Waves of Capital for Hospitality Despite Choppy Waters

he hotel industry has faced an unprecedented 24 months. Following the initial shock caused by Covid, European hospitality markets experienced a dramatic recovery in 2021. Against a backdrop of uncertainty, Eastdil Secured has been at the forefront of navigating global capital into the hotel sector, having closed €4.2 billion of European hospitality transactions across the equity and debt markets in 2021 alone.

Despite both occupational and investment market volatility, investors have continued to allocate capital towards the hospitality sector. Traditional hotel investors have been through a period of fundraising, and private equity investors have unprecedented levels of dry powder at their disposal, resulting in new entrants to the hotel market.

In 2021, European hotel transaction volumes totalled €15.6 billion. The UK comprised a substantial portion, with £4.2 billion (€4.9 billion) traded, of which nearly half originated from the regions, outside of London. Investment volumes more than doubled in the UK over the year prior and Eastdil Secured advised on a number of high-profile portfolio transactions. These included the largest UK hotel trade of the year, Project Conrad, comprising 12 Hilton hotels, in addition to Project Horizon, a 17 asset Holiday Inn portfolio and Project Holmes, a four asset Leonardo Hotels portfolio. Moreover, sizeable single asset deals also proved possible, including the sale of the Holiday Inn Kensington Forum, one of the largest hotels in London with more than 900 keys. In combination,

Across Europe, investor appetite for hotels has been motivated by a flight-to-leisure from core capital, looking to benefit from the exceptional bounce back of the resort market and to diversify existing corporate and conference exposure. This marked an observable step change for the industry, as more risk averse, lower cost of capital investors had previously, pre-pandemic, viewed assets with significant leisure demand exposure less favourably than more corporate-driven sectors.

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Sun & Beach Urban

Figure 3: Spanish 2022 RevPAR Evolution – Sun & Beach vs. Urban

Source: Instituto Nacional de Estadística (2022)

In turn, outside of the UK, activity in the investment market was concentrated around the Iberian Peninsula such that Spain was the only European market that experienced transaction activity in 2021 well in advance of 2019 levels. This surge came as a result of international capital seeking to get a foothold in what are considered to be the most solid leisure destinations from an operational and reputational perspective, including Malaga’s Costa del Sol and the Balearic Islands.

Rebounding international tourism has led to solid operating results and a remarkable champagne e ect throughout the summer season of 2022. Consumers have eagerly anticipated the return of international travel, buoyed by pandemic savings, lockdown fatigue and wide-reaching, successful vaccination campaigns. Destinations that rely on key source markets from European countries have done especially well, with travellers displaying a resistance towards long haul flights and therefore allowing European destinations to gain additional market share from further afield such as the Caribbean, North America and Asia. Furthermore, this trend has been amplified for the 4- and 5-star segments of the market, where target clientele are less sensitive to the higher costs of travel, not limited to the possible requirements for Covid testing or more extensive insurance cover.

Beyond the leisure sector, high margin hospitality businesses such as the extended stay and limited-service markets have also shown high demand from the core plus and value add investment community. Well managed portfolios with lean sta ng requirements are inherently self-protected from wage price spirals, as employee costs comprise a minimised percentage of the P&L, limiting the impact on profit margins in today’s high inflation environment.

Real estate has long been considered a hedge against inflation and in the commercial real estate universe, hotels have been a bright light by virtue of the capacity to make real time price adjustments via the possibility for a “rent” review every night. As a result, average daily rates for hotels can be expected to increase in 2022, with operators intending to pass on rising cost pressures to consumers whilst further seeking to recover lost revenues from the Covid restricted operating seasons.

From a financing perspective, alternative lenders emerged as the primary debt providers for hospitality assets in wake of the pandemic, o ering higher leverage options to borrowers with flexible loan structures and the best available execution certainty. With lending markets mirroring equity investor sentiment, the preference for deployment also shifted to prime city centre hotels, select service and fly-to resorts.

The inflationary environment and corresponding interest rate hikes have created some volatility in lending markets, but despite this, hotel loans continued to be priced and executed. Since the onset of Covid, Eastdil Secured has raised over € 2.25 billion of loan proceeds in the European hospitality sector, evidence that despite the pandemic and more recently the Ukraine crisis, Western European financing markets continue to present liquidity and functioning capital markets.

To note in comparison to the USA, European markets have remained somewhat insulated from CMBS volatility, given that less than 5% of UK and European debt volumes tend to be securitised via CMBS. However, uncertainty in the European CMBS market has curtailed lenders’ capabilities to underwrite very large ticket sizes. Banks are selectively re-entering the market to finance low-risk, outperforming assets such as resort and trophy hotels, in prime locations and backed by high-quality sponsorship.

In addition to these criteria, another fast-evolving trend within the industry has been the growing emphasis placed on ESG. In Europe, real estate is responsible for 40% of carbon emissions and hotels play a major role by using the most energy and water of any commercial building type. Institutional investors, core funds and certain sovereign wealth funds are among those putting the highest priority on sustainability, with commitments to shareholders to be “greener” and company level requirements to be on track to pathways for net zero by 2050. Led by the capital, it may be expected for a greater pricing disconnect to be witnessed for assets which do not satisfy ESG criteria, with standards being raised from an environmental perspective towards what can be considered investment grade. After labour costs, utilities represent the highest average variable cost for hotels and so in turn, hotel investors are prepared to pay a premium for the best-in-class ESG assets.

From a personal perspective, it has been both a challenge and a privilege to have started my career in the hospitality sector during what has arguably been the most profoundly transformative period of its history. Accelerated by the pandemic, market trends and investor sentiment have been continually redefined, with the focus on the hotel industry commonly being placed centre stage among the other real estate asset classes.

Despite the resilience of the sector to date, supported by the unwavering optimism of hoteliers and backed by rounds of private equity fundraising, it is clear that the years ahead will be critical against the backdrop of turbulent capital markets. Financing has proven to be increasingly crucial and in an increased rate environment, it will be interesting to observe whether more leveraged groups could potentially be required to restructure their capital stack or ultimately be drawn into disposing of assets to cover growing interest service requirements.

With whatever the future may bring, Eastdil Secured will continue to prove itself as the trusted advisor to the global real estate capital markets. Eastdil Secured is proud to have hired eight analysts from the University of Cambridge over the last five years, all of whom have had the opportunity to work on some of the most interesting and important real estate transactions across Europe.