Is there value in converting China’s hotels?

Hotels are actively traded assets in Mainland China and Hong Kong, but many investors are buying with a change of use in mind.

March 14, 2018

Hotels are actively traded assets in Mainland China and Hong Kong, but many investors are buying with a change of use in mind.

The market dynamics of China’s first tier cities and Hong Kong are very different, but the result is the same: investors buying hotels in order to convert to other uses.

China has been oversupplied with hotels for some time, says Ling Wei Tan, from JLL’s Hotels & Hospitality Group in Greater China. “A few years ago we saw a trend of hotels being converted to office space but more recently hotels have been bought with the intention of creating apartments for long-term leasing.”

Tan says older hotels, especially those with local brands, are particular targets for conversions, as they cannot compete with newer hotels and international hotel brands.

China is keen to promote the long term residential rental sector to enable young people to live in first tier cities, so there is government support for conversions.

“Converting a hotel to rental apartments is relatively easy and cheap to do,” she says. “Apartment buildings in Shanghai for example can achieve 90 percent occupancy, compared with mid-70s for hotels in the city. The tenancies are also longer.”

A recent example is InfraRed NF’s sale of the Graceland Hotel in Shanghai to Nova Property Investment. InfraRed originally planned to upgrade the hotel from a three star to a four star property but instead sold to Warburg Pincus-backed Nova, which has a portfolio of rental apartments and co-living facilities.

So far the change of use trend is limited to top tier cities such as Beijing and Shanghai. “In second and third tier cities, there is oversupply of hotels still, but often also high supply of offices and apartments so conversions do not add up,” says Tan.

Last year, Hong Kong was one of the busiest hotel markets in Asia Pacific, with HK$12.9 billion of deals, a number of which will result in a change of use.

The city does not have the same hotel oversupply nor the same degree of government intervention as China, but the higher value of other uses – particularly office use – has driven a string of hotel sales with conversion in mind.

For example, Shun Ho Property Investments bought the 317-room Grand View Hotel in North Point for HK$1 billion from Henderson Land Development and the 300-room Rosedale Hotel in Causeway Bay from Bank of China for HK$1.6 billion. It has since applied for permission to convert both hotels to office use.

Shun Ho has been buying hotels for a price of around HK$10,000 per square foot and estimates further costs of HK$2,000 – 5,000 per square foot to convert them to offices.

The best office space in North Point and Causeway Bay sells for HK$30,000 – 50,000 per square foot and while a hotel to office conversion would create lower-grade space it still offers a potential premium to current use value.

The record HK$23.28 billion sale of the Murray Road Car Park site in Central Hong Kong to Henderson Land Development last year sparked interest in sites with potential for office space. Shortly after the sale was announced, Mandarin Oriental Group said it was seeking offers for the Excelsior Hotel in Causeway Bay, which has an existing consent in place for a change of use to commercial space.

Market rumour suggested the hotel might sell for HK$30 billion but Mandarin Oriental pulled the sale in September after failing to secure bids at its required level. However, if office values keep increasing in Hong Kong, the hotel might hit the market once more.