Why developers are turning to hotels, not apartments

The cracks are starting to show. After years of defying reality about the Dublin office market’s prospects, developers are now embracing the hotel market as never before. The latest convert is the German property group KGAL, which wants to knock down an office block on Dublin’s Golden Lane and build a 225-bedroom hotel. They follow in the footsteps of Core Capital’s Derek McGrath and of Johnny Ronan’s eponymous property group, both of which have reversed planned office developments. The change of heart reflects an anaemic market for office space in Dublin, with CBRE expecting the take-up of office space this year to be roughly in line with last year but below the long-run average. They see a few bright spots on the horizon and tentative signs of the new development cycle, helped somewhat counter-intuitively by demand from artificial intelligence companies. A more downbeat view is expressed by Peter Keegan, the director of debt and structured finance at CBRE, in a letter submitted to Dublin City Council as part of the KGAL planning application. It can be paraphrased as saying that, notwithstanding the green shoots mentioned above, lenders are wary of office development in Dublin. READ MOREOr, as Keegan put it, “there will be much deeper liquidity from debt providers for the development of a hotel on the site versus a new office building ... this is a development which will be received more positively as a hotel project than a speculative office scheme”.Lenders call the shots in property development, and their enthusiasm for hotel projects is easy to understand. There is a well-documented shortage of hotel rooms in the capital, as evidenced by high occupancy rates. The shortfall is put at 3,600 beds, which equates to 20 or so hotels along the lines of the one planned by KGAL. The downside with hotels is you have to find someone to run it for you, but if you can get more than 80 per cent occupancy, you will do well. It’s not a one-way bet. About 2,600 new beds are already in the pipeline, according to consultants Mitchell McDermott. The window of opportunity is closing and hence the stampede towards hoteliership by office developers. From this perspective, their lack of enthusiasm for building apartments is hard to understand given the much larger and open-ended demand – 50,000 homes a year for the foreseeable future. Again, the KGAL planning application is instructive. It contains an assessment of the site’s potential for an apartment development. The planning report argues that if the various rules and regulations pertaining to apartments – such as access to daylight and minimum open spaces – were to be complied with, then the maximum number of apartments that could be built on the site is between 50 and 60 units. This would not be “viable” even though it is a 10-minute walk from Grafton Street. The site’s suitability for student accommodation is also deemed not to be “viable”. Urbanest, the student accommodation provider, kindly supplied a letter saying planning constraints “render it not possible” for student accommodation of sufficient scale to be viable. Two-hundred bed spaces would be needed. Viability gets mentioned a lot in the KGAL planning application, but it is not really defined. Presumably what they are talking about is commercial viability and that is something of movable feast. It takes a lot of factors into account, including the value of the site for other uses, the costs of construction and the availability and cost of debt financing. It also includes opportunity cost – whether you might make more money using the debt and resources required for Golden Lane elsewhere.Viability is thus not the same thing as profitability. It may well be profitable to build apartments or student accommodation on Golden Lane, but just not as profitable as building a hotel. Whether it is “viable” to choose an option that delivers a lower profit is another question entirely. It is perfectly reasonable for KGAL to argue it is not viable for them to choose an option – such as apartments instead of a hotel – that will deliver a lower return to their investors.But that does not mean it would not be viable for someone else with access to cheaper funding and different objectives, such as the Land Development Agency, to build apartments. Dublin city planners would be doing us some service if they looked a little deeper into the question of viability. Is KGAL saying it would not be profitable to build apartments or student accommodation on Golden Lane or simply that it would be more profitable to build a hotel? The planners might then apply their own definition of viability. It would seem axiomatic that if a 60-unit apartment development could be built at a profit, it would be more than viable from the perspective of the Government’s obligation to house people.