Guest Gouging: The High Cost of an Israeli Hotel Room

Tel Aviv is the world’s sixth most expensive city for hotels, ahead of even London, Tokyo, New York and Toronto, but it’s not because Israeli hoteliers are raking in big profits.

Amit Geron

Hila, who lives in the center of the country, was shocked. On the eve of Rosh Hashanah this year she managed to find a pleasant and well air-conditioned bed-and-breakfast for her family, with two clean and well-appointed rooms, including multichannel television and a well-stocked kitchen in Kfar Yehezkel for only 500 shekels ($127).

There is no doubt Hila found a great deal. The nearest available alternative was a bed-and-breakfast on a nearby kibbutz for twice the price. But the bargain was only relative: Hila later discovered that a work colleague had reserved a room in a four-star hotel at a Tokyo airport, the same day, for half the price.

In June, Tel Aviv had the great honor of placing sixth on the World Economic Forum’s list of cities with the highest hotel prices. Jerusalem was only a bit behind, at 14. Tel Aviv was pricier than New York, Singapore, Tokyo and Abu Dhabi. Israel was ranked the sixth most expensive country for vacations, and the 19th in terms of hotel prices.

Those high room rates aren’t turning into fat profits for Israeli hoteliers, however. The average rate of earnings before interest, taxes, deprciation and amortization in the Israeli tourism sector was 18.8% in 2014, down from 19.4% in 2013, according to the Central Bureau of Statistics. By comparison, the Intercontinental Hotels Group had an EBITDA of 39.7% and Hilton 33%. Two leading Israeli hotel chains, Dan and Isrotel, had EBITDAs of 23.7% and 21.7%, respectively.

The high rates Israeli hotel charge are mainly because they are saddled with costs that are often unique to Israel. Here are nine of the biggest factors:

The security situation

Tourism, hotel construction in particular, requires a major capital investment, but trying to earn a commensurate return is a hairy business in a market regularly rattled by wars and terrorism. The past 15 years alone have seen seven major incidents, from the second intifada to the Second Lebanon War and, most recently, Operation Protective Edge in the Gaza Strip in the summer of 2014. Both Operation Protective Edge and the Second Lebanon War took place in July and August, the height of Israel’s tourism season and the most profitable months for the hotel industry.

One of the ways the industry deals with this risk and ensures a reasonable return on its investment is by charging high prices.

“We are always living in fear of the next war,” explains Maoz Yinon, a co-owner of the Abraham Hostel in Jerusalem and the Fauzi Azar Inn in Nazareth. “That’s what we’re thinking about every time we hire another worker or add another room.” Operation Protective Edge caused his occupancy rates in Nazareth to fall from 60% to 70% into the single digits for months after the fighting ended, says Yinon.

In addition to the uncertainty, Israel’s security environment damages the country’s image in the minds of visitors. Foreign tourists can face prolonged and uncomfortable security checks at the airport, potentially turning them against Israel at the worst and discouraging them from future visits at best, he says.

Minimum wage and the exchange rate

Another major factor in the constantly rising operating costs for Israeli hotels is the combination of a higher minimum wage and the strengthening of the shekel against both the euro and the dollar.

In January 2003, the monthly minimum wage was 3,335 shekels, which was then $716 or 666 euros. Since then the minimum wage has risen by 39%, to 4,650 shekels in April. The strengthening of the shekel raised costs even more in foreign currency terms, so that the minimum wage is now equivalent to $1,195 or 1,066 euros.

Since wage costs make up 34% of hotel operating expenses in Israel (based on data from the statistics bureau), it is clear the jump in minimum wage has a major effect on costs.

In fact, the minimum wage in Israel is now higher than competing Mediterranean tourism destinations like Greece or Spain, and towers over pay for hotel staff in Egypt or Jordan.

Israeli labor law, which is relatively stringent in terms of protecting workers, adds to labor costs. The law stipulates a 50% bonus for work on Saturdays and holidays. Workers also cannot work more than three weekends in a row or more than seven night shifts in 21 days.

All these factors add an estimated 210 million shekels in annual costs for the hotels, or about 2.5% of revenue.

Kashrut

Another major cost in Israel, and rare elsewhere, is the expense of keeping a kosher hotel, even if it does not directly show up in the profit-and-loss statement. Hotels must retain an on-site kashrut supervisor, including on weekends and holidays when many bring their families with them.

The cost of food and ingredients is often higher, as particularly strict kashrut supervision can in many cases require buying from specific suppliers.

The kashrut costs affect more than just operating expenses. It is much more expensive to build a kosher hotel, since it requires almost double the kitchen space — for separate meat and dairy facilities — as well as separate sets of china, silver, serving dishes and cookware, of course.

The Israel Hotel Association estimates the additional cost of kashrut at 2.6% of revenues.

Property taxes

The way property taxes (arnona) are levied on hotels in Israel is unique: Municipal taxes abroad tend to be calculated as a percentage of revenue per tourist, rather than a fixed sum based on land value that does not take into account the ups and downs in a hotel’s cash flow, such as the winter low season and, of course, security crises.

Not only are local taxes fixed, but hotels often pay much higher rates than offices or other commercial properties, and arnona is levied on the entirety of the floor space, including “public” areas such as corridors and passageways.

These taxes, which vary from city to city, are estimated at 2.5% to 3% of revenues, while in Europe they are generally only about 0.8% to 1% of revenues.

Value-added tax

Israel’s value-added tax has traditionally been high and raises room prices for Israelis. Tourists are exempt from VAT in hotels, but Israelis represented 63% of all hotel stays in the first eight months of this year.

VAT may have been reduced this week, to 17% from 18%, but it remains much higher than in most Western countries, which generally see tourism as an industry to be promoted. Greece, for example, was forced to double VAT rates as part of its latest austerity package, but the VAT for tourism is only 13%. Spain and France’s rate is 10% and Italy’s is 7%. They all host about 20 times the number of tourists Israel does, and all charges tourists lower VAT rates.

The high cost of living

The hotel industry cannot be separated from the high cost of living in Israel, which affects the costs of operating a hotel, too, which in the end is passed on to the guest in the form of higher room rates.

Food prices in Israel were 19% higher than in other Organization for Economic Cooperation and Development member states and 25% than in the European Union, the Knesset Research and Information Center reported a year ago. Food accounts for 12% to 16% of hotel expenses, and certain items, such as soft drinks, milk and alcoholic beverages, are particularly expensive in Israel — by 56%, 51% and 33% on average, respectively, than in Europe.

Regulation

Israeli regulations add expenses in such areas as security, maintenance and operations, which usually do not apply overseas. For example, the cost of the extra security here is about 0.8% of a typical hotel’s turnover.

Examples include the instructions of the Home Front Command that requires a reinforced room on every floor; extensive space reserved for use as a bomb shelter, which does not produce revenues, and requirements for large amounts of public areas, which is aimed at discouraging hotel owners from turning their properties into apartment hotels.

Other rules require at least one-and-a-half full-time lifeguards at their swimming pools, as well as other restrictions that rarely exist elsewhere, and at a cost of 0.5% of revenues. The number of instructors required in fitness centers is another burden, as are a host of unusually stringent health and fire code rules.

Financing and capital costs

The Tourism Ministry claims that the biggest factor in raising hotel room rates is a lack of balance between supply and demand. Between 2000 and 2014, the number of hotel rooms grew by 9.6%, while the number of tourists rose by 20%.

“Since 2000 we’ve built almost no new hotels so that every time demand grows prices rise a lot,” says Tourism Minster Yariv Levin. “Even in periods of low occupancy, there’s no competition and rates don’t fall.”

In theory, the high room rates and increasing tourist arrivals should lead to more hotel construction, but it hasn’t happened due to a mix of high risk, low profitability and the long zoning approval process.

The red tape required to build a new hotel means financing costs over a long period. It takes at least five years to build a new hotel and it typically takes 15 years to recover the investment, so that financing costs can stretch out over two decades.

It can easily take five years to obtain all the necessary approvals and building permits, and the sudden outbreak of a war or an intifada can put them on hold, which explains why the banks are very hesitant to finance development of new hotels. Instead, investors end up putting more of their own money up front, which increases costs down the line.

This has led Israeli hoteliers to look overseas for new projects: In the past decade, Israeli hotel operators purchased more hotel rooms outside of Israel than were built inside the country since the state was established, in 1948.

There are additional problems for the industry, such as a shortage of mid-priced rooms, especially after the Open Skies aviation reforms with the European Union led to a surge of low-cost airlines offering flights to Israel. More foreign tourists are coming, but most of them are frugal. Airbnb and other new business models that compete with conventional hotels are putting on the squeeze, even if some new boutique hotels in Tel Aviv and other locations are doing very well.