a list circulating among the real estate community showing no less than 20 hotels in the Klang Valley for sale. Just imagine how long has this list grown right now.