Steep rises in operational costs and an uneven recovery after Covid have put leases under the spotlight. Do hotel leases still deliver the right balance of risk and reward for both owners and operators?
Recovery of Germany’s hotel sector, where traditional fixed rent leases are the norm, has been weaker than in Spain, Italy, and other markets.
Does this mean owners and operators in Germany will consider variable rent formats, or even hotel management agreements (HMAs)?
Very unlikely, said David Kellett, managing director, Invesco Real Estate: “The German hotel market is predominantly owned by German investors and for the German Investment Act, they need a lease.”
Germany sticks to fixed leases
In Germany, index-link clauses are only valid in commercial leases of 10 years or more. Turnover-based rents appear mainly in retail and some hotel leases, but these remain exceptions rather than the rule, according to a DLA Piper research paper.
HMAs have made little headway in Germany’s institutional ownership market. Regulated real-estate funds, pension schemes, and insurers must comply with the German Investment Act (KAGB), which demands stable, predictable cash flows via traditional lease structures. Pure profit-sharing or management-fee models under HMAs typically fail to meet those requirements, so direct HMAs are rare.
During a prolonged period where costs are rising more than revenue, Kellett said, from an owner’s point of view, it is beneficial to work with the same operator across a geographically diverse portfolio in which good performance can offset poor performance. “You need operators with strength and depth,” he said.
Variable leases
Pandox has been deploying variable leases in Europe since the 1990s, said Martin Creydt, SVP & director, Asset Management International, Pandox AB,
He explained the attraction of variable leases: “We are big believers in active property ownership and with variable leases you must be an active owner. It really takes two to tango and you are always in the same boat with the tenant or the partner. You cannot sit in the back seat.”
Kellett agreed that variable leases make landlords feel engaged, involved, and that they “should form better partnerships going forward,” although he acknowledged they may not be a plus point for all tenants.
Unstable times
Giving an operator’s perspective, Ronen Nissenbaum, CEO of UK, Ireland, Benelux, Spain, Portugal and US Development at Fattal Hotels, said: “Variable leases are good in a stable environment, but what we've experienced over the last three or four years is obviously a very unstable environment, with costs increasing dramatically.”
Some leases assigned ten years ago did not envisage more than one percent annual growth in the rent; instead, the rent increased by 10 percent in one year. In these cases, rather than continuing to lose money, Nissenbaum made the decision to buy three properties from the landlord and get a low rate of return instead.
He added: “When you have 20 hotels [in one country or region], there's going to be some hotels that are doing really well, and there's going to others that are losing money. And you need to find solutions for that.”
The next version of the lease
Kellett suggested updating standard lease contracts by adding elements from HMAs, like clear performance targets and rights to end the deal if those targets aren’t met. He argued that when tenants underperform the market, the owner should have tools to step in.
He said: “I think Covid and the recovery from Covid has shown that the lease probably doesn't fully work in exactly the right way, and so we do need to think about what the next version of the lease looks like.”
Again, giving the operator’s point of view, Nissenbaum explained that leases carry significant financial outlay for operators, who must guarantee millions in rent for decades.
He worried that blending leases and HMAs could turn the owners into an asset-managers, second-guessing every operational decision.
He said: “I'd be scared if suddenly you [the owner] come in and start saying your payroll is too high and your F&B costs are too high, and you're starting to act like an asset manager, when I’ve put in a significant amount of guarantee.”
Long-term partnerships
Creydt noted that long-term leases inevitably mean that both good times and bad times will occur: “Please, let's contribute together. We have to foresee long-term strategies.”
He emphasised the importance of sticking with a chosen model through headwinds and tailwinds, rather than judging it solely on short-term struggles. “It cannot just be that one year, two years, we struggle, and then it's a bad model. We have both committed for 20 years plus five years, so we must be happy campers here, alignment or not.”
Just say no
Of course, another option is to avoid leases altogether, which is what APG Asset Management does. Paul Atema, director of real estate, said APG has two models. Firstly, owning real estate and operating it themselves: “It's a developer, operator and owner model. We own everything, and we are exposed to everything, so we don't have to go through the headache of agreeing a deal with an operator,” he said.
APG likes to be fully exposed to operational risk because it lets them share in all the upside when business is good – and by the same token absorb the downside when it isn’t, he explained.
Secondly, through its dedicated hotel investment vehicle Archer Hotel Capital, APG owns real estate which is operated via franchise and management contracts.
In Atema’s view, fixed leases give too little potential reward but still carry significant downside risk, so APG steer clear of them.
All quotes taken from the IHIF EMEA panel ‘Reimagining the lease to boost investment appeal: Adapting to a new era with more flexibility.’ The panel was moderated by Arlette Mensing, director, Colliers.