With inflation still an issue in many countries the world is still grappling with many of the challenges that were set in motion by the Covid-19 pandemic. This uncertain macroeconomic environment has led to transaction levels in the hotel sector remaining relatively low, with single asset deals accounting for around 90 per cent of investment volumes and larger transactions being very few and far between.
However, positively, investors believe the frozen transactional market is likely to thaw in the near future and are looking forward to an increase in opportunities. But where are they looking to source these deals and how will the deal landscape evolve in the coming months and years?
Refinancings and restructurings
Keith Evans, CEO of Lifestyle Hospitality Capital says he expects to see increased opportunity on the back of sellers with financing issues looking to offload assets.
“We’re probably going to see increased transaction volumes because if you're a seller with some financing issues on the horizon but with relatively strong operational results, looking out two years it's quite uncertain on how those things are going to settle. So if you have a high-quality asset, why not take the opportunity when you actually have a scarcity of product in the market to make a move. We’re starting to see a bit of that happening,” he says.
Nathan Jackson, director- debt investments at LaSalle agrees that while there’s currently a lack of supply in the market, there’s an appetite for deals, and this appetite could be sated as loans reach their maturity.
“A straight like-for-like refinance in the current market is tough. If people can’t put in more capital, they will have to restructure. The refinancings coming through the system will create opportunities.”
On the road to obsolescence
Mid-market assets, though becoming more obsolete, also present opportunities for value-add investment strategies.
“Obsolete mid-market assets are a good hunting ground for us because we generally take a value-add approach to most of our investment strategies. Right across pan-European markets, we see scale in that space of traditional, underperforming mid-market assets that are maybe poorly managed and have lost pricing power. There's a lot of value-add potential for us,” Evans says.
He adds, “Often we'll take an approach which is looking at it from a design experience and taking a lifestyle to luxury approach to those assets. From a consumer demand perspective, the mid-market’s pricing power is diminishing and I think over the next couple of years, lifestyle is filling part of that gap.”
He also acknowledges the opportunities presented by office assets which may no longer be viable as offices.
“The office conversion play is quite interesting and there are a lot of eyeballs on how to navigate office conversion into hospitality or into hybrid real estate which includes not just hotel bedrooms and beverage but also extending it into co-working. Depending on the asset, you can maintain some long lead tenants as well and then sprinkle in a few other hospitality approaches,” he says.
However, challenges such as planning means that some markets are a bit more suited to execute those strategies than others.
Larry Kwon, managing director at Moelis adds that the obsolescence of certain types of hotels and offices is a historic opportunity, especially as the hospitality industry has moved from being something that's purely functional – a place to sleep – to something experiential.
“The buildings with the greatest locations are the office buildings that were built 60 years ago or the hotels built 40 years ago. They may feel out of fashion now, but they’re still in the best neighbourhoods. While there’s a valuation issue there and conversation about how these can be financed as well as the topic of adaptive re-use, I think there’s opportunity there for the hospitality industry.”
Decision making
From a debt perspective, Jackson says sponsorship, data analysis and a credible business plan are key factors when considering what deals to move forward with.
“Sponsorship is key and that goes both for the owner and the operator. We want to have someone who we know and trust and has a good track record for the relevant hotel that we're looking at. Outside of that, it's being able to triangulate trading history with the underwritten business plan. So we love data analysis; having that historical look back gives you confidence in the projections. Also, a credible business plan is really important to us,” he says.
He adds that interest coverage ratios are also coming back into focus and so is refinancing risk.
In terms of M&A trends, Kwon says there’s a lot of interest in luxury brands with home bases of Western Europe that look east as the opportunity to grow as opposed to west, into the US.
“I think there’s a lot of growth there and ultimately, there will be a lot of opportunity.”
He adds that there’s also a clear space for brands in the marketplace, noting that the distribution power of having a larger platform has proven to be very value-creative for people who are consolidating.
“In addition to that, it's cheaper than doing it through intermediaries. So I suspect that that will continue to happen and that it will be influenced significantly by growth objectives and cost mitigation objectives.”
Looking ahead, positively, experts believe global allocations into real estate - particularly in hotels and hospitality - will increase due to the potential for high yields.
“We’re in an environment where people are suddenly thinking about yields and interest rates. And where's the best place to get yield? It’s real estate. Where's the best place within real estate to get high yields? It’s hotels and hospitality,” Kwon says.
Ultimately, it seems that despite current low transaction levels in the hotel sector, the outlook is positive. As financing issues force some owners to offload assets, and as investors look to the high yields offered by real estate – especially in the hospitality sector – the stage is set for a surge in activity.
The adaptive re-use of obsolete mid-market assets and the conversion of office spaces to hospitality or hybrid real estate are potential growth areas, and investors with better capabilities and investment views are well-positioned to navigate the changing landscape and seize these emerging opportunities.
All those quoted in the article appeared on stage at the International Hospitality Investment Forum held in Berlin between May 15 and 17, in a session called - The Shape of Deals to Come: Examining Sources and Structures of Transactions