The knock-on effect - 10 October 2008

Posted by Paul Collins No comments

Without wanting to wander into the realms of massive understatement, the financial crisis now gripping the globe is set to have an impact on each and every one of us. For starters, the government has committed us to investing in the UK banking system to the tune of up to £50 billion. The effects, of course, go further than this.

Anyone who is invested in the stock market will be having kittens every time they check the prices (or just the headlines) in the papers, as this morning’s 10 per cent opening plummet in the FTSE 100 will testify. Anyone with savings, pensions or a mortgage will be checking numbers, rates and the health of relevant institutions regularly. Most will be hoping that the worldwide cut in interest rates will be passed on to mortgage customers in full, though interestingly, Northern Rock was slow to announce any such plans, despite being state-owned.

However, the crisis is also starting to drive other types of company out of business. One of these, which went into administration just last week, was Guest Invest. While most London commuters will be familiar with the company name through an advertising campaign, their business model and operation may not have been so clear.

The principle was to buy hotel properties as a company, sell individual rooms to investors who then lease them back to the hotel and share the rental profits from running the hotel as normal. The buyer of each room was also guaranteed up to 52 nights per year of free accommodation in ‘their’ room. Opinions on the reasons for the company’s failure differ, from being a victim of the decline of HBOS, who were a major investment partner, to a flawed business model – either way; the credit crunch has taken its toll.

The business model of the company certainly seems to be set up for the good times in the economy. Alistair Powell, chief executive of investment group 7CI, explains: “Guest Invest bought glamorous properties solely in central London at the height of the market, invested heavily in their redevelopment and then gave away half their income. Operating costs remain the same whether it was a paying guest or the owner staying in the room. The company was giving away half its income through free rooms, but its running costs were a further drain on profitability.” 7CI, it should be noted, invest in condo-hotel projects that they have thoroughly ‘stress-tested’ through due diligence, and which they have invested in themselves – usually a good marker for the amateur property investor.

I have long been a fan of the condo-hotel proposition, provided that the location, hotel class and profitability of the scheme have been thoroughly researched. One of the best I have seen in recent years came from the US, and was an opportunity to buy in a top-end hotel from a worldwide brand on the Strip in Las Vegas. While the entry level for this opportunity was considerable, occupancy rates of over 95 per cent at the time in the city pointed towards a profitable investment. Add to this the amount of building that has gone on around the outskirts of Las Vegas with new properties and apartment blocks springing up, and the value of a new development on the Strip is multiplied.

I am always in favour of new ideas for investments in the property markets – this is how the markets evolve, change, and eventually gain strength to weather market conditions. Guest Invest is an unfortunate example of how the property industry evolves – an idea that was great at the beginning has been found out under the spectre of economic gloom, but hopefully it will lead to the improvement of the model to allow it to survive the downturns.

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