In a challenging and unpredictable macroeconomic environment it has become increasingly important for the hospitality industry to seek out creative solutions in order to secure financing and get deals done.
The challenges
While year-to-date UK transaction volumes as of Q3 2024 are estimated to be at around £3.8 billion according to Savills – up 185 per cent for the same period in 2023 – caution remains due to the increased level of scrutiny around acquisitions which is slowing down deals, extending timelines and increasing the risk of deals being aborted.
“Banks and lending institutions are taking a lot of time when looking at underwriting hotel investments – it’s taking much longer to get through credit committees,” says Henry Jackson, head of hotel agency at Knight Frank.
And according to Savills, this increased level of due diligence - particularly around issues like cladding and M&E - and the consequent delays are likely to be exacerbated moving forward.
Jackson agrees, singling out fire compartmentalisation — a particular problem in the UK in the wake of the Grenfell Tower disaster — as an impediment to dealmaking moving forward, noting that it is emerging as a critical factor in asset saleability.
“Unless certain buildings have certificates that show that compartmentalization is to the required standards, the time is looming when that asset will be difficult to sell. Owners will need to have documentation in place prior to coming to market because otherwise it can frustrate multiple parties in multiple ways.”
Examining cost inflation and the interest rate environment, Steve Crosswell, senior relationship director – hotel finance at Leumi notes that while cost pressures have somewhat stabilised, the contractor market remains fragile.
“Costs seem to have plateaued and market sentiment is for a pattern or rate reductions over the next 18 months, meaning that developers will be able to commit to projects with a lot more certainty and confidence. Unfortunately however, the contractors market remains challenged, with a number of contractors including some large household names collapsing,” he says.
However, he remains optimistic. “The hope is that these issues wash their way through the system, providing some stability.”
Creative solutions
Philip Lassman, vice president, head of development for Northern Europe at Accor agrees that high construction and debt costs present further challenges but emphasizes the importance of creative thinking and collaboration between stakeholders in order to drive dealmaking.
“We’re looking all over the country at what’s going on in cities, towns, and out-of-town areas that will stimulate growth and development. There are a lot of big infrastructure projects around the country and it's about how you can break in there – hotels are the centerpiece of many regenerations. It’s about forward-thinking local authorities partnering with developers and brands,” he says.
Lassman stresses that projects such as airport expansions, power plants, life science parks and regeneration initiatives are opportunities for hotels to play a central role, provided all parties can align on mutual objectives, adding that success hinges on working to ensure everyone’s interests are served.
“It really comes down to all the parties understanding what all the opportunities are. There is a huge opportunity for a lot more hotels but we need to find a way which ticks all the boxes for all of the stakeholders. It’s crucial that people not only be focused on what's in it for them – you’ll never get a deal if you're only focusing on what's in it for you. You need to focus on how to make it work for everyone and how to satisfy everybody's demand,” he says.
And creativity is also important when seeking to overcome financing hurdles and get deals across the line, with creative financing solutions gaining traction in instances where banks are holding back, Jackson advises.
One of these, he says, is the use of deferred vendor loans where the seller retains a financial stake in the project to give the buyer breathing space.
“I have seen a number of deferred vendor loans, and we have structured some vendor loans where the vendor will keep some money in the deal and there’ll be a recoup of that money in one or two years, giving the buyer some space to do things like their refurb.”
Crosswell advises further. “Being really comfortable with your borrower and being able to quickly build rapport is key, as is having absolute honesty in the relationship. Borrower liquidity is also something that has become particularly important.”
He also notes that there are certain segments of the industry that are more resilient to when the economy and disposable income are under pressure.
“Generally, there tends to be a flight to quality and a flight to value so the luxury/upscale and limited-service segments trade well. Growth rates in extended stay have risen well in recent years and it remains a relatively immature segment. Branded residences also appear to be getting more and more attention,” he says.
Looking ahead
Looking to the future, Jackson says investment levels moving forward is dependent on identifying assets which will sell.
“The investor market is getting frustrated with deals falling through because the market isn’t reaching pricing expectations. So it’s down to identifying those assets that will sell at what the market is willing to buy at – and that’s when investors will really engage with their lenders and put in the time and effort required to create an offer that can go forward to the seller and potentially yield a transaction.”
He adds that looking into 2025, the hope is that further interest rate cuts will facilitate bringing down the cost of debt and that trading performance continues to remain robust.
“If we have robust trading performance and interest rate cuts, more certainty will filter down into investors and hopefully lenders, and that will further charge the investment market.”
Crosswell agrees. “The consensus seems to be that we’ll see small but regular reductions in base rate over the next 18 months. This can only be a good thing as it gives more lenders the confidence to re-enter the market and provides borrowers with the comfort that they can better manage their debt obligations.”