Mekka as most promising hotel investment market

There are a number of reasons why Makkah hotel investments exhibit the potential for 16-18% annual dividends. One, the Saudi kingdom intends to triple the number of Umrah visas and religious tourists are expected to rise to 17.5 million sometime in the next five years. Ironically, the crash in oil prices has increased the strategic importance of tourism as a source of revenue and job creation in Saudi Arabia, as Price Mohammed bin Salman noted in his recent Economist interview. Two, tourism is the second largest employer of Saudi citizens even now, a key priority for a government committed to job creation opportunities for Saudi nationals.

Three, 9.4 million pilgrims traveled to Saudi Arabia in 2015, with a 10% compound annual growth rate in the number of Umrah visas. As Makkah is the epicenter of a pilgrimage sacred to 1.8 billion Muslims, its hospitality sector faces a virtually unlimited demand curve and is a proxy for rising affluence, middle class population growth and wealth creation in Saudi Arabia, the Gulf and the entire Islamic world. This makes Makkah’s hotel micro-markets the most attractive investment in the world for a regional or global investor.

Four, the Saudi Arabian government has initiated a number of infrastructure and transport initiatives that only enhance the risk/reward calculus of hotel development in Makkah. The kingdom plans to spend $80 billion in the continued expansion of the Grand Mosque so that it can accommodate upto 2.2 million worshipers. This is essential before Saudi Arabia can increase Hajj/Umrah visa quotas for such populous Muslim countries as Turkey, Pakistan, Indonesia, Egypt and even non-Muslim countries such as India, Britain, France, the US and Canada, a strategic diplomatic priority for the kingdom.

Five, Saudi Arabia’s planned expansion of the Grand Mosque and exponential increase in foreign pilgrimage visitor quotas is complemented by more than $100 billion investments in the transport infrastructure of the Hijaz. For example, the expansion of the Haramein high speed rail links and the increase in Jeddah’s airport capacity to accommodate 30 million passengers will anchor the rise in pilgrims who will need hotel rooms in Makkah. This colossal commitment to airport/high speed rail transport/expressway capacity expansion makes strategic sense since the Saudi government plans to triple Umrah pilgrimage visa issuance by 2018. This makes investing in Makkah hospitality a non-brainer.

Six, property market investing necessitates sophisticated supply-demand models and real time analysis. Makkah hospitality has the world’s most attractive supply-demand metrics in 2016. The recent large scale demolitions have eliminated 26,000 rooms in Makkah while there is a chronic shortage of 4 star hotel rooms, a mere 11% of total supply in a market where international hotel branded keys are a mere third of total supply. As demand spikes due to the rise in visa issuance, supply plunges due to demolitions, restrictions on new developers (only Saudi citizens, not even GCC nationals, can develop real estate in Makkah) and the downgrade of many existing four star hotels to two stars or one star due to the Supreme Commission for Tourism and Antiquities (SCTA) reclassification program.

I envisage a major rise in occupancy rates and pricing power for four star branded hotels. This niche is a RevPar and gross operating margin (GOP) dream not possible in Dubai, London, New York or Hong Kong. There are a mere 12,000 four star hotel rooms available in Makkah, a city that attracts 7.3 million Umrah pilgrims in 2015. The forecast for 2016 is 9.9 million Umrah pilgrims alone. This data makes four star hotel investments in Makkah the property deal of the decade.

It takes at least three years to lease land and permits for hotel construction in Makkah. It costs $100,000 per room to develop a four star hotel in a global gateway city but a mere $60,000 in Makkah. This is a hotel investor’s dream come true!

We never forget the fairy tale dreams of our childhood. My teenage years were spent (among other things!) engrossed in the immortal literature of imperial Russia – Tolstoy, Pushkin, Gogol, Chekov, Dostoevsky and even Pasternak. The lost world of the Tsars so enchanted me, the lost world literally murdered by Lenin’s Cheka in the cellar of a merchant’s mansion on the night of July 18, 1918. I swore never to visit Leningrad as long as it bore the name of the evil monster who founded the Sovetsky Soyuz (the USSR) – and I never did. When I finally visited my beloved Saint Petersburg, the Venice of the North, I found I knew its streets, palaces and theatres from my boyhood reveries in Russian literature and history. Palace Square, Saint Isaac’s Cathedral, the Neva embankment, Vasilyevsky Island, Nevsky Prospekt, the Hermitage, the Fortanka, Mariinsky Theatre, Senate Square, the Yusopov palace on the Moika Canal. This was the city where Russia’s imperial saga was born and died. This was the city of Vronsky and Anna, the brothers Karamazov, Alix and Nicky, Tchaikovsky and Shostakovich – and the city of Vladimir Putin.

Russia trades at 5 times earnings, the cheapest emerging market on earth with good reason. The Russian rouble has fallen 120% against the US dollar since Putin’s Crimean Anschluss. The Kremlin has checkmated the West in Georgia, Ukraine’s Donbass and Syria on the battlefield but paid a ghastly economic price in sanctions. Capital flight is the highest since the fall of the Soviet Union. Money market rates soared to 17% in a failed bid to defend the rouble. Inflation has devastated the income of pensioners and industrial workers, Putin’s core vote bank. The banking sector repaid $200 billion in foreign loans in 2015 and faces a draconian credit crunch. Yet it is always darkest before dawn. The output freeze deal with Saudi Arabia in Doha is a game changer in the oil game. $400 billion in new energy projects worldwide is now kaput. The Texan shale oil drillers will go bankrupt as hedges expire this summer. Wall Street junk bonds imply a 30% default rate for shale oil and gas drillers.

The global oil glut is at least 1.5 MBD now. Yet the Black Death has de facto shut down the North Sea, the Santos Basin, deepwater West Africa, Alberta tar sands, the oilfields of Azerbaijan and the Maracaibo Basin. Saudi Arabia’s epic gamble will finally succeed when the world loses 2 MBD of high cost supply this autumn and find itself short black gold. Then and only then will the Saudis invite OPEC and Russia into a new deal that leads to $50 Brent. Is this macro oil scenario remotely priced into the money souk? In Russky, nyet!

Churchill said Stalin’s Russia was a riddle wrapped in a mystery wrapped in an enigma, like a matryoshka doll. Not Putin’s Russia. The Kiev Maidan uprising was a de facto coup against an elected President (if Putin stooge) and the Ukraine far right nationalists were once allies of Hitler’s Wehrmacht and the Himmler’s SS Einsatzgruppen. Crimea is the home base of the Russian Black Fleet since the reign of Tsar Alexander Pavelvich, Napoleon’s rival at Borodino who led the Imperial Army across Europe to Paris. Unlike Lenin or Stalin, Putin’s currency of power is money and oil, not Marxist fantasies. Sergei Lavrov is the most savvy Russian diplomat since Tsar Nicholas’s count Nesselrode. The US and Germany need Russia to vanquish ISIS, stabilize Syria, deter China, engineer a Ukraine ceasefire, kick start EU growth. If the West and Russia unite to destroy Daesh and implement the Minsk Pact, sanctions will be lifted. This will mean the mother of all stock market rallies in Russia, though the oil/rouble crash has led to both winners and losers.

Russian equities are, of course, not for widows, orphans and for those without abdominal fortitude and the right market intel with the cognoscenti in Moscow and Londongrad. After three years of horrific losses, Wall Street, the city (and UAE family offices!) are disgusted with Russian equities. Wonderful. Yet the smart hot money nibbles at the Russian firebird, even as oil prices bottom, the rouble stabilizes and the Kerry Lavrov diplomatic dance to lift sanctions begins. In times of crises, as when Moscow burnt while Napoleon slept in the Kremlin or Leningrad starved as Hitler planned his victory dinner menu, the Russian muzhik knew it is always darkest before dawn, knew the curse of the witch Baba Yaga must eventually end. So it is with Russian equities as I hunt Moscow for the next triple bagger.

Sterling’s fall from grace since its pre-crisis high of 2.10 (on cable!) to 1.39 now is the biggest currency devaluation in the history of the United Kingdom, bigger than the exit from the ERM under John Major in 1992, Jim Callaghan’s IMF humiliation in 1976, Harold Wilson’s “pound in your pocket” devaluation in 1968 or even Ramsey McDonald’s decision to take the British empire off the gold standard in 1931. Sterling has punched above its weight in Planet Forex for the past hundred years, due to the worldwide economic clout of the British Empire, (Anglobalization preceded globalization!), the North Sea oil bonanza in the early Thatcher era and London’s role as the epicenter of global casino finance since the 1990’s.

Sterling traded at 1.70 against the US dollar two years ago but is now below fair value on any credible index, from purchasing power parity to the Big Plac index. Sterling now prices in at least a two third probability of Brexit though London bookies put the odds at only one-third, even though the anti-EU campaign now has the alpha male Tory Blondie (Mayor Boris) as its leader. Does this raise the Brexit risk premium implicit in sterling? Yes, despite the resilient 4Q UK GDP data. After all, no shift in US Treasury – British gilt interest rate spread could explain sterling’s fall below 1.50. The sterling’s recent free fall is due to the politics of the EU exit campaign, not relative US/UK economic growth rates or central bank policy divergences.

I find London bookies, not City currency option traders, more credible as a forecasting tool. The Scottish referendum or even the 2015 general elections prove that British poll data are notoriously unreliable. I personally believe that Britain will not vote to exit the EU now that David Cameron has clinched better terms in Brussels on welfare benefits and migrants. I notice J.P. Morgan just turned “overweight” UK equities and HSBC’s FX strategy team projects a 1.60 sterling target by year end 2016. These forecasts hardly suggest Brexit.

Sure, we all live in a fickle world, if not a yellow submarine. Three months are an eternity in British politics, even when David Cameron offers the sceptered isle’s electorate blood, sweat and tears. Boris Johnson and Michael Gove (et tu Preeti Patel?) symbolize the visceral anti-EU DNA in Westminster that is no longer limited to the Tory backbenchers. So what happens on June 24 if Britain votes to leave the EU? A growth shock, a rate cut by the Bank of England, an exodus of offshore funds from the City, chaos in Downing Street and a sterling crisis reminiscent of Black Wednesday. This scenario is sterling Armageddon, with a cable free fall to 1.25. Brexit would mean a UK recession in 2017 and Euro/sterling could test 0.92 as British trade with the EU would tank. The world would also have to come to terms with another Old Etonian Prime Minister – Boris Johnson. Definitely not jolly boating weather for sterling or the (united?) kingdom by the sea!

Six months implied sterling volatility is 12%. It is entirely rational for sterling volatility to have spiked in the past four months, though its rationale is no longer a dovish Old Lady of Threadneedle Street but the most historic referendum since the Scottish vote, with an uncertain outcome. Strangely enough, the FTSE 100 equities index or gilts do not price Brexit, unlike sterling. So it makes strategic sense to monitor the British centric FTSE 250 index and the High Street banks, both vulnerable to a higher Brexit risk premium.

I am surprised that the UK gilt money market curve prices in a first rate hike in 2018. This is a testament to Governor Mark Carney’s dovish jawboning as well as the recent financial carnage in China/global banking shares on Wall Street. Yet history tells us that Britain is the most inflation prone economy in Western Europe and the next twist in inflation is higher, as even Carney has conceded. This means sterling shorts face existential short squeeze risks as UK data and poll results flash in real time on the Bloomberg screen. A Fed rate hike, a ECB rate cut or a Lehman scale black swan could also impact sterling’s fate, beyond Brexit and UK data. This is why trading currencies is a game of six dimensional chess.