Over the past couple of years, Europe’s largest economy has slumped from one crisis to another with lasting implications for the hospitality real estate market. In this three-part series we are putting the spotlight from Germany with articles covering the state of the transaction market, the future of leasing and more. You can read part one here.
Increasing numbers of international investors and operators betting on German hospitality and a greater exploration of operational risks is transforming the country’s leasing models, according to experts.
“Pre-Covid, fixed leases dominated the hotel industry – that was what people wanted on both sides,” says Helena Rickmers, CBRE’s head of hotel investment for Germany. “From a landlord perspective, higher rents were often perceived as better – they were looking for rent cover ratios of 1.3, which suited lenders as well.”
However, the lessons of the pandemic – and primarily the multi-faceted nature of operational risk – have informed a change in how leases are drawn up. Add to the mix an increasingly internationalised investor and operator landscape, and leases are no longer ‘one size fits all’.
“Investors have realised that they would rather have a rent cover ratio of around 1.5, which gives a bit more room to the operators, to then benefit from everything that goes above a certain threshold,” Rickmers adds, noting that demand for hybrid leases is accordingly on the rise. One of the factors that is stopping the industry from progressing to full variable leases, she notes, is the ongoing presence of German institutional investors, who require more predictable terms for regulatory reasons. Currently, insurance companies and open-ended real estate funds are only allowed to assume limited economic risks in accordance with the regulations of the German Federal Financial Supervisory Authority (BaFin).
However, she notes that “with institutions accounting for a smaller proportion of market activity over the past couple of years, and rising interest from international investors, hybrid leases and hotel management agreements (HMAs) are more frequently on the table”. She says: “I wouldn’t expect Germany to go ‘full HMA-driven’ but hybrid models are definitely here to stay as the capital targeting the hotel sector broadens.”
Leasing changes
Germany’s hotel sector is navigating a period of change, with international players driving innovation and adapting to new operational demands. Andreas Ewald, founder and managing partner of Engel & Völkers Hotel Consulting, views these shifts as a sign of positive transformation.
The continuing entry of brands has fuelled a significant growth in white-label operators, who act as intermediaries between property owners and global brands. “They have proven to be an effective solution for brands and institutions looking to manage risk exposure,” says Ewald. The pandemic showcased the industry’s adaptability as property owners and operators worked together to address financial obligations. “During Covid, we saw numerous negotiations aimed at fulfilling financial obligations or finding ways to adapt contracts,” explains Ewald. Over the past 12–18 months, Average Daily Rates (ADR) in Germany have increased significantly, accompanied by high occupancy levels. However, rising operational costs for labour, energy, and construction materials continue to challenge profitability.
Ewald highlights that evolving broader economic conditions, including recent geopolitical shifts, are influencing the market. The re-election of Donald Trump in the US signals potential headwinds for global growth, with European Central Bank policymakers warning that protectionist policies could slow Europe’s economic recovery and exacerbate inflationary pressures. In this context, Ewald anticipates further scrutiny of planned renovation programmes. “With double net and triple net lease structures, lessees are also liable for maintenance and building repairs, adding to the complexity,” he notes, suggesting that operators and owners must carefully navigate these challenges to maintain long-term competitiveness.
Despite these pressures, Ewald remains optimistic about the sector’s ability to adapt and evolve. “By embracing flexible operating models and strategically addressing emerging challenges, Germany’s hospitality sector is well-positioned for sustainable growth in a competitive global market,” he adds.
Hybrid structures
Ewald sees increasing interest in hybrid structures, which balance fixed and variable lease components to benefit both investors and operators. “They give investors a little more room to breathe if things are positive and give the operator the flexibility they need if things go down,” he says. However, institutional investors often face challenges in underwriting these properties. “The buyer usually doesn’t price the variable component of a lease into the valuation,” Ewald explains, leading to difficulties in financing and a disconnect between buyer and developer expectations. Buyers may argue that hybrid leases lower property value, while developers seek to maintain high asset prices. Despite these challenges, hybrid structures offer significant potential for fostering flexibility and resilience in the hospitality market.
Nevertheless, the complex macroeconomic environment of the last three years has switched up the faces round the deal table. Smaller ticket sizes for deals and expanding third party and alternative financing has encouraged the entry of investors from beyond the institutional environment. Similarly, the rise of investors who are operationally savvy – and want to actively run the hotels they buy – signals an increasing amount of landlords in play who will happily swap a fixed portion of leases for a piece of the action.
Management contracts
“It is to be expected that lease agreements will continue to dominate the German hotel market. However, there is an increasing dialogue about hybrid contract models that combine features of the traditional lease model with inherent aspects of management contracts,” agrees Christian Buer, managing partner at Horwath HTL Germany. Recent Horwath research has identified an increasing use of a conflict avoidance pledge or CAP clause, to hedge against downturns or difficulties. “This clause allows the lessee to amend, terminate or continue the contract if a cumulative loss (usually based on net profit) previously defined in the contract occurs,” says Buer. To bolster the investor position, inflation linked clauses have been vital in recent times, while another mechanism, the FF&E reserve account, which the leaseholder is obliged to maintain, serves as additional security for the hotel owner. In this case, the landlord has access to the account if the lessee fails to meet its obligations.
While the new lease models inherently imply both pros and cons for landlord and operator, Buer feels they are an essential part of modernising and expanding Germany’s hotel capital markets and operational scene. “These new approaches not only offer better protection and adaptability in times of crisis, but also make the German market more attractive for international hotel chains,” Buer says. “While legally sophisticated clauses can create a framework for this, the real key to functioning contracts lies in both parties implementing these agreements in practice.”