The Middle East hotel market possibly brings to mind more clichés than any other, with reams of luxury hotels, the story goes, funded by rich sheiks and characterised by financial excess and exuberance on every level.
Clichés, in many cases, catch on because they represent a kind of hackneyed version of the truth. But as we pass the halfway point in 2015, the region’s hotel market is as complex and nuanced as ever. Developers are pursuing strategies that are diverse and differentiated, new hotels are being built from luxury to budget, and all kinds of investors are involved in the market. The story, it turns out, is less of a cliché and more of a myth.
The array of interest and activity in the Middle East should not, of course, be surprising. Although the there was a slight dip in performance at the beginning of the year, with fewer visitors from Russia and the devaluation of the euro, the market has been remarkably strong in absolute terms, finishing close to the top of 15 key markets researched by a recent STR Global report. At the close of the first quarter of this year, occupancy for the region was 73.9%, ADR was £137.87 and RevPAR was £101.88.

A promising year

For investors and developers alike, a number of markets have shown particular promise so far this year. According to data published in April by Ernst & Young, Abu Dhabi recorded year-to-date RevPAR growth of 9.1%, with a 2% rise in occupancy to 86%, much of which was down to increased conference demand for its large real estate exhibition, Cityscape.
Hotel performance has also been stronger in Cairo, as business confidence is on the rise under the country’s new leader Abdel Fattah al-Sisi. According to the same Ernst & Young report, RevPAR rose by a staggering 78.7% year-on-year in April, outpacing almost every other hotel market in the Middle East and North Africa. Medina also witnessed a large jump in average occupancy and ADR, while Beirut grew steadily as tourism continued to rise in Lebanon, despite problems on the border with Syria.
In Dubai, ADR and occupancy have been falling, but the business hub still remains at the centre of the region’s success. The city continues to see the highest level of development in the Middle East, with 68 hotels and 17,358 guest rooms under construction. Large-scale development and destination-building continues ahead of Expo 2022, with The Department of Tourism and Commerce Marketing working with Mohammed bin Rashid al-Maktoum, the Emir of Dubai, to build between 140,000 and 160,000 new rooms before 2020.

Strong investment

With hotel performance so strong and development continuing across the region, a spectrum of investors can now be found in the market, from the government right through to the private sector.
"The level of financial investment in hotels is strong at the moment, and you really have everything," says Chiheb Ben Mahmoud, head of hotels and hospitality, Middle East and Africa at Jones Lang LaSalle (JLL). "You have the government, government-owned companies, public-private partnerships, government-related entities and high-net-worth individuals. The private equity segment is still lacking, but in Saudi Arabia it has a strong presence, and is underlying investments in the holy cities of Makkah and Medina, as well as hotels in Riyadh and Jeddah."
The vast majority of these investors are still based in the Middle East. Although the law in places such as Dubai, Abu Dhabi and Oman doesn’t prevent international financiers from owning hotels, European and American capital remains focused on assets closer to home, where the market is considered more liquid and predictable.
"Liquidity is obviously more limited in the Middle East, which is why private equity and financial investors, who are by definition not into long-term holding and have no special link to the destination, prefer to stay away," Ben Mahmoud says. "That said, there are a number of investors who are, for purposes of diversification, looking to the Middle East for the right opportunity."

Falling stars

As well as different investor profiles, the hotels being built in the region are becoming more diverse. For years, the Middle East – Dubai in particular – has been dominated by the luxury high-end segment. But with that market approaching saturation, in the eyes of many at least, the focus is clearly shifting.
A report published by JLL in June revealed that almost 50% of the 3,600 hotel rooms opening in Dubai later this year will have a three-star rating or lower, with 69% having either four-star status or lower. One major budget chain, Premier Inn, plans to reach 30 properties in the Gulf Cooperation Council region by 2020. According to Ben Mahmoud, the growth is down to the increased visibility of budget hotels and a broader need for diversification.
"There have always been budget hotels in the market, but in the past they were mainly unbranded and were more or less family run," he says. "Now, most, if not all, budget hotels are branded and are attracting a lot of attention. For Dubai as a destination, it helps to widen the spectrum of tourists by making the destination affordable to families and travellers with budget constraints. If the city wants to welcome 20 million tourists, it needs to cater to all budgets and purchasing powers."
Many of those investing in budget hotels perceive the segment to be less risky than the luxury market, with lower construction costs and quick return on investment. But with high land prices in places such as Dubai and Doha, a number of mitigating factors still need to be addressed.
"Land cost has always been, and always will be, a major factor for mid-scale and budget hotels," Ben Mahmoud says. "This is why three-star hotels represent less than 15% of the total capacity of Dubai at the moment. If you take a piece of land in a central business district or prime location and have a standalone mid-market hotel, the numbers won’t stack up. It’s more feasible when the hotel is part of a bigger complex and doesn’t bear the full burden of the cost. It needs to be in line with an overall logic, like the Ibis hotel, which is part of the wider exhibition centre in Dubai."
Forging franchises
As the Middle East hotel market diversifies, new deal structures are also beginning to emerge. While management agreements remain the primary form of contract between hotel owners and operators, in Dubai and Saudi Arabia a number of hotels are now operating on franchise models.
"The Middle East is certainly ready for this," Ben Mahmoud says. "With operators facing increased competition, and with budget and mid-scale hotels being branded, the door is open for these kinds of opportunities. We’re seeing outright franchise models and ‘manchise’ agreements – a preliminary period where an operator manages a hotel and then moves into franchising after a few years once the brand has stabilised the operation."
For up-scale brands, however, franchising does remain a long way off. Although the model can work in mature markets with large operating companies, in the Middle East, Ben Mahmoud says, the capacity to support large third-party operators still doesn’t exist.
"For the operators to enter franchise agreements on up-scale projects, it needs to make economic sense", he says. "There are no reliable operating companies with a lot of critical mass and solid operating systems. And it’s especially difficult here because the hotels are not simple; there is often a very large, authentic component, and hotels play a bigger role in the business community as a meeting place and venue. That makes them even more difficult to operate, which is why hotel chains have to be very careful when engaging in this kind of model."
As well as having different types of assets and working models, developers are also benefitting from a more balanced relationship with operators. Ten years ago, when operators first set up in the Middle East, they were very flexible, often granting large territorial exclusivity to developers. During the boom years, as the number of projects for operators to pick from grew, they became considerably less flexible. But today, as competition returns, that balance of power is changing once again.
"Competition is strong and owners have become more sophisticated," Ben Mahmoud says. "They don’t have advisers negotiating their agreements one-on-one in a corner of a coffee shop, so the deals are more structured and operators more flexible. Of course, we’re not talking about symmetrical relationships: operators are service providers at the end of the day. It’s the owners that will always bear the residual risks as equity owners."
With so many geopolitical risks in the Middle East and Europe, it isn’t easy to make predictions about the market going forward into 2016. But with the fundamentals in place, and the region becoming more diverse and segmented than ever, there is plenty to be hopeful about.