It is not uncommon to hear uncomfortable news about condo hotels through the media, more than expected. There may be differences between people, but I think there are many people who would think, “It hasn’t been solved yet?” Despite the noise around condo hotels, there’s not much saying about exactly what’s wrong, who’s responsible, and how to solve it.1. Real Estate Never FailsAt the root of the problem, there is the desire to invest in good assets and earn a stable return. Actually, there’s nothing wrong with it. Korea is struggling with aftereffects of rapid growth, like other mature markets, after a dynamic ride from one of the poorest countries to the 12th largest economy in the world. Companies that need to survive in a competitive environment are struggling to cut costs and reduce labors.Meanwhile, as the concept of a lifetime job has disappeared and the future has become uncertain in such environment, people are flocking to asset markets such as stocks, bonds, real estate, and more recently cryptocurrency in search of sources of income that do not involve direct labor. No one can challenge against it, as it is their right to make the most out of permitted freedom to protect their own interests in a cold-blooded capitalism society.Traditionally, real estate has been the most sought-after asset class for Koreans, especially housing. Thanks to the rapidly growing economy, people’s living standards have improved steeply, but quality housing has not been supplied sufficiently at the pace. One of the reasons was the fact that housing supply has been controlled entirely by the government, meaning that the pace of supply growth has never caught up with that of demand growth. In other words, there have not been enough supply of quality housing, and the increase in house prices has continuously expedited over time. This is where the myth of never-failing-real-estate began, and real estate actually has been the most stable and profitable asset class.* Image Source: National Archives of KoreaThe problem arose out of the inefficient market, meaning the asymmetry of market information. Those who obtained information on the development of new housing sites before others were able to accumulate wealth through real estate, but for those who did not, the soaring lease and monthly rent became increasingly burdensome. In other words, the controlled supply of quality housing actually worked as the cause of bipolarization of wealth, instead of improving living environment of the middle-class. This relative deprivation has spread the perception that real estate is a tool of exploitation rather than a stable asset. Moreover, real estate has been utilized as an easy way to boost economy or a target for regulation, depending on the government’s administrative stance, resulting in an unstable real estate market.2. Betray of Hotel MarketIn 2009, when the global economy collapsed due to the financial crisis from the U.S., the impact was relatively small in Korea. One of the biggest drivers was the Korean Wave that hit all over Asia. Korean soap operas and K-pop have been sold throughout Asia, and the number of tourists visiting Korea has increased rapidly. In particular, it was the Japanese who led this travel boom at the forefront, equipped with enhanced consumption power based upon strong Yen. Apparently, the hotels in Korea experienced an unprecedented boom then.At that time, it was difficult to find empty hotel rooms throughout the year in Myeong-dong, which was popular among Japanese travelers. Then, the government, inspired by the circumstance, began to be deeply involved in supply, just like the housing market. In 2012, the Special Act on the Expansion of Tourism Accommodation Facilities took effect and led to a rapid increase in supply of hotels. Those who had empty land or wanted to demolish and rebuild existing buildings started building hotels. The special act allowed additional density for hotel developments, significantly increasing the value of a land with a hotel. Anyway, during this time, newly licensed, high-density hotels began construction with the goal of opening by 2015.* Data Source: TourGo Korea Hotel AssociationHowever, when the Yen fell in 2013, the Japanese stopped coming, as if they never had. Hotels that had expanded their facilities and added staff in a seemingly never-ending boom had to face embarrassment. Fortunately, the Chinese travelers filled the vacancy of the Japanese. However, the Chinese were different from the Japanese. Unlike Japanese who preferred individual travel, they were mostly on group travel, and the budget allocated for accommodation was extremely tight. More than four people stayed in one room, and they started looking for hotels or even motels in the outer area in search of cheaper accommodations.However, Japanese tourists, who have been the main driver of hotel market prosperity in Korea until 2012, were replaced by Chinese tourists in 2013. Although the demand base still seemed to grow in numbers, the price dropped significantly not because of growing competitions but because of demand base shifting downward in price. In addition, the lower priced Chinese tourists brought the “underground” market – motels – “overground”. In fact, international visitors do not have to stay only at hotels, as some motels actually offered better values for money than hotels. They were just not visible to most international tourists at first. Unfortunately, it was not the end of the story. The market was traumatized even more when Chinese tourists disappeared due to MERS followed by THAAD strain.3. Dark Side of Condo HotelsWhile the problems did not spread out of those who built hotels on their own land, the problems have spread out of condo hotels to the extreme. Many people, who were unaware of the value chain of lodging industry and the volatility of the lodging market, were misled by the phrase “guaranteed returns,” and were sold and plunged into an exponentially growing financial trouble. In fact, condo hotels in Korea had fundamental problems by nature. There was nothing strange about the problems turning to bombs and bursting at the end of the day. However, it would be worthwhile to know the actual catalyst, the fact that most of the developers were not aware of the problem in the first place, and it was not properly delivered to individual unit purchasers.The first problem is that the developers without experience in lodging industry approached the condo hotel development project in a similar way to the housing development project. In the case of housing development projects, the risks borne by the developer go away as soon as the sale is completed. In other words, the only risk is how quickly and cheaply they complete the development itself, without needs for worrying about post-completion circumstances. However, in the case of hotels, how they operate after opening will have a greater impact on asset value. This is because the value of a commercial property is determined by the cash flows generated from the property. Furthermore, unlike housing, lodging properties do not generate cash flows immediately upon completion, and it takes from one year up to five years to stabilize cash flows after opening. Until then, they typically run at loss, and owners are put in a situation to make up for losses by procuring additional capital in the form of a working capital at the beginning of the opening. However, condo hotels, which were carried out in a similar way to the housing development project, often did not take into account of this working capital. It was like the individual unit purchasers paid prices including working capital, while only the real estates were delivered to them.* Data Source: Financial Statement Analysis, KOSISThe second problem is that the precise allocation of value by individual unit was not a feasible practice unless the cash flows are precisely allocated by individual units. A lodging property, including guestrooms and amenities, generates cash flows as a single business, and it is not easy to differentiate contribution of each unit, which is not an issue for housing units. Some rooms sell more at higher prices than others, while others do not. It is even more complicated to allocate operating expenses. Also, it is practically not feasible to know how much labor and materials were required to operate and how much of capital expenditures each unit needs when wear-and-tear is different, before actually seeing it. In other words, the difference in asset value among units, based on cash flows, is hard to be reflected at the time of sale. So, someone might have purchased a unit at a lower price than the actual value, and vice versa. This amplifies the problem in the post-opening operation process. For example, an owner of a well-selling unit may not be satisfied with receiving the same dividends as an owner of a poorly-selling unit. Also, an owner of a poorly-selling unit may not be satisfied with the cost of repair and maintenance as an owner of a well-selling unit.* Data Sources: City and County of HonoluluThe third problem is that many of the developers, who became aware of this problem, exploited it to maximize their profits rather than optimizing their ownership and operational structure for the purchasers. After watching the failure of early-stage condo hotels, the developers raised the sale price in consideration of the initial working capital and introduced a “guaranteed return” scheme. In fact, the returns were paid out of the reserved initial working capital, which should have been used to make up for the losses during the stabilization period. Once the initial working capital was exhausted, they washed their hands, passing the real responsibility over to the unit owners. In addition, to control the various conflicts of interests, some of the developers established separate operating companies as paper companies, and had it control access to operating performance data. They even charged management fees to the unit owners, which was also paid out of the reserved initial working capital. Some of the developers said they would take responsibility for stabilization for only a few years and hand it over to the unit owners, as a way to avoid suspicions that could potentially come up.4. Bright Side of Condo HotelsA condo hotel is not technically a hotel in the context of Korean regulations. The Enforcement Ordinance of the Building Act classifies lodging properties into tourism accommodations, general and living accommodations, and multi-living facilities, while the Tourism Promotion Act classifies tourism accommodations into hotels and timeshares. However, the Tourism Promotion Act does not allow hotels to be condomized, while allowing a membership scheme. So-called condo hotels are actually falling under the category of general and living accommodations in Korea pursuant to under the Public Sanitation Act. That being said, it’s rather similar to a motel or an officetel permitted for transient lodging operation.A condo hotel is not a unique concept of Korea though. In the U.S., condo hotels were boomed mostly in vacation spots like Hawaii and Miami. Trump Hotel in A La Moana or Fontainebleau Hotel in Miami Beach are some of the most popular condo hotels. It is true that condo hotels attracted many people as a source of stable income, in the early stage. However, due to the highly volatile cash flows, the yield has never been stable, and there were also frequent cases where additional working capital had to be paid. Crucially, condo hotels attached with famous brands regularly incurred capital expenditures for renovations, beyond the routine capital expenditures, which should have been pulled from unit owners. This made may unit owners convert their units into residences. As a result, many condo hotels have disappeared because the number of rooms in many condo hotels has not maintained stable.* Data Source: CapEx 2014 by ISHCThe remaining condo hotels in the U.S. are based on motivation to have a second home only at the purchase price without additional on-going costs, rather than to have a stable income. In other words, the unit owners does not need to worry about operating expenses other than the purchase price, as they will be paid by guests staying at the property when the owner does not use. For this reason, condo hotels in Miami are often owned by wealthy people from the northeastern U.S. or Canada, and condo hotels in Hawaii are often owned by wealthy people from California or Japan.5. Liquidation of Lodging PropertiesA lodging property is not quite designed for unit ownership. Although the role of non-room amenities has recently been gaining attention, most of the cash flows generated at lodging properties are generated through rooms. And the rooms are products based on the mass production and mass consumption of standardized products. In other words, economies of scale are bound to exert power. In order to effectively manage cash flow in the lodging market where the peak and off-season exists, both of expensive rooms and cheap rooms are needed at the same time. Also, fixed costs, which are the biggest burden on operating expenses, should be broken up as much as possible. In other words, the entire property should work as a business unit, rather than individual units to work as independent business units.Consequently, considering the stability of the operation, it would be more reasonable to liquidate interests in the property as a single asset rather than splitting ownership by individual unit. It’s a concept similar to so-called REITs, but there are limitations that lodging properties don’t exactly fit into REITs scheme either. REITs require most of the cash flows generated to be paid to investors as dividends. However, lodging properties need to retain certain level of cash as working capital to manage market volatility, or as capital expenditure reserves for future renovations, whenever there is a surplus in profits.* Image Source: KBSIt seems that the starting point for solving the problem of the already troubled condo hotels is to consolidate the ownership interests to get it ready for liquidation as a stand-alone asset. It is like putting together the torn down pieces of a dollar bill to bring back the value for trade. In this process, it may also be helpful to separate the operating entity from the asset holding entity so that they can be liquidated separately. Of course, in order for the restructuring to proceed in this direction, the pending litigations regarding the condo hotels will need to be settled in some way or another first.

The COVID-19 situation, which has been expected to calm down since massive vaccination, seems to go back into the fog due to the spread of variances. Anyway, many beloved hotels are being closed disappearing due to this long-running pandemic. Millennium Hilton, Sheraton Palace, Le Meridian and Crown have been sold, and are set to be redeveloped into residential and commercial complexes after demolition. In Myeongdong, which used to be the center of international tourists, many hotels seem to stay closed.* Photo by Jievani Weerasinghe on UnsplashIn 2020, when COVID-19 froze the lodging industry around the world, the performance of global brand hotels was also disastrous.In 2020 compared to 2019, the Systemwide* RevPAR saw a 59.0% decrease in Marriott, 56.5% in Hilton, 56.4% in IHG, 67.3% in Hyatt, and 67.7% in Accor. The consolidated results of these five listed global brand companies show that Systemwide RevPAR in 2020 decreased by 60.5% compared to 2019. Hyatt and Accor saw a larger decline than average, and the impact of Accor, which is relatively large in its portfolio, must have been greater than Hyatt.* Data Source: Annual Reports (Marriott, Hilton, IHG, Hyatt, Accor, 2019-2020)By region, RevPAR in the Non-Americas region showed a deeper decline of 63.6%, compared to a 58.6% decline in the Americas region.In Marriott’s case, the Americas region declined 57.7% and the Non-Americas region saw a slightly higher decline of 61.5%. In Hilton, the decline in Non-Americas region stood out at 66.0% compared to 53.3% in the Americas region, and in IHG, like Marriott, 59.5% in the Non-Americas region, slightly higher than 54.4% in the Americas region. In the case of Hyatt, the decline in the Americas region and the Non-Americas region was close, with 67.6% and 66.6% respectively, while in Europe-based Accor, the decline in the Americas region was 76.6% compared to 66.4% in the Non-Americas region. Based on the number of rooms, the Americas region accounted for 58.2% for Marriott, 77.1% for Hilton, 58.0% for IHG, 66.2% for Hyatt and 13.2% for Accor. In other words, while Hilton’s bias towards the Americas region and Accor’s bias towards the Non-Americas region were notable, Marriott, IHG, and Hyatt showed little difference in their portfolio mix.* Data Source: Annual Reports (Marriott, Hilton, IHG, Hyatt, Accor, 2019-2020)By brand, while the so-called life-style brands were weak, midscale and extended-stay brands were found to have been holding up relatively well.In Marriott’s case, W showed the biggest drop of 76.2%, while Residence Inn held up relatively well at 45.0%. In Hilton, Hilton had the biggest drop of 66.9%, while Home2 had the best lead at 38.8%. In IHG, Kimpton saw the largest drop among all the brands in question at 79.9%, while Candlewood saw the smallest drop at 24.4%. In the case of Hyatt and Accor, the performance was quite disappointing across their brands, and Hyatt seemed to suffer the most as Grand Hyatt and Hyatt Centric decreased by more than 70% at the same time, coupled with a small portfolio and a high proportion of life-style brands.* Data Source: Annual Reports (Marriott, Hilton, IHG, Hyatt, Accor, 2019-2020)The current situation in the hotel industry in association with COVID-19 was reflected in the share prices of the global brand companies, to a certain degree.Looking into the adjusted close price at the end of 2020 compared to the end of 2019, Marriott declined by 13.5% from 151 to $130 and IHG by 6.3% from $69 to $64, while Hilton was not so much impacted at 0.5% from $111 to $110. On the other hand, Hyatt and Accor seemed to be hit significantly by COVID-19, declined 17.7% from $90 to $74 and 21.5% from $47 to $37, respectively. The revenues of global hotel brands are tied to the revenues of their hotels, and therefore, their revenue streams are not free from hotel market conditions. However, most of them held up relatively well in share prices, compared to the circumstances in the hotel market. There seem to be several reasons.* Data Source: Historical Prices, Yahoo FinanceFirst, one of the main reasons is that the decline in revenues of global brand companies were relatively mild compared to the decline in hotel sales.Marriott's revenues fell by 49.6% while its RevPAR fell by 59.0% and Hilton's revenues fell by 54.4% while its RevPAR fell by 56.5%. IHG's revenues fell by 48.3% while its RevPAR fell 56.4%, Hyatt's revenues fell by 58.8% while its RevPAR fell by 67.3%, and Accor's revenues fell by 56.2% while its RevPAR fell by 67.7%. Most companies except Hilton found that the decrease in revenues was about 10% lower than the decrease in RevPAR. The biggest reason is that the global brand's hotel portfolio has continued to grow in 2020. By room count, Marriott grew by 1.8%, Hilton by 4.8%, IHG by 0.3% Hyatt by 10.1% and Accor by 2.0%. In other words, although the revenues from individual hotels decreased, the company's revenues were relatively less affected as the number of hotels generating such revenues increased.* Data Source: Annual Reports (Marriott, Hilton, IHG, Hyatt, Accor, 2019-2020)Second, another reason is that the decline in revenues of global brand companies was effectively blocked from flowing through to the bottom line.Looking at the ratio of decrease in net income to the decrease in revenues in 2020, Marriott was 14.8%, Hilton was 31.2%, IHG was 34.0% and Hyatt was 49.7%. However, in the case of Accor, the decrease in net income exceeded the decrease in revenues at 115.9%, which still seems absorbable considering the size of its capital stack. Of course, none of the companies actually recorded ‘net income’, but ‘net loss’, in 2020, but most of them seemed to have prevented the impact of the revenue decline flow through to the profit through an effective cost management. The size of the portfolio seemed to help here, thanks to the economies of scale. The 2020 annual report showed that Marriott had 1.64 million rooms, Hilton had 101 million rooms, IHG had 890 thousand rooms, Hyatt had 230 thousand rooms, and Accor had 750 thousand rooms.* Data Source: Annual Reports (Marriott, Hilton, IHG, Hyatt, Accor, 2019-2020)Third, the other reason that some portion of liquidity in the capital market, which were unable to find a place to park in the COVID-19 situation, were absorbed by global brand companies.In the hotel industry, where cyclical fluctuations exist all the time, it seems like a common viewpoint to perceive this time as a trough. In addition, based upon past experiences, many people seem to think that there will be a rapid growth behind it. However, since the destructive power of COVID-19 can still knock down any hotel or company in the short term, the capital market seems to focus on these big players with already secured economies of scale. In particular, Hilton may have benefited from its bias towards the Americas region in its portfolio, with an expectation for global expansion after COVID-19. As mentioned earlier, the portion of the Americas region in Hilton’s portfolio at the end of 2020 was 77.1%, larger than its peers.* Designed by slidesgo / FreepikWe don’t know yet when and how the COVID-19 situation will end, and we don’t even know what’s waiting for us at the end of that long tunnel. But as the bright sun rises back at the end of a dark night, there will surely come a day when we will have joke around this time. On the other hand, this dynamic ups-and-downs reaffirms the importance of data. Even in situations that we cannot quite follow and digest, there are cases we finally figure out how it worked as we go through the records later. Once we get there, they tell us a lot of stories. One thing clear in this uncertain times is that the more we listen to the story, the less frequent the recurrence of the same mistakes.* Systemwide: Although the term is used a little differently by company, it generally refers to hotels that a brand company engages in operations through all types of of business models, including owned/leased, third-party management and franchise. On the other hand, “comparable” generally refers to hotels under owned/leased or third-party management models, excluding franchise.

Until COVID-19 stopped everything, it was easy to find articles about growing foreign visitors in Korea along with the Korean Wave. But now they are gone and we can only see some articles about lodging businesses in crisis due to COVID-19. Here come in a question though. How many lodging properties are there in Korea, how much have they earned in the boom, and how hard are they now that the market has disappeared?* Photo by Gabriella Clare Marino on UnsplashAs of 2019, it is estimated that approximately 30 thousand lodging properties supplied approximately 800 thousand rooms in Korea. But why is it not an exact number but an estimate?First, the number may vary depending on how you define a lodging property. Under the Building Code of Korea, lodging properties are divided into three types: general and living accommodation, tourist accommodation, and multi-living facilities (floor area of 500 square meters or more). A lodging business means a business running these lodging properties. Lodging properties are commonly subject to the Public Sanitation Act. In addition, the Tourism Promotion Act is applied to tourist accommodations and the Multi-use Facilities Act is applied to multi-living facilities. As there are differences in the relevant regulations, they are all supervised by different authorities and their statistics are managed separately by each authority. The Ministry of Interior and Safety is in charge of general and living accommodations and multi-living facilities, while the Ministry of Culture, Sports and Tourism is in charge of tourism accommodations.There are certain types of properties not clear where to belong. If you operate a guest house, pension, dormitory, youth training center, youth hostel, camping site, you may or may not be defined as a lodging business. Technically, they are not lodging properties as defined in the Building Code. A guest houses and pension are classified as a single-family house, a dormitory is classified as a multi-family house, and a youth training center, a youth hostel and a camping site are classified as a training facility. In particular, a youth hostel can be more confusing because they have a similar name to a hostel, one of the categories in the hotel.Second, the number may vary due to differences in the scope of management and the aggregation criteria of statistics, subject to the supervising authority. For example, regarding the number of hotel businesses as of 2019, the National Business Survey says 746; the Ministry of Culture, Sports and Tourism says 1,983; and the local governments say 3,091. In the case of the timeshare businesses, the National Business Survey says 300; the Ministry of Culture, Sports and Tourism says 235; and the local governments say 146. The number of motels/inn businesses are said to be 23,074 by the National Business Survey and 19,841 by the local governments. For the others, the National Business Survey says 16,392, and the local governments say 6,600. The biggest factor seems to be how to count the number of businesses if a company operates multiple properties.On the other hand, there is a real challenge to figure out how much they have earned in the boom and how much they have lost in the recession based upon the public statistics.First of all, according to the 2015 Economic Census data, lodging businesses in Korea generated a total of KRW 11.5 trillion in revenues, of which KRW 1.5 trillion was left as profit. It was noted that 53,162 lodging properties participated in the survey, meaning that each property generated KRW 220 million in revenues and KRW 30 million in profit. It is not clear exactly how 53,162 properties were counted, but it is similar to 53,198 properties in local government statistics which includes properties out of business. Meanwhile, according to the Bank of Korea’s Enterprise Management Analysis data for the same year, incorporated lodging businesses generated a total of KRW 6.3 trillion in revenues and recorded an operating loss of KRW 24 billion. We don’t know how many incorporated lodging businesses were included here.Meanwhile, according to the Korea Hotel Association’s data on the operating statistics of hotel businesses, hotels in Korea sold 60% of the total 19 million rooms available in 2015, generating KRW 1.4 trillion in room revenues and KRW 1.3 trillion in other revenues. The statistics do not specify how many hotels participated in the survey, but you can infer from the separate source of data. According to the list of registered tourist accommodations, a total of 1,279 hotels supplied 117,626 rooms during this period. In other words, it is estimated that there were approximately 43 million rooms available, and the sample size in the operating statistics of hotel businesses represent 45% of the total supply. The operating statistics of hotel businesses are no longer available down to an individual property level any more due to the strengthening of privacy laws.Combining the local government statistics and the list of registered tourist accommodations, it seems like 28,674 lodging properties supplied 780,677 rooms in 2019.This includes youth training centers and youth hostels, some of guest houses and pensions, and excludes dormitories and camping sites. Of these, 69% of the accommodations represented by motels and inns. On the other hand, hotels, which provides a better visibility over the operating statistics, account for only 7% of all lodging properties. In other words, the visibility of the lodging market in Korea is limited to 7%. This is a problem because administrative policies or business decisions related to the lodging industry are made based on such limited visibility.Now you no longer have to collect fragmented statistical data and be swamped in errors and inconsistency, to analyze the lodging market or create a business plan for a lodging property.Hotelysis provides a comprehensive visibility over the lodging market in Korea with all the details about 22,459 lodging properties including general and living accommodations, tourist accommodations, and other accommodations as of 2019.This includes detailed data on facility information, demand, price, revenue, expense, working capital, financial position and asset value, which are provided for the period from 2005 to 2019 in the same format. Hotelysis’ AI algorithms have collected fragmented and scattered data from various sources, connected them and filled the blanks. Also, all the datasets went through multiple validation tests as compared to actuals, and are included in the database only when they passed the tests. (Database update 2021.12.15.)Information barriers are increasing among operators, owners, financial institutions, and advisors, who are supporting the segmented value chain of lodging industry. And it’s now coming back as a boomerang, threatening the ecosystem of the lodging industry, blocking the interaction between lodging and capital markets, meaning the flow of market liquidities. Hotelysis will continue to work on breaking down the barriers to help the lodging industry regain stability of the value chain.

In general, the lodging industry is said to be a high-risk industry due to the notorious volatility in cash flows. If you look at the lodging industry as a part of the real estate industry, it may be right. However, if you look at it as a part of the service industry, it may not be right.Photo by Viacheslav Bida on UnsplashIn fact, the lodging industry has the attributes of both real estate and service industries. First of all, non-current assets, including real estate, account for about 75% of the total assets of the lodging industry. In other words, investment in the lodging industry can also be viewed as an investment in real estate. However, unlike the general real estate industry, especially the commercial real estate industry, which is produced to generate rental incomes under long-term lease agreements for the period from 1 year to more than 15 years, the lodging industry distributes space products on a ‘daily’ basis. In addition, fixed expenses such as labor costs are higher than that of general commercial real estate sector. In other words, the cash flow generated in the lodging industry demonstrates a volatile pattern close to that of the service industry such as wholesale and retail.Source: SP 500, Barclays US Aggregate Bond, NCRIEF Property IndexThe commercial real estate is an attractive investment sector because it is a medium-risk medium-return asset class properly combining cash flow stability and capital gain maximization. If you focus on the stability of cash flows, bonds may be more attractive products. On the other hand, if you focus on maximizing capital gains, stocks may be more attractive. Although the extreme arbitrage products such as crypto-currency have attracted many people’s attention in recent years, it has been the norm to form a diversified portfolio by allocating assets to optimize the risk and return profile since the Great Depression in the 1920s. The real estate serves as a counter-weight in the asset allocations.The biggest risk in commercial real estate investment is the decline in asset value, but what stands out more is the volatility of cash flows. This is because the asset value is not recognized until the asset is actually transacted, while the cash flows are recognized on a real time basis. For example, it is difficult to specifically determine the impact of new office supplies in a market, but if tenants start to escape from existing offices, the impact becomes real. Of course, the frequency of this situation in the office sector is not high, and the solution is not so complicated.However, such cash flow volatility is ordinary for lodging properties, and solutions can also be complicated depending on the cause of the volatility. In particular, Korean lodging markets are dependent upon much more variables than the United States, parts of Europe, and Japan. First of all, the non-room revenues with higher volatility and higher cost ratio than the room revenues account for majority in the total revenues. In addition, the non-room revenues and the room revenues move on different patterns. Moreover, even the relatively stable room revenues dependent more upon international demands with heavy concentration on low-tier segment, which is more volatile and price-sensitive than domestic demand by nature. Therefore, the volatility is amplified as compared to the other markets. From 2009 to 2019, the average annual growth rate of effective rent for office properties in Seoul was 1.4% with the standard deviation of 3.6%. On the other hand, during the same period, the average annual growth rate of total revenue per available room for hotel properties in Seoul was 0.8% with the standard deviation was 19.2%.Source: Korea Real Estate Board, TourGo, Korea Hotel AssociationThe volatility in cash flows is reflected directly in the asset value of commercial real estate properties. The asset value of offices and lodging properties, both of which are classified as commercial real estates, depends on the cash flow generated from the assets. For example, a certain discount rate is applied to cash flows, obtained by subtracting operating costs from revenues such as rent, to come up with the asset value. However, a certain level of risk premium is added to the discount rate for lodging properties as compared to that for offices. In other words, when the same cash flow is generated from an office and a hotel, the asset value of the hotel is lower than that of the office.In the first quarter of 2021, the risk premium for hotels, as compared to the offices, in the United States was approximately 2.0%. The capitalization rate, the most easily used discount rate for evaluating the asset value of commercial real estate, for the office was 6.6%, while it was 8.6% for the hotel. In other words, if offices and hotels generate the same net operating profit of KRW 10.0 billion a year, the office’s asset value will be KRW 10.0 billion / 6.6% = KRW 151.5 billion, and the hotel’s asset value will be KRW 10.0 billion / 8.6% = KRW 116.3 billion. The 2.0% risk premium is discounting the hotel’s asset value by KRW 35.2 billion.Source: Real Capital AnalyticsBy the way, why does cash flow volatility affect the asset value in commercial real estate? There is a more realistic reason for this than psychological anxiety. Large-scale commercial real estate is often purchased not only with equity capital but also with debt. The cost of debt, an interest rate, is generally constant or varies insignificantly if it varies. The problem arises when the cash flow generated from the asset is less than the interest to be paid, which is called a default. If the default is prolonged, ownership can be transferred, so a certain level of solvency must be maintained at all times regardless of cash flow volatility. And the greater the volatility of cash flows is, the greater the likelihood of default is, resulting in the stricter requirements for solvency.Unlike offices where cash flow volatility is not high, the lodging properties often struggle with meeting the requirements for solvency. The lodging business is distributing not just the stand-alone space products, but the products combining spaces and services, so operating costs such as cost-of-goods and labor costs are burdensome. In other words, before paying the interest, problems may arise first in the ability to pay such operating costs. Working capital refers to cash and cash equivalents utilized to manage these solvency. To put it simply, you have a certain amount of extra cash so that you can pay the costs before you collect revenues. Of course, as revenues decrease, the burden on working capital increases. And if you don’t have enough working capital, you should be able to raise additional funds elsewhere.Source: TourGo, Korea Hotel Association, KOSISHBI Dashboard provides not only revenues and operating costs data for lodging properties in Korea, but also asset value and working capital trends data by region and property type, for the period from 2005 to 2019. In addition, it also provides relevant macroeconomic indicators together, which allows not only to capture the pattern of volatility but also to diagnose the causes.