Cruise Ship as a Real Estate Asset

Cruise Ship as a Real Estate Asset

Could a cruise ship be considered a real estate asset? Which are the similarities between cruise ships and hotels in terms of financial investment and asset management? Traditional real estate assets consist of real property: land parcels and buildings on them. However from an economic perspective, an asset consists of claims of future cash-flows which makes the real estate another form of capital asset such as stocks and bonds. On top of it land plots will never go away and therefore it constitutes a security that no other capital asset can provide.

Under these assumptions, the real estate asset market, part of a lager capital market, includes all types of properties which produce cash flows and dividends. Therefore cruise ships, which are cash-flow producers by definition, can be considered real estate assets like hotels and resorts. The comparison between hotels and cruise ships, is based on three common business variables which characterize the investment logic within both the cruise and hotel market.

1. Role of key players within the investment

Typically hotel real estate and cruise ship investments involve a range of different participants, primarily the owner, the operator and the lender.

Owners: they contribute with equity to hotel investments. They may be owner-entrepreneurs, real estate corporations, real estate trusts, investments funds, insurance companies or pension funds. Owners can manage real estate through branded operators (hotel management or franchise contracts), independent operators with a leasing contract, or directly as owner-operator.

When it comes to ownership, most cruise lines are publicly traded or owned by their parent companies’ shareholders. There are a few privately owned companies.

Lenders: in the hotel industry lenders provide the majority of the capital needed in the form of senior mortgage debt. Lenders may be traditional commercial banks, credit companies, insurance companies or real estate investment trusts (REITs https://www.reit.com), whose main interest is the returns which come in the form of operating cash flows. The major objective of the lender is to be rewarded for the risk of lending by achieving an adequate overall risk-adjusted return on investment.

In the cruise industry traditional commercial, mortgage and merchant banks are the paramount of reference for borrowers and investors. In todays oligopolistic cruise industry market, a handful of large companies account for a relatively large market share. The only way for a new cruise venture to succeed is to have a strong financial solidity and a stable cash-flow, or to meet specific niche market demands, still difficult to achieve by independent owners and operators.

Nowadays, ship owner companies rely on a wide range of options to structure their capital stack to build or purchase new cruise ships: from company’s own equity or bank loans to public offerings such as sale of equity shares, ship mortgage or bonds to the public in order to raise capital. Cruise ship companies cannot self-finance the construction or purchase of new cruise ships, which are currently the most expensive ships built within the maritime industry.

Operators: Most large hotels are operated either by branded chain operating companies or independent operating company under a hotel management agreement. There are several single owners and independent operating companies without a brand, which can also be franchised under one of the major hotel brands. A third option is a real estate owner with a leased hotel. The main goal of branded operators is to provide both the managerial expertise and brand services to increase the market coverage and market share. Operators are paid for driving revenues and for running efficient hotels to ensure a return under their brand, leveraging on their management expertise.

Cruise ship management companies provide professionally organized technical, commercial and crew management services. In order to ensure efficient ship operations and to preserve the value of the business, cruise management companies could cover a wide range of activities: crew management and manning, technical support, onboard safety management in accordance with national and international requirements, continuous improvement of safety and quality on board with fleet inspections, supply chain operations, maintenance and dry-dock projects, compliance with health and safety regulations, on-board hotel operation, ship chandlery, control over ship owner supplies with reliable budget management and reporting in full compliance with accounting international standards.

2. The complexity of the asset life cycle

Hotel investment decisions targeting the construction of new property or the evaluation of a business already in the market, depend on two main variables: the stage of the asset life cycle (introduction, growth, maturity and decline) and the phase of the market cycle (growth accelerating, growth slowing, falling and decline slowly). Both cycles streamline possible business development strategies a hotel company could target: creating wealth through new developments, enhancing incomes of the existing properties producing higher cash-flow (leveraged on more efficient operations and effective marketing campaigns) and incremental risk strategy.

A more straight forward asset life cycle of a cruise ship could be defined as follows:
Initial planning: at this stage the shipowner will start planning for the new ship involving naval architects for the design.
Ordering: the vessels requires huge amount of capital which means that the shipowner needs to secure ship financing. A negotiation between ship owner and ship yard takes place and it may involve a ship broker to work through the contract supporting the process.
Ship Building: signing of the contract, production design, material and equipment purchase, production plan development, steel cutting, assembly and mounting of ship sections , launching, finishing of the vessel, sea trial, delivery and warranty.
Operations: passengers ships today are subject to a vast array of regulations and standards from safety to crewing, from technical standards to hospitality management.
Recycling: after 25-30 years of service or when repairs and retrofitting cannot be financial justified, the ship is recycled.

The cruise market has been one of the fastest growing market of the travel industry util 2020 without showing any signs of decline. The major trends that will shape the industry over the next decade, will take the cruise industry eventually back to the pre-pandemic consistent compound annual growth rate.

In such a dynamic market, reliable evaluation of the real properties has recently become even more important for the maritime business. The same evaluations techniques which support the hotel investment decisions, could be applied to maritime industry as well: market comparison approach, cost approach and income approach or for evaluating specific projects with the NPV, IRR or the profitability index. These methods could be used to appraise port and terminal facilities, antique or classic sailing boats, motor yachts, diving chambers, cruise ships (especially at the operating stage of the ship life cycle), large oil tankers and commercial ships. Appraisals, within the maritime industry, are commonly used by property owners to determine the fair market value (FMV) of their assets for taxation, insurance and brokerage purposes https://stellaconsulting.ch/asset-management-valuation-methods/.

Hotels can get sold and purchased several times by different successive owners, within the real estate life cycle. That’s why, in the hotel industry, the use of international evaluation standards, including benchmarking techniques, is a well established practice by all stakeholders. On the other hand, within the cruise industry, it’s a common practice that cruise lines sell older ships to newer or smaller cruise companies. It’s rare for new cruise ships to be sold, by the first owner, for scrap at the end of their life cycle. Mega luxury yacht and cruise ships evaluation are performed by ship brokers (owners brokers, charterers brokers, independent brokers and sales & purchases brokers) based on empirical and market-based evaluation metrics applied to determine the FMV.

3. Real estate and the intellectual property evaluation

In the hotel industry, an accurate assessment of the intellectual property value (management agreements, franchise agreements and hotel lease) is an important component for defining advantageous deal, evaluating the financial performances of the real estate investment and for taking strategical decision on how to operate the hotel.

The same logic applies to the cruise industry where key players (lenders, owners and operators) deal with the most common contracts and agreement in use within the maritime industry to fit-out and/or operate a ship. The main contract within the maritime business are: the bareboat charter which is an agreement between a ship owner and a charterer that gives the charterer complete responsibility for the fitting-out of the vessel and its operations over the course of the charter; the ship charter agreement, which is lease agreement between the shipowner and lessee, under which the charter party rents the cruise ship and manage the commercial activities for the stipulated period (time charter parties or voyage charter parties) and the ship service agreement.

On top of the legal contracts and agreements, company’s environmental, social and governance (ESG) values are becoming more and more relevant as intellectual property while assessing the value of the business. Within the hospitality sector, the pandemic has further accelerated the focus on these critical issues and sharpened the business awareness on ESG principles. Guest and passengers are much more aware about the need of an environmental engagement (e.g. effective recycling, consuming locally produced goods and reducing plastic usage) and, in the last years, pressure has been growing for investors, owners and operators to prioritize real estate investments with ESG principles in place https://stellaconsulting.ch/luxury-hotel-brands-at-sea-market-trends/.

The outlook of the real estate market at sea: a new life style

Last but not least similarity between hotels and cruise ships is that both, cabins and hotel rooms, could be considered as a valid alternative option to vacation and residential homes.

Hotel chains are now offering residential programs (long-term stay discount and senior discount) which allow guests to move from one hotel to another within the same hotel chain. Cruise lines are marketing “your home at sea” programs onboard their fleet: cabins, apartments onboard cruise ships or condo luxury yachts, are sold to owners who are enjoying living a never ending cruise onboard a floating dynamic, active and well organized community.

Entire cruises ships have been even conceived, designed and sold as residential asset where residents and guests spend extensive time exploring well-traveled destinations. Single owners or timeshare multiple owners, will be able to cruise as often as they like for 25-30 years or if they prefer they can rent out their cabins to help offset the monthly maintenance fees (about 8% to 10% of the purchase price which varies according to many variables such as onboard facilities and service, furnitures, size and location onboard) or sell them when the expected ROI has been achieved. When to sell, remains a critical point for this type of investments. It’s not like selling real estate property ashore: the property at sea has a well defined life cycle as the ship wears out within a specific time-frame. Dynamics which create challenging and profitable conditions for a real estate market at sea with huge potentials for investors and operators, still to explore and estimate.

From the owner prospectives, the investment is not only for seniors unwilling to settle for traditional assisted living or care. It’s for any resident-travelers who want to enjoy the benefits from assisted living facility never been restricted to the same property or location, living a lifestyle that exists nowhere else on earth and never far from home. In line with the development of new market trends with great competitive potential, Stella Consulting Advisory Services support the business design and implementation of innovative strategies focused on:

Tailor-made training programs for service excellence at sea with tools and trainings to improve customer service, which is the key to success for any business that offers a product or a service to people.
Operational procedures definition and implementation.
Brand development strategy and awareness.
Financial analysis of real estate investments and evaluation for business owners and investors to bring solutions that optimize operational performance and prepare for future success.

Stella Consulting Advisory Services https://stellaconsulting.ch is supporting innovation and excellence in the hospitality industry developing applicable, innovative solutions that help businesses to prepare for future excellence with a commitment to academic rigor, service culture and quality assurance.

References

https://www.rics.org/eu/upholding-professional-standards/sector-standards/valuation/red-book/
https://www.ics.org.uk
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https://www.jll.co.uk/content/dam/jll-com/documents/pdf/research/global/jll-hotel-investment-outlook-2020.pdf
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http://www.shippipedia.com/life-cycle-of-a-ship/
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International Journal of Management and Economics Volume 53, Issue 2, April–June 2017, pp. 69–83; http://www.sgh.waw.pl/ijme/