Investment Challenges and Opportunities in the Cyprus Tourism Sector
17 July 2014 | Philip Ammerman
The Cyprus tourism sector has rightly been identified as a priority for the economic recovery of the country. Forecasts for 2014 tourist arrivals are positive, with both the Cyprus Tourism Organisation and other sources pointing to an increase in arrivals from key markets. A recent increase in hotel investments, together with Cyprus’ revised foreign investor residence and citizenship programmes, also point to renewed interest in this sector. This article reviews the general development of the Cyprus tourism sector after the 2013 Cyprus Economic Crisis, and outlines some key barriers for hotel investments.
The Cyprus Tourism Sector
In 2013, a total of 2.405 million foreign tourists visited Cyprus, a decline of only 2% over 2012. The United Kingdom was the largest source country, with 37% of total arrivals, followed by Russia, with 25%. Sweden comprised 5% of arrivals, followed by Greece with 4%, Germany with 4%, and Norway with 3%. As seen, the tourism sector is heavily dependent on these two countries.
Figure 1: Cyprus Tourism Arrivals
The general arrivals level conceals important changes in the arrivals by country. Particularly noteworthy is the decline in UK arrivals, which has fallen from a high of 1.49 million in 2004 to a low of 891,229 in 2013. In recent years, this decline can be traced to the decline of the pound sterling against the Euro, and due to the UK economic crisis between 2008 and 2011. Over the entire period, however, the decline in UK arrivals is worrying. The UK has traditionally been Cyprus’ main source market, accounting for about 50% of all arrivals. That by 2013 this had fallen to 37% of arrivals is worrying indeed.
The success story of Russian arrivals, by contrast, has partially offset the loss of the UK source market. Russian arrivals have been rising steadily since 2004, when they amounted to 83,818, to a high of 608,576 in 2013.
Russian tourists are also highly desired by the Cyprus tourism industry. In February 2014, UK tourists stayed an average of 12.4 days and spent EUR 663.2 per person. Russian tourists, in contrast, stayed 11.6 days, but spent EUR 899.6 per person, a difference of 36% more.
German arrivals have been falling steadily since 1998, when they reached 208,356, to 98,930 in 2013. Greek and Swedish arrivals have been variable, with small differences year on year.
Figure 2: Cyprus Tourist Arrivals by Country
Table 1: Average Length of Stay and Expenditure, February 2014
Cyprus Statistical Service
The Cyprus tourism sector remains highly seasonal. November – March comprise the low season, and as a result many hotels and entire tourism areas close during these month. In contrast, July – September now constitute the high season, with June nearly at the same levels. This has important impacts in tourism investment and sectoral planning, as will be discussed in more detail further in this article.
Figure 3: Cyprus Tourism Arrivals and Revenue by Month, 2013
Strong forecasts for incoming tourism have been announced for 2014, at least in some segments. Although the Russian economic situation and the Russian/Ukraine conflict point to lower arrivals from these two countries, CTO predicts that incoming tourism from the UK will rise in 2014.
The fundamental importance of tourism to the Cyprus economy is not in doubt. The Cyprus Statistical Service reported that revenue from tourism reached EUR 2.082 billion in 2013, up from EUR 1.55 billion in 2010. This is 13% of the 2013 GDP estimate of EUR 16.5 billion.
The World Travel and Tourism Council tracks a wider contribution of tourism to GDP. In its Economic Impact Report for Cyprus in 2014, the WTTC predicts that:
The total contribution of Travel & Tourism to GDP (including wider effects from investment, the supply chain and induced income impacts, was EUR3,443.6mn in 2013 (20.6% of GDP) and is expected to grow by 7.4% to EUR 3,700.1mn (24.0% of GDP) in 2014. It is forecast to rise by 5.1% pa to EUR 6,067.7mn by 2024 (30.9% of GDP).
Investing in the Cyprus Tourism Sector
"In principle they have only the finance sector and beaches to offer and now the banks are on their way to closure,” Anders Borg, Minister of Finance, Sweden (referring to Cyprus)
Following the March 2013 Eurogroup decisions and the European Union’s attempt to destroy the offshore banking model of Cyprus, attention has turned to the Cyprus tourism sector as the driving force of the Cypriot economy.
Press reports in recent months point to a few high-profile investments in the Cypriot hotel sector, including:
China Glory International Investment Group stated that it would purchase the Venus Rock Golf Resort for EUR 241 million in August 2013 from Aristo Developers. This transaction is apparently still being completed.
Russia’s Emerald Coast Properties contributed EUR 20 million to the Limassol Le Meridien’s share capital increase, securing a 50% ownership of the hotel.
Kanika Olympic purchased 55% of the Paphos Amathus in late 2013, and will transform this into an Olympic Lagoon hotel.
Despite these attractive headline figures, there are a number of negative trends in the tourism and specifically the hotel sector, which should be taken into account by any potential investor. These are:
Destination closure in key tourist areas
High fixed costs
High price competition
Low flights and controlled access
Each point is discussed in further detail below.
Many Cyprus hotel owners have still not developed a reasonable valuation for their properties. Valuations are often quoted based on theoretical asset prices drawn from balance sheet indicators, rather than from valuations of the property based as a going concern.
It is readily apparent that any investment in a Cyprus hotel today should first and foremost generate a return on capital invested. Given that most hotels are losing money, generating this return remains an open question. Yet investments based on theoretical discounts to capital values, or a future theoretical rebound in enterprise value, are unattractive to any qualified investor.
In early 2013, the author was approached by an intermediary that wanted to sell a 255-room, 5* Limassol seafront hotel for a starting price of EUR 90 million. This price is totally unreasonable, as the return on the investment would take between 12-15 years to recover, assuming a significant recovering in bookings in this property. The recent Meridien purchase (329 rooms, EUR 20 million for 50% ownership) is a good example of just how far valuations have fallen, and how far they have yet to fall.
Cyprus hotel occupancy is low: below 50% on average. Table 2 shows capacity as a function of bed nights, using official statistics provided by the Cyprus Tourism Organisation for licensed accommodation in 2012 (the last year for which data is available). This table shows that:
Cyprus had a total of 85,956 officially-licensed beds in 2012. Paphos and Aghia Napa-Paralimni have the largest concentration of beds in Cyprus, followed by Limassol. Assuming each hotel operates 12 months per year (they do not), the theoretical capacity was 31.37 mln bed-nights.
Actual bed-nights in licensed accommodation was 14.75 mln nights. Assuming the theoretical bed night capacity is correct, then occupancy was only 46.5% on an annual basis. The highest occupancy is seen in Paphos and Aghia Napa. The lowest is seen in the Hill Resorts and Nicosia.
Table 2: Cyprus Bed Capacity and Occupancy
In reality, most resort hotels close from mid-October to early April or May. This means that net occupancy, after deducting capacity due to hotel closures, is usually between 75-80%.
This destination closure practise comes at a high price:
Hotel staff must be recruited each year. This leads to a large proportion of transient hotel works, and detracts from a hotel operator’s ability to form a cadre of permanent staff and invest in guest relationships.
As hotels close, all other tourism suppliers close too: restaurants, bars, cinemas, car rental agencies, travel agencies, etc. This creates huge distortions in all aspects of employment and value creation.
The destination suffers. Visitors to Paphos, Aghia Napa and Paralimni as well as the Larnaca Tourist Area find themselves in a ghost town, with even banks and franchise restaurants closed for the winter tourist season.
Closing a destination seasonally has a deleterious effect on infrastructure. There is no reason to schedule flights to Cyprus in the winter, for instance, if there is no demand. This makes Cyprus entirely uncompetitive for certain categories of tourism, such as conferences and events.
As a destination, Cyprus finds itself competing against other, less expensive destination at the most competitive part of the tourist season. For a British tourist deciding whether to choose a June holiday in Cyprus or Turkey, it becomes easier to choose Turkey due to its lower prices and, in many cases, superior customer service.
Paphos in Winter © Philip Ammerman, 2014
High Fixed Costs
One of the main issues confronting Cypriot hoteliers is the high fixed cost environment they are forced to operate in. These costs include:
High electricity prices: Cypriot electricity prices were among the highest in the European Union according to Eurostat. Only Denmark and Germany had higher household electricity prices in 2013.
Last year, Cyprus passed an Immovable Property Tax (IPT), which will hit hotel owners in particular.
Food and beverage ingredients are to a large extent imported. This creates food costs that are usually far higher than competing destinations such as Greece, Turkey or Spain, who have a greater proportion of domestic production, or greater economies of scale and lower-cost land transport links.
High labour costs. The limited labour market and the lack of interest among many Cypriots to work in hotel professions means that most hotel labour comprises expatriate staff. This staff is usually hired at or below minimum wage, but the overall cost remains high, particularly when compared with other Mediterranean destinations.
High Euro exchange rates. While the Euro has declined by 4.8% against the Sterling, it has appreciated by 14.5% against the Russian Rouble, 6.2% against the Swedish Krona, 7.6% against the Norwegian Krone and 3.9% against the US Dollar in the past 12 months, making a holiday in Cyprus comparatively more expensive.
High Price Competition
Hotel prices are declining. While absolute figures are difficult to provide, the impact of the 2013 crisis has been to drive prices to extremely low levels. It will take 2-3 years to regenerate pricing ability, if this is possible at all.
Over the longer term, pricing competition will remain high. Online travel agencies such as Booking.com not only demand the best prices available (usually lower than on the hotel’s own website), but increase price transparency in the market.
When this is paired with meta travel search engines and fare aggregators such as Kayak, Mobissimo, Trivago or Skyscanner, it means that hoteliers face insurmountable challenges to maintaining pricing ability and margin levels.
Low Flights / Controlled Access
Access to Cyprus has, until recently, become more limited as Cyprus Airways has cut back on routes; Olympic Airways has been absorbed by Aegean; other flag carriers have reduced flights. Access in the peak tourist season is now dominated by low cost and charter airlines. While this was always the case, the consolidation of the European airline sector, and the emergence of low cost carriers are dominant airlines in much of central and eastern Europe, means that the situation is becoming more difficult than ever.
For hotels in Cyprus, this means that it is more difficult for tourists to choose a hotel independently from the flight, or a complete tourist package. As a result, margins erode further as tour operators dominate bookings, and hotels are forced to offer half board or full board specials in line with tour operator policy.
One additional downside in Cyprus is that of unlicensed accommodation. The occupancy numbers presented are under-stated because they refer only to licensed tourism accommodation, not to unlicensed accommodation. The latter has grown significantly as villas and apartment blocks were built during the boom years and are sold online to tourists. The evidence of this is seen everywhere you look:
Online travel agencies (OTAs) such as Booking.com have significant numbers of unlicensed rooms available: a simple search is sufficient to uncover these.
Specialist villa booking sites, such as VillasDirect or OwnersDirect show hundreds of offers for Cyprus. Almost none of these villas are licensed.
Any discussion with a Cypriot hotelier, or walk through the tourist area of a Cypriot resort, shows abundant further evidence of this.
CTO claims it cannot regulate this sector, and has been saying this for a long time—long before the villa construction boom. Implementing the law in Cyprus can be difficult, particularly when there are so many special interests and influential figures involved, and when CTO does not have the mandate or the resources to take legal action. This would pit CTO against the Municipalities in whose jurisdiction the unlicensed accommodation falls, and would quickly result in a massive internecine struggle which CTO would lose to special interests.
Yet the failure to act also creates problems. Law-abiding hoteliers see that rule-breakers are not punished, and are absolved of the high taxes a hotelier must pay to operate in Cyprus. What incentive does a law-abiding hotelier have to respect the laws in the face of official inaction and economic hardship? Not many. It should be no surprise, and is certainly no secret, that many hotel owners have branched out into illegal villa rentals themselves.
Cyprus Investors Citizenship
One upside of investing in the Cyprus hotel sector is the availability of the Cyprus nationality for investors. Any investor placing a minimum of EUR 5 million in the purchase of assets, shares, government bonds or long-term deposits has the right to citizenship according to the Decision by the Council of Ministers of the Republic of Cyprus of 19 March 2014.
The Cyprus tourism sector is expected to continue its trend line performance in 2014. Although the prospect for higher UK arrivals exists, this will be offset by lower Russian arrivals. There are few major changes expected in the sector. One positive aspect will be the tendering of a casino, scheduled for 2014, but this will take some years to materialise, and will not have a measurable impact on visitors.
As the financial crisis runs its course, we anticipate more Cyprus hotel properties to be offered for sale. As with any investment, it is imperative to implement a comprehensive due diligence, business plan and risk analysis prior to the investment. A coherent valuation model is needed: this is likely to be one of the main challenges in any hotel sale in Cyprus.
With few exceptions, decades of over-investment and a lack of differentiation has meant that the Cyprus hotel sector has become commoditised. Low occupancy, low profit margins, the erosion of pricing ability, continually-rising costs and overcapacity in every accommodation segment means that most hotels lose money.
This is not to say that investments will not take place and that an adequate financial success cannot be gained. But the days of “easy money” in the Cyprus hotel sector are long over. Any investor approaching the issue should do so with a clear strategy and operating plan, deep pockets necessary to provide working capital in lean times, and a strong appetite for risk.
Philip Ammerman has worked as a consultant in the Cyprus tourism sector since 1993. He has advised the Cyprus Tourism Organisation in its 1993 strategic restructuring, and most recently in setting up a system for managing EU Structural Funds. He has worked with the Association of Cyprus Travel Agents on a range of issues, including the liberalisation of the sector under the Doha round and development of a 5-year organisational strategy. He has advised over 80 hotels, travel agents and tour operators on online marketing and financial change via strategic training programmes organised by the Cyprus Chamber of Commerce and Industry, the Cyprus Tourism Organisation and the Association of Cyprus Travel Agents.