Hospitality’s ‘strong inflation hedge’ convinces Stepstone

Hospitality’s “strong inflation hedge” has convinced private markets player Stepstone to invest in the asset class in an increasingly significant way, delegates heard at the IHIF EMEA 2024 on Tuesday.

Josh Cleveland, partner & head of EMEA, real estate, Stepstone Group, is one of the founding partners of the business and a proponent of investing in hotel real estate, he said in conversation with William Duffey, senior managing director, JLL.

The “under the radar” private markets adviser and investment manager invests on behalf of investors across debt and equity strategies. Stepstone’s founding partners formed its real estate business 20 years ago, with hotels an increasingly meaningful target post-pandemic. “Across the European real estate business that I run, we have invested some $3 billion in equity, of which about a third has been invested in hospitality,” Cleveland said.

Robust fundamentals

It was all a question of the sector’s robust fundamentals, he added. “Yields or cap rates in hospitality never reached the lows we saw in other asset classes, so it’s more insulated against yield shifts,” he noted. “There is less volatility in values, which is an element of the recovery coming out of Covid. Reaching pre-pandemic figures represents a lot of growth.” For this reason and more, hospitality currently looks like the stand-out hedge against inflation, he said. “A 15-year office lease offers less opportunity to pass through inflation than rate setting daily. That means hospitality is a more effective way of offsetting profit and loss.”

Cleveland suggested that shifts in the desirability of asset classes meant that the appeal of hospitality would only rise. “At the end of the day, investors must select from the opportunities present. Office and retail are 'uninvestable’ at a board level for many funds – and they represent 50% of real estate stock.

“If half of the stock becomes uninvestable, you start to look for other assets. LPS and institutional investors are primarily getting their exposure to hospitality through diversified funds,” he added, noting that there were some exceptions, such as family offices. “By and large, a $10 billion pension fund is not directly accessing hospitality opportunities, they are going through partners or diversified funds. But seeing the returns that hospitality is providing is going to further institutionalise the space.”

Managing cycles

When asked how Stepstone identified the most suitable management partners, he said that they looked to see if “you like the strategy and the people executing on it”, adding that “you are looking at past performance to try and predict future performance”. He noted: “Finding managers will deep experience across cycles and different risk profiles is critical. Hospitality remains a significantly geared sector, and you’re always going to find a cycle, so you need people who have managed their losses to a minimum.”

Studying the outlook, he suggested that budget hotels could benefit from shifts in spending power. “People don’t stop travelling, they just move down the price ladder,” he said, adding that “many people will stop travelling before the reach the hostel segment”.

Commenting on prospects for finance and dealmaking, he said: “There is going to be a lot of debt coming due in Europe and the US, and there’s nothing that focuses the mind like a maturity date.

“That is going to trigger a lot of transactional activity, and that’s what we’re looking for. The market still hasn’t bounced back fully; we’re looking for situations where time and capital is short.”

Stepstone allocates some $15 billion annually to real estate funds, which last year included some $2 billion in secondaries and co-investments, chiefly in the US and Europe. Secondaries provide liquidity to real estate vehicles and their investors.

As well as investing in hospitality, Stepstone targets industrial and living sectors, plus alternative asset types such as data centres and cold storage.