Hospitality lenders and investors are increasingly confident about market conditions, as interest rate cuts gain speed, while budget decisions and election outcomes near conclusion.
“Hotel investment has benefitted from key trigger points in the last few months,” says Christof Winkelmann, chief market officer at German real estate lender, Aareal Bank. “One trigger point in this cycle was the first time people believed that interest rates wouldn’t go up anymore. Another was when interest rate cuts began. You saw the relief in investors, even if an expectation gap remains between buyers and sellers.”
While trades have been relatively muted, momentum in capital raising and an increase in Pfandbrief issuance – a kind of covered bond backed by long-term assets like real estate – are also seen as good signs by Winkelmann. However, he is keen to underline that Aareal Bank has remained active in the hospitality lending sector over the last few, complex years. “We truly like hotels as an asset class,” he said. “We started Covid with a hotel loan portfolio amounting roughly €11 billion and ended it with €12 billion, having seen no foreclosures in the properties we backed. We believe that banks need to flank investors in tougher times too.”
Opportunities set to continue
That said, Winkelmann notes that the pandemic was also a time of considerable opportunity, and that he sees those opportunities continuing. “Some say that room prices have risen too much, or that post-Covid travel was a bubble. We see that hotels are all full and that there is continued demand in the leisure travel space, with business travel bouncing back. MICE is on the increase.” He adds: “Whatever perceived declines there have been this year are now being filled with the gap of group travel – I’m not seeing deterioration in the sector from a performance point of view.”
Hospitality’s operational aspect – seen as a barrier to entry by some investors – also provides upsides, he notes. “Hotels have always been perceived as higher risk, so historically they have traded at higher cap rates. That also means you will struggle to get the same cash coverage, say, in the residential segment as the hotel segment. Higher cap rates mean better debt serviceability.”
Winkelmann adds: “Decreasing interest rates are usually not a good sign, as they mean that economies aren’t doing so well. But for real estate, if you can keep the top line relatively even, then interest rate decreases can have a significant, positive impact on real estate values.”
Confidence in play
“Capital markets are all about confidence,” says Ludo Mackenzie, co-head of real estate debt at UK lender and investor Octopus Real Estate. “Data points from global macroeconomics to local politics all matter. If investors and lenders can see a more benevolent environment ahead, it gives them the confidence to transact. It feels like we are turning a corner.”
Looking at the political factors in play, Mackenzie adds: “The US election is on a knife edge, but the markets appear neutral either way. If the situation in the Middle East gets worse that could have an impact on capital markets.”
Closer to home, he suggests that “the real estate industry is generally excited about a Labour government and particularly their policies for supporting housebuilding. However, their first Budget is key. Equally important will be how the gilt markets respond to Rachel Reeves’ spending plans, and whether they signal greater borrowing requirements.” He underlines: “We hope that Labour will be a government that can encourage inward investment and growth in real estate markets.”
Complex lending environment
Octopus has been lending against hospitality real estate for many years. While that is set to continue, Mackenzie outlines a complex environment which requires some caution - particularly since the recent period of high interest rates followed the downturn caused by Covid. “Hospitality took the brunt of the pandemic and across our portfolio we experienced closures. We supported all our borrowers, including those that fell into arrears. Those positions have largely recovered and are trading well,” he says.
The last couple of years encompassing war in Ukraine and high interest rates have placed other pressures on the industry, he notes. “High inflation has impacted operating costs. Initially, hoteliers were not always passing those costs on. However, more recent increases in room rates have enabled them to recover their EBITDA margins.
“We are still cautious. The new Employment Rights bill will bring changes that the industry will have to digest but are expected to push up operating costs. If you are running a small business, there are a few reasons to be nervous about your cost base.”
Looking forward, he is optimistic about hotel transaction volumes increasing, and with it, lending volumes. “Investment volumes are at their lowest level since 2008 – you can only really climb back from this point. As the environment improves, lenders become more confident. Risk appetite recovers and debt capital becomes more abundant and cheaper.”
Making the comparison with the global financial crisis of 2007, he says that “it feels a lot like 2009”. “The downturns commenced in September of 2007 and 2022, respectively. The low point took about 18 months before values started to recover.” He notes that the likes of Blackstone increasing investment activity “is a good leading indicator. A firm of this magnitude expressing confidence in the market sends a clear signal to the wider market”.
Octopus maintains clear criteria for lending against the sector. “We will lend on unbranded independent hotels in London, in Zones 1 and 2, where the value of the underlying real estate underpins the value of our security. Outside Zones 1 and 2, we will only lend against professionally managed and franchised hotels, flagged by one of the major brands like Accor, IHG or Marriott.” Mackenzie concludes: “We avoid unbranded hotels outside London – there are some brilliant hotels, but it’s a much tougher market to get right.”