Uncertain times may make for opportunities, but right now for the European hotel investment market they are creating stasis. Ironically, many of the reasons are actually outside the hospitality sector and instead reflect the knock-on effect from office value jitters.Investors and debt providers were already nervous enough about office valuations before the banking crisis and the collapse of Silicon Valley Bank (SVB) and the enforced takeover of Credit Suisse by UBS have done nothing to allay fears that the financial contagion could spread to real estate.
Those market concerns come at a time when the sun had been shining warmly on the hotel sector after the pandemic years. The pipeline across the world is expanding at breakneck speed, Asia – and especially China – are starting to reopen for business, and prospects for hotel financial performance look distinctly positive compared with the offices of Europe’s central business districts.
CBRE managing director of Continental Europe Marco Hekman says that pricing across all real estate asset classes is off around 20%-30% from peak values in broad terms. That has left markets that have been prepared to reprice well-positioned for investment, with a number of institutions focused back on real estate again, he says.
“It’s not just about taking the pain [in valuations], it’s about the truth," he says of pricing. “But I remain optimistic about a number of sectors. I think that operational real estate, including hotels, holiday parks and data centres, are all performing well."
Hekman also believes that there is plenty of “dry powder” out in the market and that many would be hotel investors are playing a waiting game, wanting volatile markets to settle before they return to real estate acquisitions.
The question for 2023 is whether hotels will be seen as a safe haven for those still keen on real estate in volatile times, or whether investors will simply put their hands in their pockets until there is more stability across European interest rates and the fallout of refinancing is better known.
Uncertain times for investment
Indeed, for lenders the rapid rise in interest rates has shifted the focus of many towards debt serviceability, which in some cases has meant restrictions on new financing in terms of loan size and covenant structures, with an upward pressure on loan pricing and subsequent contraction in the availability of debt capital.
Consequently, lesser debt availability and higher financing costs have prompted some investors to rethink their strategies, with much of the hotel transaction market going into observer mode, especially as pricing expectations between buyers and sellers remain wide.The UK hotel sector is a perfect case in point, with the weight of capital seeking to target Britain expected to drive increasing transactional volumes, particularly during the second half of the year, according to advisor Knight Frank, which says there is no shortage of buyers seeking hotels which offer value-add opportunities.Headline transactions this year so far include the £53 million acquisition by Pandox of the 232-room Queens Hotel in Leeds, Dalata’s £44 million purchase of a newly-built 192-bedroom hotel, to open later in the year as the Maldron Hotel London, Finsbury Park, Fattal Hotel Group’s acquisition of the 201-room Grand Hotel Brighton (having previously bought The Dilly in London), while Macdonald Ansty Hall sold off a guide price of £9.75 million to the Exclusive Collection.
"As confidence in the direction of the UK economy is further restored, there will come a greater urgency and decisiveness to execute a transaction,” says Henry Jackson, Knight Frank head of hotel agency. “Currently, a heightened level of price sensitivity continues, yet the lack of quality branded stock available may increase competition for assets, thereby protecting or even driving-up values in the short-term. Narrowing the gap between buyer and seller expectations, as well as securing affordable and sufficient debt to reach a positive outcome for both parties, remain key challenges.”
Accordingly, close scrutiny of underwriting will be crucial for investors and debt providers in the coming year, as cash flows must be sustainable for lenders seeking a sufficient buffer in their debt service coverage ratios (DSCRs) throughout a loan term.
Improving economic conditions
The good news is that some of heat has come out of inflation and, consequently, the prospects for what peak interest rates may look like. However, as long as interest rates remain high, the availability of debt is likely to remain constrained, firstly because of the higher cost of debt servicing and secondly, higher interest rates could lead to declines in market value.
Together, this would mean lower ceilings on loan sums as lenders’ DSCR and/or loan-to-value (LTV) thresholds become harder to meet. Meanwhile, loans maturing this year will come under scrutiny given the changed economic situation and hotel assets that fail to maintain adequate cash flows could be restricted by DSCR covenants. In turn that could see some loans downsized, require additional equity or alternative financing, such as mezzanine debt.
Encouragingly, Blackstone has closed the refinancing for its Spanish hotel company Hotel Investment Partners (HIP), which holds assets operated and rented by brands including Marriot, Ritz Carlton, Barcelo and Melia.
The investment company secured a €680 million loan from Morgan Stanley and Credit Agricole and the loan consists of a senior tranche of €475 million with a maturity of four years and an interest rate of Euribor plus 3%. In addition, it is complemented by mezzanine debt of around €205 million, with a maturity of five years and a rate of 7%.
In contrast, those who are well financed may be able to take advantage of the current pricing stand-off. Hamburg-based ECE Work & Live is working on a €60 million project with the Ruby Hotels chain for a new 165-room hotel in Rome, ECE’s first outside Germany and Austria. Construction is scheduled to start this autumn, with an opening in spring 2025.
“Our first hotel project in Italy combines the main objectives of our strategy in the hotel segment, to expand our international activities and extend them to attractive markets such as Italy, to increase investments in the conversion of existing properties and to focus on hotels [offering] leisure and business,” says ECE Work & Live hotel development director Torsten Kuttig.
The one certainty is that the fundamentals of the hotel industry remain robust, as evidenced by the sector’s impressive post-pandemic rebound and established reputation as an inflation hedge. If buyer and seller expectations can come closer, and with growing concerns about the office sector prompting investors to cast their net wider, the second half of 2023 may yet be a strong one for Europe’s hotel market.