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Hotel investors in Australia are confronted with two types of risk when constructing diversified portfolios; systematic and unsystematic. Systematic risk (also known as market risk) is the part of total risk that cannot be eliminated or reduced, no matter how well an investor attempts to diversify a hotel portfolio. It is the volatility due to national fluctuations (or fluctuations in an aggregate group of investable markets, e.g., capital cities plus Gold Coast and Cairns) and all hotels have some systematic risk. The greater the systematic risk of a hotel, the greater the return investors should expect from the hotel. No matter how much total risk a hotel has, only the systematic portion is relevant in determining the expected return (and the risk premium) on that hotel.

Unsystematic risk (also known as specific risk), on the other hand, is the risk due to the idiosyncratic fluctuations unique to a hotel, a competitive set of hotels or a city hotel market. It is the proportion of total risk that is not associated with contemporaneous fluctuations in national performance and while it cannot be eliminated entirely, it can be reduced through diversification. Exhibit 1 ranks the top 10 Australian hotel markets from lowest to highest systematic risk (left to right) assuming 5-year holding periods and an investable universe of the top 10 hotel markets.

Exhibit 1: : Historical Systematic and Unsystematic Risk Measured by Annual RevPAR Growth for the Top 10 Australian Hotels Markets with a 5-Year Holding Period Ending 1993 -2019

Source: Hotel Investment Strategies, LLC based on Australian Bureau of Statistics and STR data.

Interestingly, with a longer holding period of ten years, systematic risk declined in only three markets, Sydney, Melbourne and Hobart as illustrated below.

Exhibit 2: : A Comparison of Historical Systematic Risk Measured by Annual RevPAR Growth for the Top 10 Australian Hotels Markets with 5 -Year and 10 -Year Holding Periods.

Source: Hotel Investment Strategies, LLC based on Australian Bureau of Statistics and STR data.

Beyond markets, the analysis to identify the proportion of systematic and unsystematic risk should be undertaken at the tract and the competitive set level to help determine the expected return (and the risk premium) on a prospective hotel investment.

Savvy hotel investors understand that the price of a hotel should be determined by its contribution to a diversified portfolio. Investors are not willing to pay a premium for bearing risk that can be diversified away. The expected rate of return an investor chooses to value a hotel should reflect the contribution the property makes to a well-diversified portfolio.