By: Clay B. Dickinson, Senior Manager, Summer 1996

International hotel companies are rapidly expanding into emerging markets around the world. This is particularly true of U.S. based hotel companies expanding into the Latin American region. The question is, why? What factors are leading these companies to seek the new El Dorado in a region that has traditionally been associated with political and economic instability?

Hotel development in Latin America has been characterized by two extremes: large international chain-affiliated properties in international gateway cities and in certain resort areas; and small independent hotels and inns dispersed throughout the region. The industry evolved this way for a number of reasons, including the political and national economy structures, public sector participation in economic development, significantly underdeveloped infrastructure outside of the major cities, capital formation, tourism development incentives, macro-economic instability, and an unequal distribution of income.

These factors and numerous others have resulted in a Latin American lodging industry that is extremely underdeveloped vis a vis the U.S. and other developed areas of the world. Pent-up demand is evident in most markets and is illustrated by the high occupancies and average room rates achieved by a relatively poor-quality hotel product.

Another indicator is the lack of chain affiliation of the regions’s hotel supply coupled with the virtual nonexistence of Latin domestic hotel chains. Just over 10 percent of the region’s total lodging supply is chain-affiliated, and the vast majority of that is with U.S. and European chains.

Upon further scrutiny, one would learn that chain penetration is restricted almost exclusively to gateway international cites and major tourism destinations, such as the Caribbean; Cancun, Mexico; and Rio de Janeiro, Brazil.

Given this rather bleak panorama, why are so many hotel chains pursuing hotel opportunities throughout the region? There are companies that look upon the region and its historical challenges and decide to forgo what others perceive to e a tremendous opportunity. What is it that the optimists see that the others choose to ignore?

The answer stems in large part from the radical political, economic, and regulatory reforms sweeping across Latin America. From Mexico in the North to Chile in the South, virtually every Latin America country has embraced the principles of a free market economy and scrapped decades of the state interventionist policies of import substitution. Even Cuba is instituting some changes. These reforms, together with a diminishing number of new development opportunities in the relatively saturated markets of the developed world, are considered to be the primary reasons behind the push into Latin America.

In addition, the more adventurous chains have sought to mitigate the risks dissuading the more timid companies by:

• Proceeding from the basis of a well conceived strategic expansion plan that anticipates the potential pitfalls and risks.
• Undertaking extensive market research and detailed due diligence for each project.
• Adjusting yield requirements to account for increased risk.
• Choosing financially solid local joint venture partners with impeccable reputations.

Numerous other factors and trends are transforming the economic and political landscape of Latin America and creating a world of opportunities for domestic and foreign hotel investors alike in the form of acquisitions, leveraging of equity positions, joint ventures, access to international capital markets, management contacts, franchises, and new developments.

Many of the older, more established international chains already have a significant presence in Latin America on which they can build. Now, with new optimism, they are capitalizing and expanding on existing management contract relationships with government owned properties, the direct ownership of key hotel properties, and franchising in location like Mexico and the Caribbean.

The high development activity of major hotel companies - both local and international - in Latin America indicates that most of the opportunities mentioned here are being exploited in one form or another. Such activity has changed the relative position of various hotel chains in Latin America. Generally, U.S. based hotel companies are more conservative in their expansion strategy, seeking primarily to grow through franchise and/or management fee income. Perhaps most active among U.S. companies, Marriott has dramatically expanded its presence. European, Asian, and growing domestic chains tend to be more aggressive in direct investment in hotel real estate. In finance, Mexican domestic chains have taken most advantage of the public equity markets to fuel their growth initiatives.

Latin America has historically been a relatively closed market to most foreign investment, due largely to the import substitution model of economic development advocated by most Latin countries from World War II to the late 1980s. Recent political, economic, and regulatory reforms enacted across the region are creating extraordinary expansion opportunities for a variety of businesses, including the hotel industry.

Summary

While major hotel company presence in Lain America has been largely confined to large hotels in gateway cities or resort areas, these reforms are creating opportunities for a broader spectrum of hotel product. Moreover, companies are utilizing a broader range of expansion tactics, ranging from outright acquisition to joint ventures and franchising to achieve their strategic objectives. In general, the primary drivers of hotel companies’ international expansion efforts are diminishing opportunities in home markets, perceived pent-up demand in emerging markets, and considerably greater operating margins, and hence, more attractive investment yields.

The Real Estate Report is published by KPMG's National Real Estate, Hospitality, and Construction Practice. © 1996 by KPMG Peat Marwick LLP All rights reserved. For additional information email KPMG.

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