What’s the price of sitting on the sidelines?
by Simons Chase, Editor-in-Chief
SAN JUAN, PUERTO RICO – “Where to start?” was a topic of interest at the Cuba panel of the CHICOS 2015 HVS Caribbean Hotel Investment Conference held this week in San Juan, Puerto Rico. For hotel developers and operators, distilling the bigger picture and framing the argument around risk management was a key take away that industry players focused on.
The Upside in Cuba
The first consideration is to evaluate the magnitude of the opportunity in Cuba’s hospitality and tourism industry and, in particular, the hotel sector. While detailed hotel sector data remains elusive, by all accounts, occupancy and RevPar appear to be in a strong uptrend. A robust development pipeline confirms this trend as media reports indicate full occupancy as a limiting factor for visitor growth during this year’s high season.
Cuba’s current development pipeline includes new entrants as well as incumbent players exploiting opportunity in the most dynamic segments of the hotel sector. For example, Germany-based Kempinski has partnered with Gaviota, a Cuban government entity, to refurbish a landmark building in Old Havana into a 246 key, 5-star luxury hotel (Hotel Manzana) slated to open in 2016. There appears to be a French construction company involved in the project – a sign this hotel is being constructed under a date-certain, fixed price contract that is standard in more mature marketplaces.
Of the estimated 18 foreign hotel brands active in Cuba today, Meliá Hotels is by far the most important single foreign player. The Spanish company started operations there in 1990 and today manages about 3,000 rooms via 27 management contracts with various entities of the Cuban government (excluding current projects under development).
Meliá has announced two new projects. The largest is the Meliá Veradero Internacional. This renovation of an existing property will become a 934 room all-inclusive resort divided into two areas: families and adult-only.
It is vital for Cuba’s stated national development goals to make the hospitality and tourism industry deliver as a source of dynamic growth. There is no other industry capable of driving the growth that Cuba needs after decades of isolation and chronic lack of investment. It is equally vital for the government to transition employment away from the government – the dominant actor in the economy today – to the private sector.
Cuba’s central planners are undoubtedly looking at the Dominican Republic’s (DR) economy for a roadmap as to the potential for hospitality and tourism to be a key driver of growth and transition. The DR enjoys the top spot for tourism in the Caribbean with 5.14 million arrivals in 2014, a 9.6% growth in arrivals from the prior year.
What’s more compelling is the dynamic link between the DR’s growth in tourists arrivals and GDP growth – a feature that is presently absent in Cuba’s economy. According to Smith Travel Research, the DR logged 2014 occupancy of 71% for reporting hotels, up 0.56% from the prior year. The reported ADR was $124 (up 10.76%), leading to RevPar of $88.31 (up 11.63%). The bottom line for the DR economy was 7.5% top line growth in 2014, driven mostly by the hospitality and tourism industry.
Cuba, with a similar number of rooms and 40% fewer arrivals compared to the DR, logged virtually no top line economic growth in 2014 despite double-digit growth (estimated) in hospitality and tourism. Thus, the keystone to Cuba’s national economic policy means a long-term alignment of interests with hotel operators and developers to produce economic growth and transition.
How much growth is there? Reports indicate Cuba could support 10-12 million annual tourist arrivals within a decade. There is no other place on earth today with visibility on 300-400% growth in the hospitality and tourism industry within a relevant timeframe for hotel developers and operators to execute against.
The Risks in Cuba
Putting aside country risk, Cuba has no shortage of risks for developers and operators to address when putting boots on the ground. According to the Cornell’s Center for Hospitality Research, the four main risks are: (1) finance and banking availability is lacking; (2) the Cuban government must be a partner in every foreign enterprise; (3) labor availability and terms are controlled by the government; and (4) the nation lacks credible dispute resolution entities (courts or arbitration).
Despite these risks, Cuba has attracted an impressive pipeline of projects by both new entrants and incumbents. While the vast majority of these projects involve operators’ securing management contracts, there are recent reports of developers partnering with Cuban government entities for equity stakes in new projects. And some new mixed development projects include the sale of villas and condos to foreigners.
The U.S. embargo virtually rules out any form of participation by a U.S. entity at the moment. Within this window, non-US developers and operators appear to be finding plenty of opportunity – and the Cuban government is likely to continue to favor non-U.S. entrants no matter how the rules change in the future.
What’s the price of sitting on the sidelines? There are two positive changes that could propel the hotel sector into overdrive and leave the latecomers with only scraps to pick over. First, the U.S. will eventually end the embargo and open the sector to U.S. players. Second, Cuba could resolve its sovereign debt situation, join the World Bank and International Monetary Fund (IMF) and embark on a massive infrastructure investment program under new long-term sovereign credit facilities. In this case, tourism and hospitality would likely gain even more focus as a vital source of employment and also a source hard currency to support debt service payments denominated in $US or Euros.
Finally, these two factors could be resolved simultaneously thereby creating a stampede situation not favorable to – and perhaps even hostile to – new entrants. In this case, Cuba would also have to resolve the issue of U.S. claims stemming from the expropriation of property and businesses after the 1959 revolution. Such a sweeping change would be a tall order but not out of the realm of possibility.
So, where do you start? The Cuba government publishes an annual Investment Portfolio with details about projects suitable for foreign investors. According to reports, this year’s list includes 59 hotel management contracts. The Brookings Institute published an insightful and still relevant summary of last year’s 168-page portfolio. According to Brookings, “The government publication provides remarkably frank, data-rich surveys, sector by sector, of current production capabilities and shortfalls – must reading for specialists in the Cuban economy.”
For U.S. investors, the Cuba Journal published a Complete Guide to Investing in Cuba that addresses special considerations for U.S.-based investors. There is a link to last year’s Investment Portfolio.
The Cuba Journal has so far been unable to find the current Investment Portfolio document. It was announced just a few days ago, so there may be a delay in gaining access to the document. Check back for updates.
Yet the best place to start is by getting on a plane and going to Cuba.
