Investment Opportunities in Tourist Accommodation Facilities:  A Case Study for Batumi

Ioseb Khelashvili

Journal number 2 ∘ Ioseb Khelashvili ∘
Investment Opportunities in Tourist Accommodation Facilities: A Case Study for Batumi

https://doi.org/10.56079/20222/9

The tourism industry has traditionally been the leading sector of the economy of the Georgian Black Sea resort of Batumi for many decades and is currently experiencing rapid growth. This trend is accompanied by an increase in investment activities and the constructions of rental accommodations. Developers are focusing on promoting their rooms and apartments, positioning them as a source of long-term rental income, while potential private (mostly non-professional) buyers are facing difficulties in making grounded investment decisions. The purpose of this study is to identify a number of key indicators that determine a reasonable return on investments in Batumi tourist facilities. After empirical research on a wide range of variables relevant to making investment decisions in this market, key representative indicators were identified and a research design were developed to explore local investment opportunities.

Classifying investment proposals into 4 categories depending on their size, the applied methodology determines frames of profitable investment opportunities for each category. The research design can be applied to other similar destinations as well, by adjusting the indicators to the specifics of the relevant investment markets.

Keywords: Tourism, investment, rental accommodations, returns on investment, Batumi

JEL Codes: E22, H54, L83, R42

Introduction

Batumi is a city in the country of Georgia with a long history and cultural heritage dating back to the Middle Ages. It is the capital of the Adjara Autonomous Republic of Georgia and the second largest municipality in the country with a population of over 171,000 people (National Statistic Office of Georgia, 2022). (The city is located in the subtropical zone at the Black Sea, has a length of 21 km along the sea coast and comes close to the Turkish border in the South.

Batumi, which developed as a seaport, also began to acquire tourist functions from the second half of the 20th century, and in the 21st century has gained increasing popularity among foreign and local visitors.

Before outbreak of COVID-19 pandemic, in 2019, 51.8% of the country’s holiday, leisure and recreation foreign visitors, and 18% of domestic visitors arrived in this resort (GNTA, 2021). In general, Batumi hosted 2.1 million visitors in the same year (Invest in Batumi, 2021).

Tourism is a leading sector in the city’s economy, attracting developers to invest in tourism accommodations. Georgia in general and especially Batumi has one of the most attractive investment climate and business environment. “Georgia ranks seventh in the 2020 World Bank’s Ease of Doing Business index, twelfth in the Heritage Foundations’ 2021 Economic Freedom Index, eighth in the Economic Freedom of the World of Frazer Institute, and 45th in Transparency International’s Corruption Perception Index” (Investment Climate Statement, 2021). In Adjara region, where Batumi is the foremost economic driver, 33% of all investment comes in tourism industry (Invest in Batumi 2021). The increasing interest in investments is observed both from supply as well as from demand sides (see Figure 1.)

Existing supply of hotels by years and Breakdown of Hotel guests by

purpose of visit, 2016-2018

Figure 1

Over the last decade steadily is expending the role of individual (physical person) investors in Batumi accommodations. The growing number of individual private investors, intending to purchase renting accommodations to receive a secondary benefit, usually lack of experience to properly evaluate the cost of their proposed investments, mostly relying on the advertised information provided by the developers and/or their agents, while underestimating future expenses and cost of capital, expected period of return of their investments, market conditions, etc. For this purposes we provided a special study in case of Batumi to identify the acceptable investment opportunities and the relevant key indicators helping to making first approach investment decisions.

The main purpose of the research is to develop a research design for identifying profitable investment options in tourism accommodations (such as a mid/economy class hotel room, apartments, villas, etc.) for small/private investors and determining the relevant key indicators for making first-approach investment decisions, choosing Batumi tourism destination as a case study.

The research stages included:

Review the basic concepts and research design of Investments in accommodation facilities in relations to hospitality business, based on a case study of Batumi destination
Identify the key indicators of investment proposals in Batumi accommodation facilities, offered by developers (or their agencies) to the small business initiators;
Reveal the range of prevalent investment opportunities based on the key inter-related indicators in Batumi accommodation facilities.

1.Conceptual framework and research design

Conceptual framework.

Each investment case is, usually associated with a wide range of specific provisions, including but not limited to investment amount, price and its structure, currency, payment provisions and schedules, transfer of rights, added services, etc. (Nowell, etc., 2006; Taiani, etc. 2018; Younes, Kett, 2008). Likewise, the cost of capital for acquiring the property for potential investments usually differs depending on the share and the provisions of employed loans, availability of alternative investments options, and the value of a purchasing property for the specific investor, and so on (McGough, Berry, 2020). When study refers to a specific tourism destination which includes significant amount of properties for sale, the underlined variety of investment provisions become a subject for standardization and generalization in order to reveal typical indicators and ranges of their variety (Nowell, etc, 2006; Taiani, etc 2018). This is especially important for growing number of small private investors intending to purchase accommodations for renting them to visitors and gain a secondary benefit.

In our research we apply the concept of NPV of the expected revenue with the related typical and foreground for the destination indicators, their rates and ranges when appropriate (Dogru, 2017; McGough, Berry, 2020). Break-Even-Points (BEP) determines the assumed ranges of key indicators, which frame the options for investments with positive NPV (Feinstein, 2007; Higgins, 2012).

The applied research methodology includes: a) the review of the variables of the proposed investments in Batumi tourism destination to identify the key (principal) components; b) determining the range of their fluctuations and classifying each of such variables into representative categories; c) applying the indicators of these categories to determine the relevant BEP-s for framing the options of investments with positive NPV.

Research design

Thegoals of private investments are:

Rent out facilities (rooms) to visitors to generate income from the investment;
Benefit from property capitalization;
Receive a social benefit from the use of property as a second house for recreation and/or temporarily residence.

These goals are not mutually exclusive.

In the study, we refer to the first underlined goal, which is to rent the facilities to visitors to generate income, either directly or through an agent.

The starting point was to identify the key indicators of investment proposals in Batumi accommodation facilities, offered by developers (or their agencies) to the small business initiators;

Based on investments concepts in general and in the field of tourist accommodation in particular, combined with the specifics of the destination Batumi, we reviewed and analyzed 24 related web sites (see attachment), provided in-depth interviews with the relevant realtors, and obtained statistical data from the official statistical reports.

The study revealed 33 indicators influencing on the buyers (investors) decision making. These indicators are:

Type of property (Apart hotel, Hotel, Villa, Condominium, guest House, others)
Size of the property; (rooms, sq. m)
Stage of construction; (pre-construction; so called “Black Carcass”; “White Carcass”; Building Construction Completed; Ready-to-Enter Rooms);
Date of construction (years)
Furnishing status; (fully furnished, basically furnished; not furnished)
Utilities’ quality; (Heating, Cooling)
View; (Sea, Mountains: City; Closed)
Parking; (Open space; Underground: Not available)
Quality of the Building’s Exterior (Fresh and Ecologically friendly; Fresh but Ecologically not Friendly; Eroded and/or damaged)
Quality of the Building’s Interior (Comfortable; partly comfortable; not comfortable)
Quality of the room constructions (Comfortable; partly comfortable; not comfortable);
Date of construction; (Year)
Location; (distance to the Seaside; Distance to the Old City)
The neighborhood (Comfortable; partly comfortable; not comfortable )
Services availability
Security
Alternatives availability
Price
Terms of payment
Terms for Mortgage
Price competitiveness
Expected ADR
Expected occupancy rate
state period for the investments Reimbursement
Offered guarantees
Recreation and sport facilities within the building
Catering facilities within the building
Developers (selling agencies) reputation
Marketing information
Received advises from trusted person (persons)
Property ownership regulations
Tax payment regulations
Property owners related regulations

The observed wide verity of indicators, with their uneven role in each specifies case, shows the importance of developing a so-called first approach methodology for determining the common key indicators and the ranges of their fluctuation. It will also help to understand the “big” picture of investment options in the destination.

The (statistical) analysis revealed 4 leading components (factors) with the relevant properties which are significantly reflecting the effects of the remaining. These factors are: offered property price, expected renting out prices, expected occupancy rate, and the Expected reasonable period of the reimbursement.

Considering the range of these principal component variations were made the following assumptions:

Reasonable period of the return on investment - ROI – 10 years
Discount rate expressed in WACC - 15%
Share of loan in an investment capital – 50%
The typical (representative) categories of Investment amount per one renting room - $30 000; $60 000; $90 000; and $120 000.
Size of standardized renting room – 30 sq. m
The range of Annual Average Daily Rate per room – ADR, in the range from $20 to $120:
The range of Occupancy rate – OCC%: 20% - 70%
Break-even point – BEP is a point at which income of the 10 year period less investment equals 0

Comments on the selected assumptions

In practice, ADR or OCC% are closely inter-related indicators with inverse influence. In case when one of this indicator falling within the assumed range but moves the other related one out of the assumed range, the results are not ignored.
The proposed generalized (simplified) ROI is called Indicative ROI, for the purposes of this study. It includes Room Revenue, ADR, and the Return period.
The Indicative ROI is calculated based on the assumed 15% WACC. This discount rate is a generalized and rounded indicator including several due payments which have an individual and specific methods of calculation. It includes costs of local expenses to maintain property, USD long-term inflation rate -2.3% (Knoema, 2022), average debt cost along with the standard values specific for the country – long-term debt in USD: 6-7%, cost of private capital and Beta risk (0.89) (National Bank of Georgia, Statistics 2022), local property tax – up to 1% (more details see table 1).

Property related taxes (REDCO, 2022)

Table 1.

Property related taxes	Comments
Tax on the purchase and sale of real estate in Georgia.	There is no tax on purchase and sales of property for foreign citizens in Georgia. When purchasing property, only the state fee of 51 lari has to be paid. If desired, the buyer can pay a fee of up to 305 lari, and the data on the change of ownership of the property will be entered into the Register within one hour.
Property ownership costs.	After the purchase of property, the owner must pay maintenance tax for the building and the surrounding area. The tax is from 0,5 to 2,8 lari per square meter of the property and depends on the region, location, property's status and purpose of use. Other expenses such as water, electricity, gas or heat bills are paid separately, according to meter readings or at a fixed rate.
Property tax.	Property tax in Georgia is related to local taxation. It is described in Chapter XXIX Chapter IX of the Tax Code of Georgia. The tax amount is determined on the basis of a previously submitted declaration. The Tax Code of Georgia determines the maximum tax limit; however, the precise amount of the tax is determined by the local government of each municipal formation. For instance, the representative body of Batumi established a property tax for individuals at 0.2% in 2017. Also, The property tax rate depends on the annual family income: • from 40,000 lari - 0%; • 40,000 - 100,000 lari - 0.05-0.2%; • from 100,000 lari - 0.8-1%. If a family's annual income exceeds 40 thousand lari, then the value of their property is determined by the tax office based on market prices. Let's suppose, a market value of the property is valued at 100 000 lari, then at the end of the year, they are obliged to pay property tax of 200 lari. If the family's income exceeds 100,000 lari, then the family will have to pay 0.8% of the market value of the property

Considering all the mentioned above provisions, which may very per specific case and the related regulations, we made a logical (reasonable) assumption for WACC at 15% for this research. The calculation applied the following formula (Higgins, 2012):

WACC= [(1-Tax)D%+E%]/[(1+WACC)^n]

The return is considered as a net income and calculated by using the following formula:

2. Research outcomes

Under normal business conditions, the profitability of the low investment strategy, at $30 000 per room, can be more realistically maintained with an ADR range between $42 -$50, and annual occupancy rate between 40-33% respectively. If the business can develop certain competitive advantages to increase ADR up to $55-$66, acceptable occupancy rate can be decreased down to 30%-25%. Alternately, under the steadily growing demand resulting in higher occupancy rates up 55%, annual ADR options can be reduced down to $30. The BEP-s for these fluctuations range from ADR $27 at 60% occupancy rate on the one hand, and from $70 ADR at 23% occupancy rate on the other hand (See hraph.1). However, these edges are hardly achievable, considering that in a normal pre-pandemic business environment, the average ADR for the local upscale and middle class hotels were $60, and for budget/economy class accommodations - only $28, with average occupancy rates of 44% and 32% respectively (Hotel Market in Georgia, 2019). According to the analyzed date, in general, a $1 change in ADR will promote a 1.01%, change in occupancy rate, and a 1% change in occupancy rate will provide options to change ADR by $1.57.

NPV for $30 Investment

Figure 2

Derived by the author

The below-average investment strategy, with an increased amount of $60 000 per room, becomes more responsive to changes in occupancy rates, while allowing for the widest range of volatility within a given BEP, which in turn sets the framework for a positive NPV of the investment. In average, the increase/decrease of occupancy rate by 1% results changes in ADR by about $2.75, while decrease/increase of annual ADR by $1 promotes changes the occupancy rate by only 0.59%. The most realistic annual ADR in this category varies from $70 to $90 with 47%-36% occupancy, respectively. For the destination, the least realistic looks the case with $150 and relevant 22% occupancy rate. Meanwhile, the exclusion of this case from the consideration does not change the underlined features of this investment.

NPV for $60 000 Investment

Figure 3.

Derived by the author

The above-average investment, amounting $90 000 per room, further increases sensitivity of occupancy rates and weakens the potential of ADR effect. Within the determined BEP of the indicators, insuring a positive NPV for the investment, the average change of occupancy rate by 1% will assumedly change the ADR by $3.32, while change of ADR by $1 will expectedly change the occupancy rate by only 0.38%. In addition, this investment scenario raises the lowest required level of occupancy rate up to 29%. In other words, the lower that this level of occupancy rate cannot be compensated by the high ADR, which in this destination is determined at $150 maximum.

NPV for $90 000 Investment

Figure 4

The most capital-intensive investment in the study, amounting $120 000 per room, keeps approximately the same inter-dependence between the ADR and occupancy rate indicators as in previous case. However, under this investment scenario, the required minimum level for occupancy rate is significantly higher reaching 39%. It narrows the flexibility of pricing policy for this category of investments / business operators in relations to the relevant accommodations.

NPV for $120 000 Investment

Figure 5

Derived by the author

Table2

Conclusions

The study identified more than 30 variables that influence investment decisions in Batumi accommodations to be used for rental to visitors. Further analysis revealed key components among them, including investment amounts, ADR, OCC%, WACC and payback period of investments, all relevant to the destination.

Based on the provided analysis and collected empirical data, the study determined frames of BEP-s, measured by combination of ADR and OCC%, for 4 representative categories of investments that are generating positive NPV. The investment categories included $30 000, $60 000, $ 90 000 and $120 000 per room. Revealed outcomes shows the options for potential investors.

The study identified the ranges of key indicators – ADR and OCC% - supporting profitable investment options in Batumi renting accommodations, highlighting their maximum and minimum values. These values varies in case of ADR - from $25 to $170 and in case of OCC% - form 22% to 66%; For potential business operators, this will serve as basic indicators for choosing a specific business strategy and/or making a specific investment decisions.

The provided analyses in relations to Batumi destination confirmed the general trend showing that the higher ADR allows to reduce occupancy rate. Specifically, within the frame of determined BEP-s for the investments with positive NPV, 1% change in occupancy rate expectedly changes ADR by $2.70, while $1 ADR may cause 0.58% change in occupancy rate. However, these relations varies depending on the volume of investments.

The research design including – identifications of key indicators, measured in inter-related ADR and OCC%, for determining their ranges within the frame of BEPs for the investments with positive NPV, can be applied to any other similar tourist destination for the same purpose, with the adjustments of key indicators for the case study.

Limitations

The study uses data relating to a regular, multi-year evolving investment environment, excluding the variance caused by the spread of COVID-19 infection, which, however, has a time-limited impact on the subject of the study. There are already positive signs of a return to normal conditions. Thus, the results of the study will retain their reliability.

Also in the course of the study, the framework of key indicators was determined to identify options for profitable investments. However, each individual case usually includes a number of specific conditions, both on the supply side and on the part of private investors.

Given the limitations mentioned above, it is believed that the results of the study are useful for making first-approach investment decisions, as well as for understanding the investment climate of the Batumi tourism destination.

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