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Newstead developer Petty: financial models don’t work for hotel-only development

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This is the fourth in a series of reports on the state of the Bermuda tourism industry.

We will examine how far we have fallen since our heyday in the 1980s, why dozens of resorts and hotels, including highly rated ones, have failed and closed, why no one wants to invest in a hotel in Bermuda right now, why no new developer has broken ground despite promise after promise, and what it will take for a new resort to be built, and for the less than 50 hotel properties we have left to be profitable enough to keep their doors open.

As the first developer to build a new hotel in Bermuda in four decades, once proud owner of Newstead Belmont Hills, Kevin Petty, gave us an eye-opening view of what it takes.

And he has a simple answer to why there have been only three new hotel properties built in Bermuda since 1972: “No one can make the financial models work.”

Mr Petty took the risk of making a badly needed investment in tourism when no one else would.

He believed he was investing in a new beginning for the hospitality business in Bermuda, with the third best tourism year in Bermuda’s history seen in 2007.

But it proved to be the worst of timing.

Butterfield Bank, itself brought to the brink after $200 million-plus in losses in both 2009 and 2010, last January in a shock move put the property in receivership. It has not been able to sell it since.

Looking back at the development stages, Mr Petty, who has been in construction 20 years, said he first had to manoeuvre through a minefield of development and foreign ownership restrictions to come up with a model that could work and win approval from the Department of Tourism, Department of Planning and Finance Ministry.

He contracted Ernst & Young to do the Newstead/Belmont Hills financial model for the entire development (surprisingly, Mr Petty noted, it was Ernst & Young that was appointed receiver for the financially troubled development).

Construction and the major refit of the Belmont Golf Course took place in 2001 to 2002, the construction and successful sale of 72 Belmont houses from 2003 to 2007, and the beginning of construction for the new all-suite hotel and fractional product at Newstead in 2005 to 2008. Newstead was all fractional, but suites were rented as hotel rooms when the fractional owners didn’t use them.

“All the money for the sale of the 72 Belmont homes was reinvested totally back into the construction of Newstead, nothing was taken out of these proceeds,” Mr Petty said. “It was repaid to the Butterfield Bank. On top of this income, additional funds were needed to complete the construction of the new Hotel.”

He added: “There were independent project managers that scrutinised all aspects of these developments, from the start of both projects, overseeing and approving the construction and drawdowns of all monies spent, for Butterfield Bank.”

Higher than expected building costs and design issues were a major setback. Then the global financial crisis hit, almost freezing up the market for fractional condos.

Mr Petty said he personally lost millions and is sorry to any one of the fractional owners that felt let down by his group and apologised to any creditors that lost money in what he felt was an “abrupt” receivership.

But despite the devastating experience, Mr Petty said he still stands behind Bermuda, and wants to encourage new hospitality investment, although he says it will take bold moves for it to succeed.

If you believe the speculation at the highest levels in the industry, almost every hotel in Bermuda right now is struggling financially, and other heavily in-debt properties could very well end up where Mr Petty did and it may be only a matter of time for some. Much depends on demand picking up and occupancy substantially improving. But even that may not be enough, hoteliers told us.

Mr Petty agreed to answer our questions for this series in the hope his insights into building and operating in Bermuda in this challenging economic climate might help to bring about a new model for successful tourism investment.

“I am not the one Bermuda should throw to the curb for failing, especially in this economic crisis,” he said. “I may have failed initially, but I can and am willing to be part of the solution, with the experience I have gained in recognising the pitfalls that will encompass any developer/investor going forward.”

He told us he recently shared with the current Tourism Board’s senior members his experiences and advice going forward for any new tourism projects.

Why is it so difficult to make any hospitality project work in Bermuda?Cost of construction and materials for construction of a new hotel are far too great, unless all duty is relieved and freight costs are reduced. It has to be a collective buy in from all persons involved, and there needs to be give and take.

The cost of building a three- to four-star hotel product in Bermuda has tripled in 15 to 20 years.

Overruns of the original timelines of construction, and little accountability by local architects to the developer or investor. There should be cooperation in a development from the beginning when everything is flowing perfectly to taking part of the responsibility of mistakes and design flaws at the end. All parties involved in constructing the tourism product need to hold hands in sorting out the issues associated with operational problems.

What happened with Newstead Belmont Hills?The sustainability of a debt that was willingly and continuously loaned by the bank over 12 years, that could not be serviced or maintained, when all hotel rates decreased massively, and occupancy levels decreased at the same time. The debt could not be paid back in a reasonable period of time, after the complete build out, including all the building problems associated with the project. Hospitality construction is like no other, these are individual rooms with very independent issues unlike an office block. For example, separate hot water heaters in each room, separate air conditioning with separate controls, that run 24 hours a day when a tourist is in residence, individual kitchens, refrigerators, smoke detectors, security issues for all doors’ access, TV’s, internet capabilities, all in a controlled environment of approximately 500 square feet.

What are the top three things that could be done right now that would help any new investment in tourism to be successful?1. Open up all doors for non-Bermudians and Bermudians, to purchase any part of any new projects that have a tourism designation, no matter what size or make up: fractional, hotel/condo, etc.

2. Cut all related duty for anything related to tourism products, and all construction materials, furniture and fittings.

3. Allow for a real estate sale of some portion of the property zoned tourism, so that a given investor or developer can expect to receive a decent return on their investment, in a reasonable time frame.

What happened to the fractional market?Bermuda is renowned for its repeat visitors, so the fractional model was a good one, once. It is now somewhat saturated for the present day economy and price point.

Again, the recession and Bermuda’s banking system were overheated when they were built, and too much money was loaned, that cannot be repaid, so the fractional product which has had to be discounted so quickly, is a worry for those that purchased at the top of the market. When a product has a deep discount, new buyers worry there is more economic trouble associated with that particular development, that has had to discount so quickly after completion.

How does the cost of electricity in Bermuda affect the costs of running an operation and the bottom line?The electricity costs for running a hotel in Bermuda are far too high due to the cost of oil. You cannot predict the cost of electricity when you design a hotel, prior to actually building it. In our preliminary budgets for this cost, we were extremely off on our calculations.

Why have only three properties been built in Bermuda since 1972 (Newstead, redeveloped 9 Beaches, and Tucker’s Point), one of which has closed and the other is in receivership?No one can make the financial models work in an environment that has numerous overruns, constant time delays, and in a construction market that has been overheated for years. Land cost is far too high to have a fighting chance. There is no reasonable return for an investor, over a reasonable period of time, based on the high costs associated with building a new product. The risk to reward ratios are far too great.

Once developers and investors do their calculations and have a truthful and real understanding of what it actually costs to build and sustain a new hospitality venture today, they generally back away and go to other locations where the labour market and costs are easier and less prohibitive. They realise that there is no reasonable return on their initial investment. Hotel room rates and occupancy levels have all dropped in this current global recession, but that is not the only reason for any future developments proceeding.

Have the costs of Government fees hurt the future of the hospitality business year to year?Yes. Government needs to put aside any fears that developers and investors are making huge profits, and encourage a mutual partnership, where the complete truth of financial numbers are shared and believed. Government fees have to be positioned fairly to compensate any development, and also help towards relief for payroll taxes, hotel occupancy taxes and social insurance for employees.

The taxes are far too high for this pillar of the economy and for endeavouring to keep Bermudians working in a dying industry. Most employees in the tourism business make too little, and rely on the gratuity system far too heavily, to survive. I feel for the housekeepers, and front desk personnel, as they are the front line employees and are making the least amount of money. With the fractional model, at least employees are kept working throughout the whole year. There is no off season because the fractional owners pay a monthly maintenance fee that compensates employees all year long.

Employers are too handcuffed as well with these high Government taxes for the hospitality business.

What is your view of Bermuda as a tourism destination?Bermuda is an awesome hotel destination, with it’s location, beauty and proximity to the Eastern seaboard gateway American cities and the European connection. Bermudians are, on the whole, a very friendly and hospitable people to visitors. So it has huge, natural advantages going for it.

In your opinion, what additional Government or other incentives and/or policy or law changes would be desired to attract hospitality investors to Bermuda and get them to break ground?Government can do so much, immigration policies need to be relaxed, the approval process for any sale of fractionals or any process for real estate transactions that pertain to any income derived from a hotel development needs to be speed-tracked through all departments. There should be a separate function of Government, solely for tourism-related projects, to really impress any developer.

Property developer Kevin Petty
Newstead: In receivership

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Published March 20, 2012 at 2:00 am (Updated March 20, 2012 at 9:13 am)

Newstead developer Petty: financial models don’t work for hotel-only development

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