The Hong Kong Hilton: The Case o f the Disappearing Hotel

by William Hsu and Robert O' Halloran

pp. 46-55

Segmentat ion for a Multiunit Restaurant Opera t ion- - Taking Location into Account When Advertising

by David C. Bojanic and Linda d. Shea

pp. 56-61

Bed and Breakfasts in ArizonamDemograph ic and Operating Statistics

by Gary Vallen and Wallace Rande

pp. 62-68

Opened in 1961, the Hong Kong Hilton closed its doors in 1994 to make way for redevelopment of its site into commercial office space. The hotel was closed not because it was unsuccessful or losing money, however. Instead, the decision to close was based on the simple fact that its owner could achieve a higher return on the site from a commercial building than from a hotel. Several factors entered into the decision of Hutchison Whampoa to demolish the landmark property. Among them were the increasing cost of labor, a requirement for retrofitting hotels for sprin- klers, zoning restrictions, and the general cost of real estate in central Hong Kong. The Hilton was by no means the only property removed from supply. Hong Kong lost a net of nearly 900 rooms from 1993 through 1995, even though hotel occupancies averaged above 80 percent for the period and well over 2,000 new rooms opened.

As new restaurants enter the market and franchise operations continue to expand, restaurant owners and managers recognize that customers can vary greatly from one geographic market to another. Market segmentation is necessary to distinguish not only between regional locations but also between specific locations within local markets. This study examines the differences among restaurant customers dining at a downtown location compared to those dining at a similar restaurant in a suburb of the same city. Differences were found in patrons' average age, discretionary in- come, reasons for dining out, loyalty, advertising-vehicle effectiveness, and the relative importance of restaurants' desirable attributes as defined by customers. Downtown diners tended to be younger with lower average annual incomes than suburban diners, but often used employers' money to purchase meals. Downtown diners desire good-quality food delivered in a convenient, timely fashion, while those in the suburbs want good service and value. Suburban diners tend to be more loyal over time and, more so than downtown patrons, are likely to take advantage of advertising ve- hicles that offer discounts and specials.

A 1995 quantitative study of 79 of Arizona's 159 bed-and-breakfast opera- tions yielded a profile of the state's B&Bs. All sample statistics were ex- pressed as weighted averages. The number of rooms for the sample was 4.7 per operation, below the national B&B-industry average of 7.3 rooms. Occupancy was 52 percent, above the industry average of 41 percent, and the room rate was $85, less than the industry's average of $103. The average payroll in 1995 was $30,321, compared to the industry average of $20,832. The average of these B&B's real-estate values was $516,892. Arizona B&B operators spent substantially less on marketing than B&B operators nationwide. More than a third of the respondents felt that net- working opportunities were the most important service offered by an association while another third indicated that referrals were the main benefit.

The H0ng K0ng Hilton

The Case of the

Disappearing Hotel

by William Hsu and Robert O'Halloran

The Hong Kong Hilton was worth more dead than alive, even though it did well

from day one. Here's why.

1 January 22, 1994, Hutchison Whampoa, the company that owned the Hong Kong Hilton Hotel, an- nounced that it had bought out the remaining 20 years of the manage- ment contract with Hilton Hotels Group for US$125 million (about HK$965 million)./The landmark hotel subsequently closed its doors on May 1, 1995, to be torn down and rebuilt as a multi-story com- mercial office complex. The 26- story, 750-room Hilton Hotel was the oldest "grand dame" hotel on the Hong Kong island. It opened its doors in 1961 and had since been the favorite hotel for tourists and dignitaries alike. 2

*South China Morning Post, "The Review," April 29, 1995, p. 1.

2See: Curt Strand, "Lessons of a Lifetime: The Development of Hilton International," Cornell Hotel and Restaurant Administration Quarterly, Vol. 37, No. 3 (June 1996), pp. 83-95.

The announcement also included plans of Cheung Kong Holdings (like Hutchison Whampoa, owned by Li Ka Sing) to j ointly develop Hilton's neighboring sites--a pri- vate car park and the Beaconsfield House, a crown property belonging to the Hong Kong government)

If any hotel deserves the title of institution, the Hong Kong Hilton was that hotel. Its staff of 850 was long-term and loyal. Hilton Hotel employees were given an average of nine months of salary as part of the

3South China Morning Post, September 15, i995, p.B-1.

William Hsu, Ph.D., is a professor at the Hong Kong Polytechnic University, and Robert O'HaUoran, Ph.D., is a professor at the University of Denver.

© 1997, Cornell University

46 I~R~tLI HOTEL AND RESTAURANT ADMINISTRATION QUARTERLY

August 1997 • ~2

Exhibit 1 Hong Kong room supply

R o o m s

a d d e d

Newton Hotel Hong Kong 362

R o o m s d e l e t e d

Silvermine Beach Regal Hongkong Lee Gardens Fortuna Eastern Valley Po Hang Ritz-Carlton China Harbour View Gold Coast BP International House

China Merchant South China Ambassador Harbour Pearl S e a v i e w Hotel

Emerald

135 423 - - 660

187 - - 111 - - 70

216 - - 310

443 536

- - 285 204 - - 313 - - 156

263 - - 316

Peninsula Hotel Extension 150

San Diego Hotel 99 Victoria Hong Kong Hilton

536 7 5 0

Teta/ 2,831 3,694

N e t - - 8 6 3

"retirement fund" Moreover, Hutchison Whampoa was able to place over 60 percent of the Hllton's employees in the new Harbour Plaza Hotel, located in Hung Hom, Kowloon.

James Smith, the Hilton's last general manager, said the buy- out was an unfortunate, but logical business decision: "As a hotel, it's worth $500 million; as an office block, it's [worth] $1 billion." Most hoteliers we contacted agreed that it is un- likely that another top hotel such as the Hilton will be built in central Hong Kong, because land values there are among the world's highest. Moreover, the Hilton was not the first hotel to be bulldozed in favor of com- mercial space. In October 1991 the 194-room Grand Hotel closed its doors in Tsimshatsui, Kowloon, in favor of a multi- story office tower. In 1993 the 20-year-old Lee Gardens Ho- tel in Causeway Bay was also knocked down to make way for a commercial office project. The same fate took the Ambassador Hotel and the China Harbour

View Hotel. Exhibit 1 shows which Hong Kong hotels have checked in and checked out.

Those hotels' removal is made even more peculiar by the fact that tourist arrivals to Hong Kong con- tinue to increase. Arrivals in 1994 grew by 11.6 percent over 1993, to 8.9 million visitors. That number is estimated to double by 2004. With the new Chek Lap Kok Airport under development and further expansion of the Hong Kong Con- vention Center, tourism and con- vention activities should achieve new records. The $64.3 billion gen- erated in 1994 made tourism Hong Kong's second-largest earner of foreign exchange. 4

4Eastern Daily, May 19, 1995, p. 17.

Hotels are traditionally among the most lucrative and glamorous of real-estate projects, even though they are complicated to operate. Hong Kong's annual city-wide occupancy usually exceeds 80 per- cent--a rare performance among international markets. Yet many hotels have been removed even in the face of excellent returns. 5

The case of the vanished Hilton should not be viewed as the story of this hotel alone, because the deci- sion to remove such a hotel affects not only the hotel itself, but also the nature of Hong Kong as a tourist destination. This article explains some of the rationales for the deci- sion to close the Hilton. The reader will see that any hotel owner, devel- oper, or investor must contemplate these issues in determining the best use of a given real-estate parcel.

The Hotel Ordinance On August 8, 1988, an electrical fault sparked a blaze in the lower floors of the 16-story Mirador Mansion in Tsimshatsui. As dense smoke enveloped the building, 327 residents and hostel guests were evacuated. The fire drew 320 fire- men and 27 fire engines. Twenty- three people, including a baby girl, four elderly men, two elderly women, and two firemen were treated for smoke inhalation at the Queen Elizabeth Hospital.

The Mirador is just two blocks away from Chungking Mansion, a building that is home to some 170 guesthouses and businesses, where a Danish tourist fell to his death try- ing to escape a fire. 6 In this mansion, there are about 150 hostels ranging from a single room to multi-story accommodations. Those hostels provide inexpensive and affordable accommodation for hundreds and

SSouth China Morning Post, January 18, 1995, p. B-2.

6South China Morning Post,"Fires," August 8, 1988.

48 EHRNELL HOTEL AND RESTAURANT ADMINISTRATION QUARTERLY

thousands of budget travelers each year. Many of those tourists are from mainland China visiting Hong Kong on a special permit and demanding cheap, short-term accommodations. That in turn encouraged rapid growth of hostels and guesthouses.

Like the Mirador Mansion, the Chungking Mansion was originally built as a residential property. As the number of visitors from the main- land increased, entrepreneurial own- ers have renovated their individual premises into guesthouses. Those owners, however, employed unli- censed electricians and failed to install transformers that would have handled the electrical load created by the appliances installed for hostel guests, particularly in-room cooking facilities. The shoddy and improper wiring allowed fires in the over- loaded cables. Between August t988 and January 1995 the Chungking Mansion experienced a total of 28 fires, most due to electrical short circuits and malfunctions of cookers.

As a consequence of the many fires, the Hong Kong government in September 1988 approved the Hotel and Guesthouse Accommodation Ordinance, which required hotels and guesthouses alike to hold a li- cense to be renewed yearly. The ordinance changed license fees from their former flat rate to a scaled scheme based on a property's total number of rooms. Many hotels faced a fee increase of as much as 13 times over the original annual fixed rate of HK$24,000 per property. 7 The au- thorities also required all hotel op- erators to carry out remedial work to meet new safety requirements before September 1993.

The ordinance drew immediate criticism from the powerful Federa- tion o fHong Kong Hotel Owners, whose members (including Li Ka

7South China Morning Post, January 20, 1995, p. B-2. At current exchange rates, HK$24,000 is equal to about US$3,100.

Handover Headaches With the shortage of rooms and good results from 1996 and early 1997 hoteliers raised room rates in anticipation of Handover, when they expected people to come in droves. Some are coming: there were, for example, 400-plus television stations and well over 7,300 journalists in Hong Kong for the event. But others stayed away due to high prices or were kept away by government action.

Hong Kong hotels faced a particular challenge during the remainder of July after Handover. Many tourists were scared off by the Handover prices, and to make matters worse many hotels asked tourists to book the rooms in a package deal, such as the five days before or after Handover (with little discount). Such sales tactics discouraged many tourists, not to mention business travelers. As a result, the true challenge was to fill rooms the rest of the month of July--when tourists were being lured away by favorable prices in Singapore, Malaysia, and Thailand.

Hotels catering primarily to travelers from the Chinese mainland also suffered because the government stopped issuing visas for the month of July to forestall an expected flood of people to Hong Kong. Thus, Handover has disrupted the hotel trade at all levels. Hong Kong Tourist Association Chief Executive Amy Chan said: "Hotels that are near the Convention Center or on either side of the Hong Kong harbor are full, as they are near the action, but those farther away have had trouble."*--W.H, and R.O.

HandovermHong Kong

Typical Handover Handover Hotel rate rate room occupancy

Peninsula $3,100 $5,000 100% Mandarin Oriental 3,000 4,830 98% Conrad 2,850 2,850 100% Imperial 950 2,600 40% Holiday Inn Golden Mile 1,300 3,500 70% Kimberly 1,550 1,997 50% Royal Park 1,780 1,980 70% Island Shangri-La 2,700 3,850 100% Warwick, Cheung Chau 990 990 95% Marco Polo 1,850 2,380 70% Metropole 1,330 2,409 94% Hyatt Regency 1,680 3,960 94%

Note: All figures HK$. Handover was June 28, 29, 30, and July 1 and 2, 1997.

Source: South China Moming Post, May 20, 1997, p. 3.

*South China Morning Post, May 20, 1997, p. 3.

Sing) owned many of the finest hotels in the territory, such as the Hong Kong Hilton, the Peninsula, and the Mandarin Oriental.

A federation spokesman claimed that "almost all the recognized ho- tels in Hong Kong would fail to meet the new, tougher regulations, and remedial work would cost mil- lions." The federation gave the ex- ample of a new 3-star property that had to spend almost HK$7 million replacing fire-exit doors with the more fire-resistant models.

Federation executive director Michael Li claimed that the Licens- ing Authority's list (of facilities in- cluded in the license law) had un- fairly included some guesthouses and hostels considered by many operators unqualified to claim the title of a hotel, s He suggested that the licensing ordinance should focus only on those guesthouses and hos- tels located in buildings never in- tended for public accommodation--

SHongkong Standard, November 18, 1991, p. 10.

August 1997 • 49

Exhibit 2 Hong Kong economic indices (1987-95)

Economic growth (%)

16

8 .r-.

4

2 ......... J V

0

1987 1988

Unemployment (%)

3.5

1989 1990 1991 1992 1993 1994 1995

i l l l l l . ...... 2.5

2.0

1.5 "~-

1.0

1987 1988 1989 1990 1991 1992 1993 1994 1995

Inflation (%)

14

12

10

8

6 ~

1987 1988 1989 1990 1991 1992 1993 1994 1995

Source: Oriental Daily, October 12, 1995.

exempting purpose-built hotels. Li also contended that the tourism industry of Hong Kong, which earned HK$63.4 billion in 1993, would be endangered by the licens- ing conditions because those rules are inflexible and inappropriate for the hotel industry.

The Licensing Authority also refused to offer any grandfather clause that would exempt those hotels that were already built and that complied with the building codes and fire regulations in force when they were constructed. The authority felt it could not exclude existing hotels from an ordinance that was intended to license all ho- tels and bring them in line with existing codes?

A particularly stringent regula- tion required all hotels to have sprinklers. Old hotels had not been required to have a built-in sprinkler system, and installation of sprinklers would necessitate demolishing up- per floors to accommodate the nec- essary water tanks. Needless to say, such construction would seriously disrupt daily operations and entail great expense.

Importing Labor One of Hong Kong's historic com- petitive advantages was its abun- dance of skilled labor and the re- sulting low wages that meant inexpensive goods and services. Some hotels operated economically with a ratio of two employees for each guest room. After nine years of annual inflation hovering around 9 to 10 percent per year, however, Hong Kong's labor rates in the mid- 1990s were high, compared with neighboring countries such as China, Vietnam, and Cambodia. Many industries (especially manu- facturing) consequently have moved

9Letter to His Honorable Chris Patten, Gover- nor of Hong Kong, Federation of Hong Kong Hotel Owners, October 30, 1993.

5o EBRNELL HOTEL AND RESTAURANT ADMINISTRATION QUARTERLY

to mainland China or elsewhere seeking lower-wage workers. The result was that Hong Kong's economy turned flat in the 1990s. *° Unemployment reached new highs in 1995, and the cost of living soared (see Exhibit 2).

Responding to employers' pleas regarding rising labor costs, the Hong Kong government developed a labor-importation scheme that allows 25,000 "skilled" expatriates annually to come to Hong Kong to work in various industries. The scheme has created contention be- tween employers and employees in virtually all industries, particularly hotels. The hotel sector's quota sup- plied only about 10 percent of its annual labor demand.

Hotel employers contended that the quality and productivity of Hong Kong employees was low, particularly in front-line positions. Employers said they were unable to develop a qualified labor pool that could keep pace with increases in demand. They urged the govern- ment to increase the labor-import quota to the hotel sector. Moreover, employers indicated that their ex- haustive efforts to attract qualified local workers were in vain. Al- though many local workers at- tempted to switch to the hotel sec- tor when their manufacturing jobs moved out of Hong Kong, employ- ers said many didn't measure up even after on-the-job training.

The Association of Hotel and Restaurant Employees vehemently opposed the labor-importation scheme. The association claimed that as hotels dosed down for rede- velopment into commercial space, employees who were laid off found it difficult to find jobs in the same industry. 1* The association deemed employers' request for more im- ported labor to be a move to hire

1°Eastern Daily, October 12, 1995. p. B-I. l~Sing Po, October 7, 1995,p. 10.

Exhibit 3 Hong Kong employment, 1995 Sector Total

Electricity, gas, and water 0.2% Transport, storage, and communication 6.2% Construction (manual workers only) 6.7% ~6staurahts ~ a 66tbiS Wholesale and retail 11.5% Manufacturing 14.8% Community, social, and personal services 15.5% Financing, insurance, real estate, and business services 17.7% Import and export 18.7%

Source: South China Morning Pest, October 13, 1995, p. B-4.

Exhibit 4 Hong Kong hotels: mean revenues and expenses, 1994

Department revenues Rooms 56.5 ° Food 25.6 Beverages 6.8 Other food and beverage 1.2 Telephone 3.8 Minor-operated 3.9 Rentals and other income 2.4

Department expenses Rooms 11.7 Food and beverage 24.0 Telephone 2.1 Minor-operated 2.0

Total 39.9 Department profit Rooms 44.8 Food and beverage 9.4 Telephone 1.6 Minor-operated 1.9 Rentals and other income 2.4

Total 60. 1 Undistributed operating expenses Administrative and general Payroll and related 3.8 Others 2.5 Total 6.4

Marketing Payroll and related 1.2 Others 2.5 Total 3.7

Energy costs 3.4 Property operation and maintenance 3.7

Total undistributed operating expenses 17.2 Income before management fees 42.9 Management fees (base and incentive) 3.7 Income before fixed charges 39.2 Fixed charges 13.6 Income before taxes 25.6 Reserve for capital replacement 1.1

*Excludes hostels and guesthouses.

Hostels, guest-

65.4% 19.1 4.0 0.9 4.3 3.8 2.4

All High tariff High tariff Medium hotels tariff hotel,,

(%) (%)

i5.4 18.7 2.5 1.6

38.2

Source: Horwath Asia Pacific

50.1 5.3 1.8 2.3 2.4

61.8

5.0 2.5 7.5

1,2 1.4 2.6 3.9 3.5

17.5 44.3 2.6

41.7 11.1 30.6 0.9

August 1997 • 51

cheaper labor and reduce their pay- rolls and benefit expenses while claiming to upgrade quality. The employees also charged the employ- ers with blatant age discrimination when they allegedly recruited young expatriates, rather than retaining local, laid-offworkers (in their late 30s and 40s) and thereby saved money on the company retirement and pension plans) 2

Both sides have sought help and political influence from the Legisla- tive Council, the statutory law- making body in Hong Kong. The election campaign for the sole seat in the council's hotel and restaurant- service sector, held in 1995, pitted candidates supported by the con- tending groups. Chan Wing Chan was nominated by the Association of Hotel & Restaurant Employees with heavy union support, while Michael Li is the same person who is execu- tive director of the Federation of Hong Kong Hotel Owners.

Chan won the seat by a relatively small margin. Shortly after, on Octo- ber 12, 1995, Governor Chris Patten announced an amendment to the labor-importation scheme that would reduce the hotel allocation from 25,000 to 5,000 workers annually.

Operating Costs A hotel is a complicated and expen- sive business to run. Horwath Asia Pacific compiled figures showing that payroll expenses for Hong Kong hotels reached 37 percent of rev- enue. Hotel operation is also a cycli- cal business. Even considering Hong Kong's high average occupancy, its hotels squandered its owners' capital with unsold rooms. Comparing ho- tels' expense percentages with those of a commercial office complex, one sees that management fees, utility bills, security-management charges, HVAC, and other costs are generally

t2Sing Po, October 3, 1994, p. 14.

being borne by the tenants of a commercial building. Payroll is not a factor. As a result, owners of com- mercial properties can often antici- pate a strong return on their capital investment. Exhibit 5 compares de- veloping a hotel with developing a commercial building, with figures compiled by Pannell Kerr Forster.

Would statistics like those in Ex- hibit 5 convince a hotel owner to make the drastic decision to demol- ish a hotel and build a commercial building? Not alone, but they add another factor to those already dis- cussed. Perhaps most fatal is the as- tonishing rise in land values and the demand for commercial space.

The Plot Ratio Thickens Since mid-1992, Hong Kong's office-rental market has strength- ened rapidly. Rentals hit a low of HK$16 per square foot during the 1991 recession, and stood at $38 a square foot just after Tiananmen Square in 1989. By 1995, however, rents in central Exchange Square were hitting $100 per square foot.

The Jones Lang Wootton index recorded that office rents increased 40 percent during 1993 alone, and climbed another 10 percent in the first two months of 1994. Given the demand, grade-A office space is drastically in short supply, especially in Central, where the vacancy rate is a mere 2 percent. Average monthly rents in Central are now around $90 per square foot- -one of the highest rates in the world. Most real-estate analysts expect commercial rents to continue their rise and believe office space will be in great demand, espe- cially at prominent locations in Central.

On a commercial site in Central, the market value of a grade-A office space is 4.5 times that o fa tariff-A hotel such as Hilton. 13 Exhibit 6

13South China Morning Post, March 3, 1995, p. B-10.

gives a simple comparison of the return available in Hong Kong for a commercial office building and that of a hotel. The office building gives greater cash flow and offers a higher residual value than the hotel under the assumptions existing at the time of the Hilton decision. That higher expected return from commercial development placed hotels in a disadvantageous position.

The Hong Kong Hilton was located at 2 Queen's Road, the center of Central District and a premier location with a relatively unobstructed harbor view. But the hotel's mere location was not the only real-estate factor that hastened its demise. Zoning restrictions also became a problem. At the time of the decision to demolish the Hil- ton, Hong Kong's building and planning regulations contained no zone especially for hotels. For that matter, the government offered no special tax incentives for hotel developers.

A particular aspect of the zoning code, the plot ratio, worked against hotels. The plot ratio specifies the relationship of the square footage of a building to the square footage of the land on which that building rests. The higher the plot ratio, therefore, the less restrictive the zoning. Domestic properties, for instance, have a plot ratio of 8 to 10, while non-domestic and com- mercial ones have a plot ratio of 15. I4

Hotels were generally treated as domestic rather than non-domestic or commercial properties. Hotel developers were generally assigned a plot ratio of 10, which would generally include the basement and the engineering rooms. At that, they had to obtain the concessions from the government to get that high a ratio.

14South China Morning Post, March 3, 1995, p. B-10.

52 EBRNELL HOTEL AND RESTAURANT ADMINISTRATION QUARTERLY

T O U R I S M M A N A G E M E N T

The plot ratio was calculated at the time the government auctioned the land. Factors bearing on the ratio are density of population, sew- age availability, and transportation services.

Considering land values, potential return, and fire and zoning codes, it is little wonder that the owners of hotel properties have been doing their sums. "You cannot blame the hotel investors," said Manuel Woo, executive director of the Hong Kong Hotels Association,"but we are seeing an epidemic of hotels turning into commercial buildings, and I am very concerned." The situation in Hong Kong is unusual in that office space is extremely valuable, while the incentives to own a hotel are few. Even more peculiar is the fact that the hotels being demolished were profitable enterprises, in contrast to, say, hotels in New York City in the mid-1960s, when many unprofitable properties were leveled.

Hilton Aftermath The demolition of hotels seems to have abated in recent months. Per- haps the real-estate market has reached some sort of balance be- tween office space and hotels. Nev- ertheless, two of the major hotels in Central, the 605-room J.W. Marriott Hotel and the 513-room Conrad Hotel, were unexpectedly put on the block to be sold. Both owners gave their reason for the sale as get- ting rid of non-core business. The owning group of the Conrad, the Taiwan-backed Pacific Electric Wire & Cable conglomerate, wants to sell its 30-percent stake in the Conrad for HK$600 million, while the Brit- ish Swire Group put a price tag of about HK$2.8 billion on its wholly owned J.W. Marriott Hotel. Both hotels are located in Central and both hotel-management companies are expected to continue their man- agement of the hotels after the sale.

Exhibit 5 Comparison of hotel and commercial projects

Factor

Development costs

Operating costs

Years to reach stabilized operation

Staff required Capital replacement Occupancy variance Payback period

Hotel

Luxury hotel, HK$1,195 per sq. ft.

- Luxury hotel, 74 percent

3 to 4 years i 1.6 persons per room 2-3 percent annually Daily 8 to 12 years

Commercial building

Grade A (excluding land) per building, HK$990 per sq. ft. Insurance, gross-revenue tax, maintenance expenses passed to tenants

1 year Fewer than 40 total 2 to 3 percent every five years 2 to 3 years' lease terms 2 to 5 years

Source: Panneit Kerr Forster ConsuJting Limited

Exhibit 6 Redevelopment values of office and hotel

Office Development criteria Construction period 3 Plot ratio 15.0 Net site area (sq. ft.) 40,000 Gross floor area (sq. ft.) 800,000 Net-floor-area efficiency 0.8 Net floor area (sq. ft.) 480,000

Construction costs 1 Hard costs (including FF&E) Soft costs 2

Total construction costs (excluding land)

Projected market value Net site area 40,000 Plot ratio 15.0 Gross floor area 600,000 Market value (sq. ft.) $ 7,363 Hotel income 3 Hotel cap rate 4

Market value (1998) less: total construction costs

Residual site value Discount factor 5

Market site value (1995) Owner's profit (@25%)

Residual site value (HK dollars)

$594,000,000 $266,735,700

$860,735,700

$4,417,800,000 $860,735,700

$3,557,064,3O0 0.731

$2,600,214,003 $650,053,501

$1,950,160,502

Hotel

3 12.5

40,000 500,000

0.65 325,000

$597,500,000 $268,307,375

$865,807,375

40,000 12.5

500,000

$167,232,317 0.0925

$1,807,916,941 $865,807,375

$942,109,566 0.712

$670,782,011 $167,695,503

$503,086,508

Hotel residual site value as percentage of office residual site value: 25.8 percent Increase in hotel plot ratio for hotel value to equal office value: 3.88

1 Construction costs for office at HK$990 per sq. ft. and HK$1,195 per sq. ft. for hotel including FF&E; source: Davis, Langdon, and SEAH 1994 Handbook. 2 Period of 1.5 years at t 1.0-percent interest-only rolled into financing. 3 Stabilized hotel income (all HK$): average rate, $1,700; occupancy, 85 percent; total revenues, $643,201 220; departmentat Income, $347,971,860 (54.1 percent); income before management fees and fixed charges, $232,195,640 (36.1 percent); income before debt, depreciation, taxes, $167,232,317 (26.0 percent). 4 Overall capitalization rate on base market sales. 5 Three-year construction period at an 11-percent rate for office and a 12=percent rate for hotel to reflect a higher cost of capital for hotels.

Source: Pannell Kerr Forster Consulting Limited, "Comparative Marketing Position" (Heng Kong Hotet Market Position Paper), p. 1fl-45.

August 1997 , 53

Exhibit 7 Public companies' hotel holdings

Company Hotels

Mandarin Oriental Mandarin Oriental Excelsior

Rooms

542 897

Hong Kong and Shanghai Hotels Peninsula Hotel 300 Kowloon Hotel 735

Shangri-La Hotels and Resorts Island Shangri-La 718 Kowloon Shangri-La 565

Regal Hotels International Hong Kong Regal 425 Kowloon Regal 592 Airport Regal 385 Regal Riverside 828

Grand Hotels Grand Plaza 248 Grand Tower 549 Wesley 251

New World Hotels New World Harbour View 862 New World Hotel 543

Omni Hotels Omni Hongkong 665 Omni Marco Polo* 440 Omni Prince* 401

Furama Hotel Enterprises Furama Hotel 517 Majestic Hotel 387

Lai Sun Garment Int'l Ltd. Ritz Carlton Hotel 216

Jardines Matheson Holdings Ltd. Conrad Hong Kong 513

Great Eagle Holdings Ltd. Hongkong Renaissance 500 Eaton Hotel 422

Sino Land Co. Ltd. City Garden 615 Royal Pacific 675 Gold Coast Resort 450

* Owned by Wharf (Holdings) Ltd. Source: Ming Po, September 9, 1995.

Existing hotels are in a strong position to charge high room rates. Because of high occupancy throughout the year, remaining ho- tels have been able to increase room rates substantially beyond the annual 9-percent inflation rate, jumping rates by 15 to 20 percent annually and by 25 percent in some cases.

While those room-rate increases are keeping the hotels alive, they also may be driving some price- sensitive tourists elsewhere in Pacific Asia. Until the new hotel rooms are opened, room rates will almost cer- tainly continue to escalate. That puts even more pressure on the Hong Kong tourism industry.

Prospects Many of the factors that contributed to the downfall of the Hilton and other hotels remain unresolved. The recently completed changeover of administration of Hong Kong makes matters even more uncertain.

Fire ordinances. The Hotel Ordinance (fire code) went to the newly elected Legislative Council (Legco) for consideration, but China authorities insisted that the election of that council constituted a viola- tion of the agreement between China and Britain. Dissolved as of June 30, 1997, the former Legisla- tive Council will be replaced by new officials to be selected out of 400 current members. The fire ordi- nance remains in limbo.

Plot ratio. The government of Hong Kong has set aside about nine sites for hotel development in Hong Kong and Kowloon. Most of these sites are in suburban rather than central areas. In a move to encour- age development of these hotel sites, the government announced on Sep- tember 2, 1995, a relaxation of plot ratios for hotel developments to a maximum of 15, similar to that of other commercial developments. At the same time, however, the govern- ment also decided to remove any concession regarding the basement and the engineering plant rooms for the purpose of calculating the plot ratio for new hotels. .5 This conces- sion was regularly made to hotels for the past 30 years.

The plot-ratio changes failed to stimulate a major rush to develop or expand hotels, probably because of the confusion with the simultaneous change in the ratio and elimination of the basement concession. ~6 The relaxation of the plot ratio has little effect on the 16 districts in Kowloon

lSMing Po, November 21, 1995,p. 10. 16South China Morning Post, September 19,

1995, p. B-9.

54 I U ~ t l l HOTEL AND RESTAURANT ADMINISTRATION QUARTERLY

T O U R I S M M A N A G E M E N T

where most hotels are located. The chart in Exhibit 9 shows the distri- bution of Kowloon hotels.

The Conrad Hotel announced expansion plans, but the effect of the sale of Pacific Electric Wire & Cable's stake in the property is as yet unknown. One other hotel that plans to increase its floor space and room count by as much as 32,000 square feet is the 392-room Eaton Hotel, in Kowloon. 17 Its owning company, Great Eagle Holdings, has been in the construction business for many years. Actual construction of the extra hotel floors will be done by Great Eagle's real-estate arm.

Financial Decision The decision to demolish the Hong Kong Hilton and replace it with commercial space was one of eco- nomics. For a real-estate-business conglomerate like Hutchison Whampoa, the commercial office building offers far greater appeal than did the hotel. ~8 For a publicly traded company, moreover, the board of directors' responsibility is to ensure that the stockholders earnings are being maximized. In this case, the owner had what could be characterized as a fiduciary duty to investigate and compare the two types of real-estate investment and calculate the best return. The pres- tige value of owning a world-class hotel does not offset the simple calculation of financial return on an office building.

Does this mean that hotels will disappear entirely from Hong Kong (or any other destination)? The answer is that some companies are specifically in the hotel business, rather than in the business of man- aging a real-estate portfolio. Such

~TSing Po, October 8, 1995,p. B-3. lSSouth China Morning Post, December 17,

1994, p. 23.

Exhibit 8 Plot-ratio comparison, l-long Kong and Kowloon

Highest plot ratio under old scheme* Area

Hong Kong 10 times 15 times

Kowloon Domestic: 9 times Commercial: 9 times

Highest plot ratio under existing scheme

Domestic: 9 times Commercial: 12 times

*Includes consideration of basement and utility space, which effectively increases the plot ratio.

Exhibit 9 Distribution of Kowloon hotels (1995)

Hostels, guest- High tariff A I High tariff B I Mid-price I houses (no.

Areas (no. of hotels) (no. of hotels) (no. of hotels) of operations)

Tsimshatsui 1,619 (3) 6,623 (11) 3,612 (8) 1,780 (9) Yau Ma Tel, Mong Kok - - - - 1,990 (5) 1,064 (5) Kowloon City - - - - I 389 (1) - -

I

Total 1,619 (3) 6,623 (11) 5,991 (14) 2,884 (14)

Total

13,634 (31) 3,054 (10)

389 (1)

17,077 (42)

Note: The above does not include the Harbour Plaza Hotel and the San Diego Hotel completed in fall 1995 (source: Ming Po, October 8, 1995, p. 8-3).

publicly listed hotel companies as Shangri-La Hotels and Resorts and Regal Hotels International, which will construct its fifth Hong Kong hotel at the new Chek Lap Kok Airport, are unlikely to face the kind of decision that Hutchison made. Companies like Shangri-La and Regal will generally not be affected by short-term deterrents involved in government regulations. They will continue to develop ho- tels, work with the government (old and new), and continue to operate hotels.

Moreover, with the new conven- tion center being completed just before the 1997 Handover and the new Chek Lap Kok Airport to be completed by August 1998, Hong Kong is expecting a greater influx of tourists. With the shortage of rooms, developers are rushing in to capitalize on the strength of the tourist market. Thus, there will al- ways be room in the inn. CQ

Exhibit 10 Hotel supply in Hong Kong

No. of No, of Year end Hotels Rooms

1987 56 21,022 1988 65 22,882 1989 69 27,031 1990 75 28,146 1991 82 31,163 1992 86 33,534 1993 88 34,044 1994 85 33,490 1995 86 33,052 1996 88 33,536 1997 (estimate) 93 35,101 1998 (projected) 106 40,641 1999 (projected) 115 44,128 2000 (projected) 116 44,436

Source: Hong Kong Toudst Associa- tion, Hotel Supply Situation, No. 1, January 1997.

August 1997 * 55