Hotel investment opportunities in Hungary.
By Lorenz, Andreas F.,Cullen, Thomas P.
Publication: Cornell Hotel & Restaurant Administration Quarterly
Date: Thursday, December 1 1994
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Despite its problems, Hungary may be the most attractive investment environment in
Eastern and Central Europe.
ALTHOUGH MUCH of the euphoria about the opening of Eastern and Central Europe
has waned as a result of the complications involved in operating in that unstable
environment, development and expansion of the hospitality sector has continued
steadily. The lead countries for hospitality development have been the Czech Republic,
the Slovak Republic, Poland, and Hungary. Hungary, with its stable political environment
and relatively progressive reforms, has been the subject of special attention that has
resulted in its receiving over half of all foreign investment destined for Eastern and
Central Europe. Moreover, due to its long-standing history as a tourist destination, and
its relatively liberal pre-1989 policies, Hungary received quite a bit of attention from
Western hotel companies even before the breakup of the Soviet Bloc. Political changes
begun in 1989 brought many foreign investors to Hungary, and Western hotel chains
began rapid development of properties. A large void in the luxury segment was quickly
identified and filled, and this segment has now essentially reached saturation. However,
opportunities still exist for developers and operators who are willing to face the
difficulties and frustrations involved in entering the Hungarian market. In 1993 I
interviewed three Hungarian hotel executives and nine Western hotel executives
(European and American) to elicit their perspective on economic development and
investment opportunities in Hungary. Prior to expanding on where those opportunities
lie, this report reviews Hungary's privatization methods, supply and demand in the
hospitality industry, and some of the strategies that have thus far been employed to enter
the Hungarian market.
Government and Privatization
With privatization and economic-reform efforts now in their fifth year it is evident that
the Hungarian government, while trailing behind its original schedule for converting
from a centrally planned to a market economy, is genuinely committed to economic
transformation. Privatization has been slowed by the government's efforts to prevent
unemployment and inflation rates from getting out of control. That foreign investors
agree with this approach is reflected in the US$2 billion dollars in cash and other assets
that they pumped into the Hungarian economy during 1992.(1)
Privatization efforts in Eastern and Central European countries cannot be compared to
privatization that has occurred in Western market economies. There are a limited
number of applicable experiences for Hungarian officials to draw on. Furthermore, the
absence of functioning capital markets renders the valuation and sale of properties and
companies chosen for privatization difficult.
Privatization in Hungary is controlled by the government-run State Property Agency
(SPA) and began on a grand scale in 1989. One of the stated goals is to transfer ownership
of most state-owned enterprises to the private sector within a five-year period. While
some areas have been earmarked for Hungarian majority ownership, one of the goals of
the SPA is to attract a considerable inflow of foreign capital.
An important aspect of SPA policy is that bids are not assessed by purchase-price offer
only. Equally important, if not more so, is that takeovers or joint ventures help the longterm economic goals of Hungary in such areas as technology, management, and
finance.(2)
In October 1993 a new governing body, the Hungarian Investment and Trade
Development agency (ITD Hungary), was created to boost exports and to attract foreign
investors to Hungary. ITD Hungary is a Western-style, independently incorporated
company that was set up with the help of Irish, Canadian, and German advisors. Among
other areas, it will focus on the tourism industry. However, ITD Hungary differs from the
SPA in that it is concerned with selling smaller properties (those valued at US$2 to $30
million), none of which are government owned. This allows the agency to avoid the
agonizingly slow process of privatization that has crippled investors' attempts to buy
Hungarian hotels.(3)
Because Hungary got a head start on privatization, in comparison with other Eastern and
Central European countries, those neighboring countries have had the benefit of drawing
on Hungary's experiences.
Four approaches. There are four primary methods of privatization employed in Hungary.
The first may be referred to as piecemeal in nature. Under this method privatization takes
place unit by unit. Thus, for example, a large manufacturing company would be split up
and each factory would be sold singly to investors, or, in the case of a hotel company, each
of the company's hotels would be privatized individually.
Under the second method companies are privatized as a whole, with foreign or local
investors acquiring equity in the entire business. A recent example of this form of
privatization is the purchase of the Hungarian hotel chain Pannonia by the French hotel
giant Accor. Accor acquired a 51-percent stake in Pannonia in 1993 and plans to use
Pannonia for its Eastern and Central European expansion strategy.
A third alternative is floating a company on the stock exchange. This method was
successfully employed in privatizing the Danubius hotel chain. To encourage investment
by domestic entrepreneurs, the initial public offering may be structured to provide
financial incentives for local investors. These incentives can include tax deductions,
preferred loans, bonus shares, and discounts for buys in excess of a set number of shares.
Shares may also be offered exclusively to local investors for a specified period, after which
the remaining shares can be sold to foreign investors. The Danubius offering, against all
expectations, proved so successful that it was bought up entirely by Hungarian
investors.(4)
EXHIBIT 1
Hungary tourism earnings (US$millions)
1988
531.50
1989
541.70
1990
824.00
1991
1,002.30
1992
1,231.40
Source: Based on figures collected by the Central Bureau for
Statistics.
A fourth method is the use of vouchers. Under this system vouchers are given to the
public who can redeem them for equity in a particular hotel or other business. This
system has been quite popular in the Czech Republic. The drawback is the danger of
investment funds moving in and managing vouchers for multiple individuals on a large
scale by promising a guaranteed return. Since these funds would then in essence control
the privatized business, they could exercise enough power to divert badly needed
reinvestment funds to voucher holders. This may ultimately lead to the decline of the
company in question, because reinvestment is more important than ever at this stage of
the game.
The Importance of the Tourism Industry
According to a 1989 Economist Intelligence Unit Report, Hungary in the late 1980s
received roughly 20 percent more visitors than the United Kingdom, while its revenues
from international tourism barely exceeded 10 percent of those of the United Kingdom
because the visitors to Hungary were primarily from poor Eastern countries.(5) This
situation, however, is changing. An increasing number of visitors now originate from
Western countries and tourism has become the major foreign-currency generator of the
Hungarian economy. In 1992 tourism contributed between 7 and 8 percent to the GNP.
The dollar figure amounted to over US$1.2 billion, an increase of 23 percent over the 1991
figure.(6) The official tourism earnings between 1988 and 1992 were as shown in Exhibit
1.(7)
EXHIBIT 2
Arrivals in Hungary and Romania 1989-1993 (excluding day trips)
HUNGARY
ROMANIA
1989
14,490,000
4,901,000
1990
20,510,000
6,533,000
1991
21,860,000
5,360,000
1992
22,096,000
6,280,000
1993
23,000,000
NA
Source: World Tourism Organization
The Hungarian Tourist Board, however, estimates the total 1992 convertible foreignexchange receipts to be between US$2.5 and $3 billion. The reason for this difference is
that officially registered tourism receipts exclude transactions through personal foreignexchange accounts and also direct foreign-exchange transactions between foreign tourists
and privately owned enterprises or individuals.(8)
Tourism Slowed Down
The Hungarian hospitality industry experienced two strong growth years in 1989 and
1990, especially in Budapest. This was followed by three more or less stagnant tourist
years (1991, 1992, and 1993). Reasons for this slowdown include the Gulf War, the
continued ethnic conflict in the former Yugoslavia, the unification of Germany (Hungary
used to be one of the favored tourist destinations for East Germans, who now
predominantly explore Western countries), political changes in former Soviet Bloc
countries, and a worldwide recession. Even by the end of 1993 tourist-arrival growth was
nowhere near the incredible 41.5 percent of 1990. However, tourist spending per capita is
on the rise, so income generated by tourism continues to increase while visitor numbers
remain almost stagnant.
A situation that deserves closer attention is the vast difference between the total number
of overnight tourists and the total number of registered hotel guests, which in 1992
totaled about 22.096 million and 2.801 million respectively. The following explanations
may shed some light on the issue. Roughly 60 percent of the foreign visitors to Hungary
originate from the former COMECON countries and the former Yugoslavia. Of these the
majority stay with friends or relatives. In addition, much of the travel originating from
the former Yugoslavia consists of permanent refugees who do not use temporary lodging.
Furthermore, many Hungarians supplement their income by renting private rooms to
tourists, thereby providing a very popular alternative for both foreign and domestic
travelers.(9) According to the Central Bureau for Statistics, registered private rooms for
rent have a nationwide capacity of more than 78,000 guests while the capacity of
unofficially rented rooms is estimated to be as high as 558,000. As such, the number of
unregistered private rooms cannot be dismissed lightly.
Arrival Figures
Despite the slowdown, Hungary remains the most frequently visited nation in Eastern
and Central Europe, with a 7.7-percent market share of total arrivals to Europe in 1992.
The closest rival in Eastern and Central Europe was the former Czechoslovakia, which
trailed far behind with a 2.8-percent market share.
Hungary has continued to experience growth while many of its neighbors have recently
experienced declines in tourist arrivals. Two notable exceptions are Poland, which
experienced healthier growth rates than Hungary for 1991 and 1992 (although not in real
numbers), and Romania, which experienced a growth rate of 17.2 percent in 1992.
However, Romania's rate of tourist arrivals has fluctuated widely over the past few years,
probably due to the internal problems of political stability, and the 1992 increase still left
Romania's tourist-arrival figure below its 1990 total.
Supply: Location, Distribution, and Type
By far the most important tourist destination in Hungary is the capital, Budapest, which
is often referred to as the Paris of Eastern Europe. This city of over two million
inhabitants (roughly one fifth of Hungary's total population) functions as the country's
hub of transportation and its center of economic and cultural activity. According to
Horwath Consulting in Hungary, 45 to 47 percent of Hungary's total guest nights are
spent in Budapest. Thus one should not be surprised to find that 44,000 of the country's
282,000 total beds are found in the capital. It must also be emphasized that Budapest has
roughly 24,000 of the country's 66,000 hotel beds--and that included among those are
92 percent of all five-star hotels and 77 percent of all four-star hotels countrywide.(10)
While the total number of beds includes registered hotels, guest-houses, bungalows,
camping grounds, and private rooms, there are many nontraditional lodging sources that
have been omitted (and are discussed later).
Hungary's second most important tourist destination is the Balaton region. Lake Balaton
is the largest and warmest freshwater lake in Europe, with nearly 200 kilometers of
shoreline providing both sandy and rocky beaches. In the summer the lake is ideal for
water sports, while it usually freezes over in the winter, providing opportunities for
various winter sports. In addition to being the premier destination for lakeside relaxation
and water sports, the Balaton area is also well known for its health spas, historical
buildings, and the fine wine produced there. The Balaton region, according to the
Hungarian tourism authorities, has a total of some 88,000 beds, of which 11,000 are in
traditional hotels. According to the Hungarian tourism authorities, the Balaton region
comprises a total of 56 hotels, of which there are three four-star and seventeen three-star
properties, but no five-star accommodations.
The Danube Bend is the third most visited destination in Hungary. It is located
equidistant (about a two-hour drive) from Budapest and Vienna, and is popular for its
scenery, riverside spas, and beaches. Other popular destinations include Matra-Bukk,
Hungary's largest wine-producing region; and cities such as Soporon, close to the
Austrian border; and Pecs, in the south.
Nontraditional Lodging
The development of guest-houses or pensions is a significant trend and a growing source
of room supply. According to Janos Hegymegi, executive managing director of Horwath
Consulting in Budapest, roughly 60 small pensions have been developed in Budapest
during the last three years alone. Hegymegi figures that, given an average size of 15
rooms, they add about 900 rooms to the capital's supply and range from two- to four-star
quality. Meanwhile, Hungarian tourism authorities estimate that there are 481 pensions
nationwide.(11) However, the government's figure does not include those pensions with
fewer than 20 rooms. Consequently, although state officials speak of 34 pensions for the
nation's capital, Hegymegi's figure of somewhere around 60 is likely to be more accurate.
Private rooms. A second, substantial source of room supply in Hungary is the renting of
private rooms. Many Hungarians add to their incomes by renting private rooms to
tourists. Due to its affordability, this lodging alternative is especially popular among
domestic travelers and those from other Eastern and Central European countries. It is
difficult to get an exact figure on the size of this type of room supply. Hungarian tourism
authorities put the number of homes privately renting rooms at 17,289 with 78,077 beds
and a total number of 3.46 million guest nights. However, this figure represents only
those privately rented rooms that have been registered. The figure of non-registered
rooms is estimated to be substantially higher: 131,035 homes with 558,075 beds.(12)
Former party and union hotels. Under the communist government both the party and the
labor unions owned hotel-like properties where party officials and union members could
spend their vacations. The Balaton area was one of the prime spots for these properties,
many of which have since come onto the market, nearly doubling the Hungarian hotel
capacity. However, these properties are usually of such poor quality that they do not even
approach Western standards. Since renovations would be too expensive in most cases,
complete replacement may be the only solution.
Vacation homes. Due to the lack of investment possibilities under the communist regime,
a significant portion of Hungarians invested their savings in vacation homes. These
homes are usually much nicer than their primary places of residence and are most often
found at Lake Balaton and the Danube Bend. Since it is customary to have relatives stay
at these homes and to rent them to friends, there is little potential for domestic tourism in
those areas. A knowledgeable local source estimates the potential of domestic tourism in
major vacation destinations as a maximum of 10 percent of the total tourism to those
destinations.
The Hungarian Gaming Industry
In 1993 there were thirteen casinos in Hungary, nine of which were located in Budapest.
The most popular casino, the Imperial in Pest, attracted between 500 and 600 guests per
day, while the second most popular casino, the Gresham, attracted roughly half that
number.(13) At that time all Hungarian casinos except one were hard-currency based.
The usual currencies for gambling and pay-outs of winnings are Deutschmarks, Austrian
schillings, or U.S. dollars.
The Hungarian gaming market is clearly dominated by Austrian interests, which are
represented through the Casinos Austria Group. The group has shares in 12 gambling
establishments together with the 100-percent Hungarian state-owned Gambling share
company. (Gambling Kft, Szerencsekerek Kft, and Elso Magyar Jatekkazzino Kft are
subsidiaries of Szerencsejatek Rt.)(14) Other interests have originated from Germany,
Great Britain, Israel, Spain, and the United States. By July 1993 three new casinos had
opened and two or three new projects were soon to come on-line. While up to that year
the majority of gambling establishments had been located in the capital city, the new and
planned casinos tilted the scales somewhat so that provincial casinos now outnumber
capital-city establishments.
By 1993 the finance ministry had issued a total of 25 licenses and was considering
applications for five more casinos. While some analysts are beginning to argue that the
Hungarian gaming market has reached saturation, the government authorities are
enticed by the $1 million concession fee that comes with a five-year license.(15)
To make the fee somewhat more attractive, the government is tapping new markets by
moving toward allowing domestic-currency-based casinos. While this change in policy
theoretically opens the door to all of the roughly ten million Hungarians, the real number
of potential domestic customers is much lower due to continued unemployment and the
decline in real wages. This makes highly profitable casino operations based on domestic
gamblers more of a dream than a possibility, at least for now.
When the competition for operating existing gambling establishments was opened up in
1990, applicants calculated their costs and returns based on a ten-year license which, up
to that time, had been the norm. They were unpleasantly surprised when they were
granted only five-year licenses (with very few exceptions for luxury casinos). Nonetheless,
many went ahead with their projects and are now facing difficulties.
While the state-owned Elso Magyar Jatekkazzino Kft declared a 1992 income of 22
million Deutschmarks (U.S.$14.67 million) and a net profit between 10 and 22 percent,
German-owned Schilling Kft stated that its three casino operations were not expected to
recoup their initial investments during the duration of the five-year license.(16) On the
other hand, operators of the American-owned Las Vegas Casino stated that during its 422
days of operation it had attracted 233 customers per day, earned 8.9 million
Deutschmarks (roughly US$5,514,250) and paid US$3.56 million in gambling tax.(17)
Privatization and Supply
There are three main hotel companies in Hungary. These formerly state-owned
companies--Danubius, Pannonia, and HungarHotels--control well over one-third of the
total hotel-room supply and thus influence the Hungarian hospitality industry
tremendously. All three companies were at various stages of privatization when I wrote
this article. According to one Hungarian hotel executive, in 1992 the three competitors
shared the market in the following manner: Danubius controlled roughly 10 percent,
HungarHotels controlled roughly 15-16 percent, and Pannonia controlled about 13
percent of the entire market.
Danubius
Danubius is interesting in that it is only in indirect competition with the other two
Hungarian hotel giants. By concentrating almost exclusively on thermal-spa hotels, with
the exception of a few high-quality urban hotels, Danubius has been able to carve a niche
almost all its own. The emphasis on thermal-spa hotels and the related specialization in
associated medical treatments have created an international reputation and wide
clientele for Danubius.
According to Danubius's 1902 annual report , the company's occupancy rate for that year
was 69.7 percent, which was 23.7 percent above the national average. Occupancy figures
for the first half of 1993 were at 68 percent and were projected at roughly 70 percent for
the entire year. Virtually all guests were foreigners (94.8 percent). The major source
countries were Germany, Austria, Switzerland, and the United States.
The privatization of Danubius. In the course of privatization Danubius disposed of
operations that were not profitable and sold its lucrative interest in Hungarian casino
operations (Casinos Hungary Ltd.). According to Sandor Betegh, president and CEO of
Danubius, this latter point was a result of the decision to concentrate exclusively on the
market for thermal-spa hotels.
Initially the SPA had hoped to sell Danubius (or a stake thereof) to a Western buyer.
However those plans had to be abandoned when a 1991 tax-law change had severe
negative effects on the company. In December 1992 Danubius made the news when it
went public by floating 25 percent of its equity on the Budapest stock exchange. The
flotation raised $24 million and was viewed as extremely successful, especially in that the
entire issue was bought up by Hungarian investors. (Previous flotation attempts of other
companies had been much less successful, making Hungarian investors cautious.)
Shares of the company are being held by small domestic investors, municipalities,
Danubius employees, individual Danubius hotels, and the SPA. The SPA holds roughly 30
percent of the shares and is looking for a large, possibly foreign investor. Danubius's two
most profitable franchised properties (Hilton and Ramada) will stay in the Danubius
group, much to the dismay of the franchising companies that were hoping to gain full
management contracts.
The future. In response to questions about long-term strategy, Betegh stated that the
company will remain dedicated to the operation of thermal-spa hotels in Hungary.
Danubius will seek to expand its market and the number of operations in that country,
but is also looking at international expansion. Expansion in Eastern and Central Europe
was considered difficult due to nationalism and the resulting potential for anti-Hungarian
sentiments in some neighboring countries. However, Betegh declared that Danubius's
expertise in operating spa hotels was sought after internationally and that entities in such
countries as Germany, England, Ireland, Israel, and Egypt had expressed interest in
working with Danubius.
Pannonia
Pannonia, in contrast to Danubius, is a traditional hotel company. Its target markets are
tourists and business travelers, not spa guests. However, the company stands out among
the three formerly state-owned hotel companies in that it has properties in Germany and
Austria.
During a personal interview, Gregor Berghof, managing director of Pannonia Hotels
Munchen GmbH, supplied the information for the following account of Pannonia's recent
history. Pannonia was hit badly when the Hungarian parliament voted to discontinue all
government subsidies. For Pannonia this meant that it suddenly had to pay 29-percent
interest on its Austrian loans. It had previously paid only 6 percent and the Hungarian
government had subsidized the difference. Pannonia found itself with 215 businesses of
which 129 were losing money as a result of the loss of government subsidy. The company
was facing bankruptcy and had to look for foreign capital. This essentially meant that
Pannonia had to privatize. A stock company was created, with the SPA holding 100
percent of the stock, and J.P. Morgan was put in charge of valuing Pannonia. To make the
company more attractive for foreign investors, all but 45 of the 215 businesses--including
many non-hotel, small-staff operations--were sold and the labor force was cut from 9,000
to 6,000 people.
The Accor-Pannonia deal. The privatization process was internal. In other words, J.P.
Morgan valued the company and then sent the result to a selected group of interested
entities who then had a certain amount of time to make an offer. Among the highest
bidders were Hyatt, Accor, and private bank consortia. Accor's bid for 51 percent of
Pannonia's stock was found to be most attractive by the SPA. The bid is believed to have
valued the hotel company well above $103 million, which was Pannonia's last recorded
book value at that time.(18)
As it turns out, Pannonia was actually purchased by a consortium, headed by Accor, that
includes the European Bank for Reconstruction and Development (EBRD), the Italian
investment group IFIL, Accor's long-time financing partner Bank Indosuez, and the
insurance company A.B. Generali. The consortium paid nearly 140 percent of face value
for its 51 percent of the shares and Accor plans to spend an additional $30 million
renovating existing Pannonia properties.(19) Earlier reports had indicated an initial
pledge by Accor of $15 million for refurbishment.(20)
Under the deal's arrangement, assets valued at Hungarian forint (HUF) 1.1 billion will be
separated from Pannonia and transferred back to the SPA and local councils. Among the
assets to be transferred are the Olimpia and the Palace hotels in Budapest, numerous
restaurants in the Lake Balaton area, and a 49-percent stake in Pannonia-Fusion Rt. (the
company that operates Burger King quick-service outlets in Hungary).(21)
The Pannonia properties in Germany have been a source of some confusion. Trade
magazines refer to Pannonia in Germany being included in the Accor deal; however,
Berghof stated that the German venture is excluded from the deal. The HungarianGerman collaboration started about eight years ago and was finally founded with 60-
percent Hungarian and 40-percent German interests. However, due to the way that the
statutes in the contract founding Pannonia in Germany were written, Accor would have to
own 75 percent of the Hungarian-German venture to exercise control.
According to Laszlo Juhasz, privatization manager, Pannonia Hotels, Hungary, the
venture with Accor will work in the following way. Pannonia and Accor will focus on
upgrading the existing Pannonia properties. Pannonia will become the representative for
Accor in Eastern and Central Europe and will manage Accor products for Accor in that
market area. Some will become Accor brands and some will stay under the Pannonia
name. Accor will not directly develop hotels in Eastern and Central Europe; Pannonia will
be in charge of Eastern and Central European expansion. Pannonia products will be
similar to those of the Accor brand Mercure. Profits from franchise and management fees
in Eastern and Central Europe will be divided between both companies. Some analysts
expect that the remaining 49 percent of ownership will eventually be floated on the stock
exchange.
The future. If the Accor-Pannonia deal actually materializes the way Juhasz envisions, it
sounds like a mutually beneficial relationship. Pannonia will be provided with a muchneeded injection of foreign capital, as well as additional Western management expertise
and access to Accor's international reservations system, "Resinter." Accor, on the other
hand, will gain an immediate and strong presence in Hungary. Because the Pannonia
brand is well known throughout Eastern and Central Europe (a result of the large
numbers of Eastern and Central European tourists who travel to Hungary each year),
there is a strong potential for developing the brand in the entire region.
Accor's resources and its need for strong connections for Eastern and Central European
development, coupled with Pannonia's expertise in dealing with the bureaucratic process,
could make the two companies a formidable team. On the other hand it should be kept in
mind that a native Eastern European or Central European brand could almost be a
liability due to nationalist resentments.
Furthermore, it remains to be seen whether Accor's plans for Pannonia are indeed as rosy
as Juhasz outlined them. The first potential dispute may well arise over the status of the
German and Austrian Pannonia properties in this deal.
HungarHotels
The biggest Hungarian hotel company, HungarHotels, is in direct competition with
Pannonia. In 1989 HungarHotels was the first of the three state-owned hotel companies
to make the headlines due to privatization efforts. But those headlines, unfortunately,
were the result of a scandal.
A Dutch-Swedish consortium had made a bid for 51 percent of the company and that bid
was approved. However, when it became public that the purchase price had the
approximate value of one building, parliament decided to reverse the decision. According
to Sandor Betegh of Danubius, the SPA took away about 30 poor-performing hotels of a
total of about 50 properties of the HungarHotel chain to make the company more
attractive for privatization.
The sale of the Duna Inter-Continental. During 1993 HungarHotels made the news once
more when it sold to Marriott the Duna Inter-Continental Hotel, which it had previously
managed under a franchise agreement. This deal was viewed as important in that it was
the first successful, structured tendering process of this kind in the name of privatization.
Much to the dismay of Inter-Continental it was a real auction in which old acquaintances
did not count, so that Inter-Continental's offer was rejected. Marriott's offer is estimated
to have been about $53 million with an additional $12 million budgeted for
renovation.(22) This new Marriott property will become the second Budapest hotel to be
managed directly by an international hotel company. Prior to this sale the Kempinski,
which opened in 1992, was the only such venture. The deal took nearly one year to
conclude due to legal wrangling and financing issues. It was a means for HungarHotels to
raise much-needed capital.
The future. With the sale of its most prestigious property, the Duna Inter-Continental,
HungarHotels was able to somewhat dampen its monetary shortages. However,
privatization will occur sooner or later, and it is highly probable that the SPA will model
the privatization of HungarHotels after that of Danubius, floating shares on the
Hungarian stock exchange.
Occupancy and Demand
With the exception of the four-star category, country-wide occupancy rates dropped
slightly in all categories between 1991 and 1992. The increase in the four-star category
was so slight that it can be considered essentially stagnant. Demand patterns for
Budapest were similar to those of the rest of the country; however, occupancy rates as a
whole were higher in Budapest across all categories. While it was not possible to obtain
statistics on the breakdown of business versus tourist travelers from the Hungarian
tourism authorities, a 1992 report by Horwath Consulting sheds some light on the
issue.(23) The study is based on a 1991 survey of 13 four- and five-star city and thermalspa hotels located in Budapest and the Hungarian provinces. The study's mean occupancy
rate of 65.1 percent and mean ADR of US$79.82 is congruent with the data from the
tourism authorities, considering that the Horwath data is based on four- and five-star
hotels only. As shown in Exhibit 3, the market-mix data taken from the 13-hotel sample
indicated that the largest guest segment (for the mean of the sample) consisted of tourists
(28.9 percent), followed by business travelers (23.8 percent) and tour groups (23.5
percent).
While the market-mix figures were taken from a set of four- and five-star properties, they
are still helpful in gaining an understanding of the type of guest mix in Hungarian hotels,
especially considering that most of the foreign involvement in the Hungarian hotel sector
thus far has taken place in the luxury market.
Implications of the Demand Data
The overall decline in occupancy, excepting the four-star category, is an especially
interesting phenomenon. It is commonly agreed that the luxury segment in Budapest and
most other Central European capital cities is rapidly approaching saturation. The
situation is logical; the initial wave of travel to the area has been by top-level business
people seeking comfortable Western-style accommodations in which to conduct their
negotiations. Those hotel companies catering to this segment that were not already
present in these locations but had the means to respond to the need quickly moved in to
take advantage of the outstanding return-on-investment potential. This trend was further
aided by the fact that most secondary cities lacked the infrastructure and attractions (be
they business or entertainment) to draw foreign travelers. This situation is slowly
changing. We may well be witnessing the beginnings of what Jan Willem den Ridder,
development director (international) of Holiday Inn Worldwide, has called a convergingdemand scenario. Foreign tourists and business travelers are no longer willing and able
to pay the high rack rates commanded in past years. For business travelers, the
phenomenon is due not only to company cutbacks but also due to the change in the
composition of this segment from top managers (who accept only the best
accommodations) to middle managers as euphoria over the newly opened Eastern and
Central Europe wanes. While many foreign travelers are trading down, economic
conditions are improving for some Hungarian travelers, and they are trading up.
Therefore, demand will likely converge somewhere in the two- to three-star market. As a
result, some hotel companies are interested in developing budget-type accommodations
in less-prestigious Hungarian secondary-city locations, as well as in other Central and
Eastern European markets.
Attractive Markets
Investments in Eastern and Central Europe can be attractive, despite their relatively high
risk, because initial investments have the potential of being paid off quickly due to low
payroll costs and comparatively high occupancy rates. Low payroll is important in this
equation because it boosts gross operating profits. This is even more noticeable for
European companies since European payrolls are normally considerably higher than U.S.
payrolls.(24) According to Ulrich Gevers, managing director of Globotels Development &
Management Consulting GmbH, margins in Eastern and Central Europe may be 30 to 40
percent higher than in Western Europe. This sentiment was echoed by InterContinental's senior vice president of development, Terje Myklebust, who stated that the
Eastern and Central European markets are especially interesting due to the high
profitability rates that can be realized by charging international rates while operating at
local cost levels. This results in profitability rates of over 50 percent, compared to a 20- to
30-percent norm in Western European countries.
Sources of Capital
One of the biggest problems for all hotel companies expanding into Eastern and Central
Europe is the issue of financing. In some ways this is surprising since one might expect
that, in addition to the usual governmental and institutional lenders, there would be an
active interest on the part of second-generation immigrants from Eastern and Central
Europe who are now living in the United States or Western Europe. While there are some
investors with such motives, the investment community as a whole has remained
extremely cautious.
International funds and lenders. Most of the financing in Eastern and Central Europe is
being done through Austrian banks such as Kreditanstalt and Girozentrale. This should
not be surprising due to Austria's long history as the gateway to Central and Eastern
Europe. Austrian banks tend to require 25 to 35 percent of real equity (excluding land)
and at least 50 percent of the loan must be syndicated. In addition, Austrian banks like to
work with such agencies as the Overseas Private Investment Corporation (OPIC), the
International Finance Corporation (IFC), and the Export Import (EX-IM) Bank, and they
will consider equity participation in sound projects.(25)
Other sources include funds such as the European Board of Reconstruction and
Development (EBRD) and the IFC, which may directly finance 25 to 35 percent of total
capital. EBRD funds, generally limited to 35 percent, are quite difficult to come by for
business projects since they have been earmarked mainly for infrastructure
improvements at this point. While export credits limit hotel companies to using products
from the country in which the credit originated--for furniture, fixtures, and equipment,
for example, hotel companies gain the advantage of being able to use the credit as an
equity equivalent (i.e., as a security against another loan).
East and west disagree. While contract law, or the ability to transfer property from one
entity to another, exists in Hungary, local conditions inhibit the best use of property.
Especially for income-producing real estate and businesses there is the issue of pricing.
The complications involved in pricing are compounded by the fact that the conventional
valuation methods that have become the norm in the United States and Western Europe
(e.g., the sales-comparison approach, the cost approach, and the income-capitalization
approach) are rendered virtually useless in an emerging market economy in which true
markets do not exist, transactions and historical precedents are extremely scarce, and
inflation is rampant.(26) The fact that Hungarian hotels do not yet follow the Uniform
System of Accounts for Hotels serves to further complicate valuation. Even if a value or
price can be somehow established, it is very difficult to cross-reference by applying
multiple valuation techniques, and the lack of capital makes it difficult to move property
into the hands of those who can use it most productively. Of course, there is also the issue
that much of the existing building stock, both residential and commercial, is at the end of
or has surpassed its economic life. Nearly 50 years of public ownership has had a
devastating effect on the condition of existing buildings.
Speaking about Eastern and Central Europe in general, Raymond Chigot, vice president
of corporate development for Hilton, stated that the differences in the perception of land
value between Western companies and local land owners (usually the city or state) are
quite severe. While Western hotel companies generally value the land at 8 to 10 percent
of project value, authorities contributing the land to a deal often expect to be
compensated with 50-percent equity. That this is unrealistic can be seen by the fact that
land in prime Western European locations is usually valued at only 12 to 15 percent.
According to Chigot, the problem is partially one of misperception. Often the authorities
contributing the land are under the impression that hotels can be sold at a huge profit
immediately after having been built. They do not realize that the property will have to be
operated for four to five years before it can be sold with a capital gain.
To Build or To Buy
Despite the poor condition of many existing hotels, industry specialists remain divided
over whether to buy existing hotels or to build them from scratch. The sale of the former
Duna Inter-Continental helped to spur this debate, as it was the first real market
transaction in Central and Eastern Europe. On the other hand, Budapest's newly built
Corvinus Kempinski serves as a counterweight in the debate. It is the most modern hotel
in Hungary and the first Western hotel to be opened by a Western team.
Even though there seem to be convincing reasons to shy away from existing properties,
there are equally convincing reasons against building a new property. While building
costs vary greatly based on the locality, the construction company, and the financing
structure, they are generally prohibitively expensive because many of the building
materials have to be imported.
Massive schedule and cost overruns are the norm. In addition, the purchase of land can
be quite expensive. Generally it appears that Western hotel companies are interested in
existing properties that have a well-established track record, that are of historical
significance, or that are in prime locations.
Foreign ownership and capital repatriation. The existence of joint ventures between
Hungarian and Western companies dates back to the early 1970s. However, foreign
investment was not of significant importance until the Law on Investment by Foreigners
in Hungary was passed on January 1, 1989. This law entitles foreigners to rights similar to
those of Hungarian investors, allowing foreign ownership of up to 100 percent of former
Hungarian state-owned or privately owned enterprises, permitting repatriation of capital
and all profits in convertible currency, and establishing tax holidays for foreign investors.
By opening the door wide for foreign investors, this law has been important to
privatization efforts.(27)
The only major restriction is on ownership of land. Foreigners can own property only in a
roundabout way, by purchasing it through their own Hungarian-registered companies.
Land may be purchased only as necessary to permit a foreign business to conduct its
affairs. In other words, a manufacturing company may buy enough property to build its
production plants, but it may not buy and sell real estate in order to produce additional
income.(28) On the one hand Hungarians have strong fears that foreign enterprises, or
individuals, will drive up real-estate prices through large-scale purchases, which explains
the previously outlined restriction.(29) On the other hand, complete capital repatriation
and various types of tax holidays serve as incentives to get foreigners to exercise
ownership opportunities and thus to speed up privatization efforts.
Mortgage law. Hungary is progressive in the area of mortgage law, having introduced
mortgage legislation. Mortgages are made possible through registration with the Land
Title Register.(30) In theory, that should give owners access to much-needed capital for
construction or renovation by enabling borrowers to offer banks the real estate as security
on a loan. In practice, however, buildings are often so run down that banks regard them
only as potential liabilities and not as security. Therefore access to capital markets is
quite restricted; the mortgage market is in effect nonexistent and interest rates on longterm loans are approximately 40 percent.(31)
These characteristics, along with the perception of high investment risk by domestic and
foreign financing sources, have made investment in Hungary quite difficult for foreigners.
While foreigners may be legally able to acquire property rights, they are often unable to
muster the financial strength to do so.
Addressing restitution. One of the most fundamental rights of real-estate owners is the
right of quiet enjoyment. This right protects property owners against having false claims
made against the title of their property. Since deprivation of property rights was a core
principle under communism, property was forcefully expropriated under communist rule
and turned over to the state.(32) A major concern for buyers of real estate all across
Central and Eastern Europe has been that former owners could step forward and make
restitution claims. Hungary managed to effectively address this problem when it passed
the so-called Compensation Act (Act XXV of 1991). This act forbids direct restitution and
compensates former owners by issuing coupons that can be used toward the purchase of
another property being sold by the state.
The question of land title. While the Hungarian government has made great progress in
addressing the issues of property laws and land registration, one of the biggest headaches
for developers in Central and Eastern Europe is the question of title, which affects
financing. One hotel executive told how a particular property had come across his desk
six or seven times, each time with a different entity claiming to be the owner and wanting
to strike a bargain. The fact that the cost of simply exploring a single project may be as
high as $500,000 plus a significant time commitment illustrates the problems. However,
it is a commonly shared opinion that property purchases from the state are quite safe, as
the Hungarian and other Central and Eastern European governments are generally
committed to solving post-purchase title questions or disputes. This is a direct result of
the Central and Eastern European governments being in need of hard currency and thus
wanting to portray the picture of a stable investment environment. Rights of disposition
and exclusive possession have also been specified in the avalanche of reforms initiated by
the government in the last five years.
Potential roadblocks. In general, foreign hotel companies are having trouble finding
reliable local partners. This is a serious problem since these companies are dealing in a
new operating environment characterized by constantly changing laws and bureaucracies
that are inefficient and finessed by well-connected insiders. The lack of local partners
may be explained by the fact that communist economies did not foster an entrepreneurial
spirit. While it is possible to find partners in the sense of contributing land or buildings, it
is virtually impossible to find locals who are willing and able to contribute hard currency.
Virtually all of the industry executives interviewed for this report indicated that the lack
of a service orientation in Eastern Europe is not too great a problem. In general, the
Eastern European education systems have produced excellent learners and employees.
Young workers can be easily motivated by comparatively good pay. Marriott, for example,
has adopted a strategy for some of its Eastern European properties that calls for the
hiring and training of an all new staff made up of young language-school students,
preferably without prior hotel experience, and this approach has been very successful.
Hotel-Company Strategies
Most of the development in Eastern and Central Europe has been in the luxury segment.
It is therefore not surprising that virtually all Western hotel companies have concentrated
their efforts on the capital cities. There are some exceptions where comparatively
luxurious accommodations can be found in secondary cities such as Brno in the Czech
Republic and Krakow and Szczecin in Poland. However, these are exceptions and most of
the better hotels in secondary cities predate the wave of political change and are or were
owned by the state. Furthermore, they are for the most part only marginal in quality by
Western standards. In Hungary most of the secondary city development has taken place
close to the Austrian border and in the Balaton and Danube Bend regions.
Due to the nature of their products many Western hotel companies Due to the nature of
their products many Western hotel companies currently involved in Eastern and Central
Europe are unwilling and unable to consider locations other than country capitals. This
mode of development planning was especially emphasized by such companies as
Kempinski, Hilton, and Four Seasons, the last of which currently has no properties in
Eastern and Central Europe but is looking at the region. Nonetheless, all those
interviewed shared the opinion that there is significant opportunity in the two- and threestar market in both primary and secondary locations. Since the returns to be made on
hotels in this market segment are lower and coupled with less prestige than those of
luxury properties, the efforts to meet the emerging demand in the lower categories have
been hesitant.
Steve Haggerty of Hospitality Valuation Services International in London went so far as
to call Warsaw a virtual "blood bath" for five-star hotels. He indicated that many of the
luxury-market hotel investments in Eastern and Central Europe have turned out to be
financial disasters due to development saturation, out-of-control construction financing
resulting in excessive per-room building costs, and, in some cases, infeasible
development as a result of financing provided by international funds that would not have
been provided by commercial sources.
Types of Products
While the primary strategy employed by virtually all of the major players to date has been
one of moving into capital cities to quickly rake in the extraordinary returns that can be
made by providing top accommodations at high rates and high profit margins, some
changes are beginning to take shape. A particular example of these changes is Holiday
Inn Worldwide's plan to meet demand in the two- and three-star segments. Holiday Inn
appears to be well equipped for a hub-and-spoke development pattern in Eastern Europe,
with a segmentation strategy based on multiple name-affiliated brands.
That Holiday Inn plans to take advantage of its array of products can be clearly seen by its
analysis of the Eastern and Central European markets and, more specifically, by its plans
for the Hungarian market. Holiday Inn has identified the previously discussed
converging-demand scenario as an opportunity to exploit. Accordingly, den Ridder
anticipates that either Holiday Inn Express, Holiday Inn Garden Court, or a hybrid of the
two brands could cater to this emerging demand.(33) These hotels will have between 100
and 200 rooms and will be found in secondary locations. It is anticipated that the hotels
will be modular or prefabricated, with a construction time of six to nine months. Since
these lodging products will be located on the fringes of secondary cities and will not be
dependent on prime downtown locations, the company will be able to avoid problems
with existing buildings. Furthermore, this will have the benefit of introducing a consistent
product.
Considering Accor's historical approach of blanketing the market by providing lodging
products for most market segments and its recent purchase of a 51-percent stake in
Pannonia, it is to be expected that Accor will move to cater to the two- and three-star
segments as well. The product range included in the Pannonia package would allow Accor
to cover multiple segments if it decides to pursue such a strategy.
Hotel companies are entering the Eastern and Central European markets through a host
of methods. Management involvement includes franchising, management contracts, full
ownership, and joint ventures. Ownership arrangements vary from full ownership to
direct participation in the privatization process and joint ventures. Holiday Inn has been
attempting to stick to a strategy of franchising new properties in secondary city locations
and getting management contracts for its deluxe Crowne Plaza hotels in primary
locations. The problem with this strategy is that there are simply not enough willing
Eastern and Central European entrepreneurs with the necessary financial means to make
hotel franchising a rapidly growing concept. This problem has hindered Choice Hotels
from entering that market and it is the reason that Holiday Inn has been forced to take on
equity in its franchisees' Eastern and Central European projects.
Ownership arrangements have differed on a case-by-case basis, and throughout Eastern
and Central Europe a growing trend is joint-venture agreements. The reasons for this are
as follows:
* There is an inadequate supply of local investors prosperous enough to become
franchisees.
* The governments have caught on to the fact that as owners they bear the downside risk
of operations under management contracts.
* The governments are trying to privatize existing hotels and are thus eager to sell
individual hotels or entire chains. If a full sale cannot be arranged, they seek substantial
equity participation at a minimum.
* Financing is too sparse to make full ownership on behalf of Western hotel companies an
option.
The Investment Horizon
The Hungarian hotel investment environment is risky. Economic deficiencies have
resulted in a high debt structure and high unemployment rates. The potential for ethnic
tension resulting from 3.5 million ethnic Hungarians living in neighboring countries as a
result of the 1920 Treaty of Trianon should not be underestimated. Additional challenges
are presented by the slow process of market entry as a result of large, nearly defunct
bureaucratic entities, the cumbersome privatization process, and, most importantly,
difficulties of financing as well as land-title questions.
While these barriers to entry are significant, they should be assessed on a comparative
basis. At this time, despite its problems, Hungary is still arguably the most attractive
investment environment in Eastern and Central Europe. Hungary has been able to attract
over half of all foreign investment destined for the entire Eastern and Central European
region between 1989 and 1993. The country has had a stable, reform-minded government
since the 1990 democratic elections.
Even the return to power of the former communists, now Socialists, in the May 1994
democratic elections is not to be seen as alarming. The June 24 coalition between the
Socialists and the liberal Free Democrats was formed to facilitate and show the new
ruling party's commitment to push ahead with economic reforms.(34) Hungary enjoys
one of the most advanced banking systems in Eastern and Central Europe and has
attracted foreign investors by taking comparatively liberal attitudes in terms of business
and land ownership by foreign entities as well as capital repatriation and taxation.
Hotel investments. Investment opportunities in Hungary do exist in the hospitality
industry. While they are no longer as easily identifiable and don't offer as high a rate of
return as they did three or four years ago, the patient investor will still be attracted to
Hungary.
Catering with one product to the more price-conscious and value-seeking foreign traveler,
as well as to the emerging domestic traveler, has become the new key challenge. The
future for Hungarian hotel development lies in the two- and three-star categories. Such
development should be based on a strategy that can encompass both primary- and
secondary-city locations. This would not be feasible for luxury hotels due to their high
per-room construction costs and because they rely on the prestige factor of trophy
locations, which are hardly ever found in secondary cities or on the fringes of Budapest.
One other possible niche is the health-spa-hotel market, which has been identified by
Danubius. However, Danubius's advantage is so strong that it would prove extremely
difficult for a newcomer to effectively penetrate that market. The gaming market is
another option, but it is becoming flooded, especially in those areas conducive to hardcurrency gaming. Thus, the economy segment--exemplified in the United States by such
products as Travelodge, Holiday Inn Express, and Hampton Inn--remains the entry
segment of choice. The potential viability of such products has already been evidenced by
the high number of small pensions and private-room accommodations that have sprung
up across Hungary and are now catering to the two- and three-star segments. Those
companies that establish presence and brand awareness first, and manage to do so while
turning a profit by catering to both local and foreign travelers, stand to gain the most in
the Hungarian market.
While opportunities exist, investors will have to take a long-term approach that will allow
them to have lodging products in place to cater to the more-or-less stagnant foreign
demand and to the domestic demand as it emerges. It is completely unrealistic to expect
the standards of even the most advanced of the Eastern and Central European countries
(such as Hungary, Poland, and the Czech and Slovak Republics) to catch up to those of
Western Europe in the near future. However, these countries will catch up eventually.
The key is to realize that the measurement unit is more likely to be one or two decades
rather than five or six years. The problems today go beyond the macroeconomic realm;
they are of a structural nature and require systemic change as evidenced by the fact that
reforms are necessary in virtually every field including banking, taxation, government,
investment policies, and, of course, people's thinking of what the role of government
should be.
1 Ernest S. McCrary, "Hungary Finds Pace That Suits it Best," Global Finance, Vol. 7, No.
4 (April 1993), pp. 75-79.
2 Jim Hamill and Graham Hunt, "Joint Ventures in Hungary: Key Success Factors,"
European Management Journal, Vol. 11, No. 2 (June 1993), p. 241.
3 Economist Intelligence Unit, "New Moves to Attract Investment for Hungary's Hotel
Industry," Travel Industry Monitor, No. 45 (December 1993), pp. 20-21.
4 "Danubius Shock Offering," Central European, February 1993, pp. 6, 8.
5 "Danubius Shock Offering," p. 39.
6 Economist Intelligence Unit, p. 21.
7 Ungarisches Tourismusamt, Tourismus in Ungarn 1992 (Budapest: Tamas Teglassy,
1993), p. 5, based on figures collected by the Central Bureau for Statistics.
8 Economist Intelligence Unit, "Eastern Europe's Travel Industry Worth More than
Official Figures Suggest," Travel Industry Monitor, No. 46 (January 1994), p. 14.
9 World Tourism Organization, cited in: Jill Hunt, "Foreign Investment in Eastern
Europe's Travel Industry," Travel & Tourism Analyst, No. 3 (1993), p. 67; and "Hungary:
More Tourists Visit Hungary," Reuter Textline, MTI-Econews, February 7, 1994.
10 Tourimusamt, p. 21.
11 Tourimusamt, p. 21.
12. Tourimusamt, p. 17.
13 "Hungary: Top Casino Attracts 500-600 Visitors a Day," Heti Vilaggazdasag, July 10,
1993.
14 "Gambling Casinos in Hungary," MTI-Econews, February 11, 1993.
15 In 1992 the 40-percent gambling tax earned the Hungarian state a total of HUF 860
million (according to a September 1994 conversion rate that would be US$7.86 million)
from casino operations. In other words, the total casino revenue for that year was about
HUF 2.116 billion. In addition to this sum, the government also earned money from
licensing fees.
16 The average 1992 exchange rate was US$1 to 1.61 Deutschmarks, as presented in
International Monetary Fund, International Financial Statistics, January 1994
(Washington, DC: International Monetary Fund, 1994), p. 248.
17 "Hungary: Top Casino Attracts 500-600 Visitors a Day," op. cit.
18 "Accor Close to Hungarian Hotel Chain Deal," Financial Times, March 9, 1993, p. 24.
19 "51% of Pannonia Goes to Accor Consortium," MTI-Econews, December 1, 1993.
20 "French Buy Hungarian Hotels," Financial Times, March 19, 1993.
21 "51% of Pannonia Goes To Accor Consortium," op. cit.
22 Jill Hunt, "Foreign Investment in Eastern Europe's Travel Industry," Travel &
Tourism Analyst, No. 3 (1993), p. 83.
23 Horwath Consulting, Hungary; Hungarian Hotel Industry 1992, p. 5.
24 Higher Western European payroll costs relative to those of U.S. firms are due in part
to (1) substantially higher wages across the board, (2) employer-paid health-care benefits,
and (3) a minimum of five weeks of paid vacation in most Western European countries.
25 Charles A. Bell, "Opening Up Eastern Europe: New Opportunities and New
Challenges," the Cornell Hotel and Restaurant Administration Quarterly, Vol. 33, No. 6
(December 1992), p. 58.
26 Stephen G. Haggerty and Keith L. Lostaglio, "Applying Western Valuation Techniques
in Emerging Hospitality Markets," The Real Estate Finance Journal, Winter 1994, p. 5.
27 Keith Crane, "Property Rights Reform: Hungarian Country Study," in OECD Centre
for Cooperation with European Economies in Transition, Transformation of Planned
Economies: Property Rights Reform and Macro-economic Stability (Paris: OECD, 1991),
p. 79.
28 lbid.
29 Crane, p. 83.
30 Preslmayr & Partners, p. 45.
31 Lou Cook, "From Budapest to Berlin," Urban Land, September 1993, p. 20.
32 "Survey of Privatization in Eastern Europe," Financial Times, July 3, 1992, p. 1.
33 See also Alan Solomon, "Holiday May Take Express to Europe," Hotel & Motel
Management, Vol. 208, No. 5 (March 22, 1993), pp. 6, 58.
34 "Hungarian Coalition to Push for Reforms," New York Times, June 25, 1994, p. 3; and
"Leaders Back Free Hungary Plus Stability; Socialists to Support Liberalizing Market,"
New York Times, June 26, 1994, p. 4.
EXHIBIT 4
Contributions of joint-venture partners
Foreign hotel company
* service know-how
* internationally known brand
* business and marketing expertise
* service training
* management development
* finance
* access to international reservations system
* improved competitiveness
Local partner
* knowledge of local political situation, economy, and customs
* general management
* access to local travel agencies and other distribution channels
* local equity contribution (usually in the form of land and buildings)
* contracts and relationships with host country's government
* recruitment of local labor and trade-union relationship
* access to local financial institutions
Adapted from Jim Hamill and Graham Hunt, "Joint Ventures in Hungary: Key Success
Factors," European Management Journal, Vol. 11, No. 2 (June 1993), p. 239.
Andreas Lorenz, with Landauer Realty Advisors in Boston, received an M.P.S. degree in
1994 from Cornell's School of Hotel Administration, where Thomas P. Cullen, Ph.D., is an
associate professor of management strategy.