The steady rise in the risk-free rate has likely been one of the factors behind the sluggish hotel transaction market as core investors find more predictable returns elsewhere.The question is: are hotels still attractive to those seeking stable income from low-risk investments?
Hospitality ‘quite a good hedge’
It’s a challenging environment, but David Kellett, managing director, head of alternative investments, Europe, at Invesco Real Estate, points out that hospitality is benefitting from some of the biggest demographic and societal trends, for example the growth of experiential travel, and therefore in the current market is “quite a good hedge”.
Invesco’s approach to hotels has been focused on a hybrid lease model, which includes a minimum fixed rent with a variable lease on top, and the group added three hotels to its European Hotel programme last year with a combined value of approximately €100 million.
“Where there’s a revenue top up, you can benefit from inflation, so in this current environment of higher inflation and rates, hospitality works quite well for core investors, it’s a good position to take. But in the context for the wider market, we all need to appreciate this is not an easy time for core investment more generally,” he says.
Union Investment Real Estate GmbH, which has a global hotel portfolio comprising 90 properties with an estimated value of €6.7 billion, is still investing in hospitality, confirms head of department investment management hospitality, Andreas Löcher – in fact, the group signed its first resort deal late last year as well as the Grand Palais building of the Steigenberger Grandhotel & Spa and Dortmund’s Westfalen Center this year.
“The hotel product is working very well operationally coming out of Corona, so this is something we’ll continue to focus on,” he says – however, clarifies that at a “lower pace” due to the buyer-seller pricing gap meaning fewer transactions.
Lower transaction volumes
He suggests that there may be more movement towards the end of the year, while Philippe Rossini, deputy hospitality portfolio management at Swiss Life Asset Managers France, says that he has recently observed more understanding from brokers that, “it’s not a phase, that the interest rates are not going to lower, and you have to lower your expectations at some point”.
He says: “With the rising interest rate we can’t buy assets at the same rate we used to, the buyer and seller sides have to come together, but there are limits to what the buyer can do in terms of lowering our expectations.”
So where is the market for core investors today? “When interest rates were 0 and you could buy 4% and give your investors 4%, give or take, they were quite happy with that, because that was 4% more than 0, so that worked quite well,” explains Kellett.
“The problem now is that the debt rate is 4%, and so they’re going to want more than 4%. It’s that switch in the cost of capital which is going to affect all of us and what we’re doing and change the dynamic. Even for core money coming in, you’re going to have to show good return profile.”
He adds that not only are transaction volumes currently low, the pipeline also isn’t huge with the bid offer spread “not conducive for a strong pipeline”. While the expectation was that there would be a lot of distressed assets following the pandemic, it was not the volume that would have been anticipated, he explains, and although there will be factors that force sales such as refinancing events, he believes this is still a year away.
Löcher says that there are interesting assets on the market, it’s about overcoming the challenge of pricing and reaching a point where a deal can be reached. Rossini says he is seeing more assets and opportunities in Spain, where the market has recovered more strongly post-Covid than in countries such as Germany. “Hospitality as an asset class still has potential,” he argues.
NOI growth is key
Kellett, meanwhile, stresses the importance of net operating income (NOI) growth: “You can believe a story of NOI growth in some of those markets, and you need that, because without that you can’t get the returns to the right level to work,” he says.
“We need to be seeing NOI growth and to be able to underwrite NOI growth that is strong, otherwise we have no leverage benefit… To make even close to the pricing that people want, you have to be able to believe in the upside and the NOI growth.”
However, he agrees that the hospitality market is still attractive to core investors for reasons including its lack of rent caps, compared to residential.
“You go into the residential space and there are rent caps everywhere you look. Hospitality is nice because it doesn’t have that, it reprices every night,” he points out.
“As an asset class it’s moved up the spectrum of where people want to invest. They see it as an inflation hedge and a better pro-cycle investment than, say, office, at this point in time.”
All those quoted in the article appeared on stage at the International Hospitality Investment Forum (IHIF) held in Berlin between May 15 and 17, in a session called: Can Hospitality Still Work for Core Investors?