COVID-19 has undoubtedly created a range of challenges within the real estate market, both accelerating trends identified before the pandemic and creating entirely new ones. Bohill Partners is hosting a series of events, bringing together senior leaders from specific sectors, to discuss the impact of the crisis and the challenges it presents and share ideas on how to deal with some of these issues.
Having covered a number of other asset classes in recent roundtables, our attention turned to hospitality, the sector which alongside retail has been most affected by the current crisis. While many hotels have been allowed to re-open, travel restrictions and concerns about social distancing and hygiene present a range of challenges. We gathered eight industry experts from influential investors, advisors, banks, and operators across Europe to discuss the impact of the crisis on the hospitality sector and what the future may hold for the asset class.
What are hotel companies doing to inrease occupany?
It’s clear that hotel operators will need to change the way they work to survive the crisis. One point of change is the implementation of additional cleaning procedures and cleaning standard verification processes, such as Accor’s agreement with Bureau Veritas. While all our participants agreed that it is vital for consumers to trust the brand to uphold hygiene standards, not all were convinced by the usefulness of the new verification processes. Some participants felt that there were too many cleanliness labels in the market, which left consumers lost, and others argued that consumers do not want to be constantly reminded of the pandemic by health and safety notices. One extended stay operator has found that concepts which encouraged guests to live as they would have pre-covid are performing better than products with a visible focus on social distancing and cleanliness.
It goes without saying that pricing will also play a part in getting people back into hotels. A senior hospitality advisor noted that he had seen companies cutting room rates and the CIO of a budget operator confirmed that they had been aggressive on pricing to increase occupancy. Other adjustments to operations have been more creative; offering day rates for remote workers looking to escape a chaotic environment at home without risking a long commute, or changing marketing to attract a different type of customer. Budget hotels and hostels are not seeing the demand from large groups that they are used to, and one participant noted that their business had shifted their focus to independent travellers. They have seen an increase in demand for their family rooms with families wanting to get away without breaking the bank, whereas their larger bunkbed rooms remain mainly empty. In order to capture this new demand, they have launched a separate booking engine to offer families an attractive price and the opportunity to spend time in several different cities as part of one booking.
How are operating models being adapted to cope with the crisis?
Our participants agreed that being an owner operator in this market can be advantageous. Although growth is more capital intensive and you potentially have less funding available to invest in the operation you do avoid the potential conflict between landlords and tenants seen in the fixed lease model. The fixed lease model is particularly prevalent in Germany and while so far owners have been very supportive and agreed to rental deferrals, the longer the situation continues the stronger the pressure on the relationship will be. In many cases, the two parties simply don’t understand each other – owners neglect the operational risk of a hotel and operators disregard the need for transparency.
If the fixed lease model is to work during such market conditions, owners must make more of an effort to understand and underwrite the operations and operators must be more transparent about their performance. Of course, obtaining this information is easier said than done. One suggestion was that banks set these standards, refusing financing without performance reports from the operator. This is already a requirement from many banks and one participant confirmed that they only finance leased properties if the lease agreement demands the provision of operating performance figures. While new leases increasingly do include this requirement, many older lease agreements do not; as such, only 5-10% of their hotel loan book is based on leases with the majority based on management agreements.
Another hurdle to resolving the conflict between landlords and tenants is the passivity of operators’ shareholders. In some cases, hotel chains are owned by cash rich funds who, instead of injecting their own capital into the operator, push the operator to negotiate their rent down. While owners are keen to show solidarity with their operators, there must be some give and take. That said, owners could also do more to accommodate for the changes in operating performance levels, such as adopting hybrid lease or turnover based lease models. The consensus is that communication is key. Owners, operators (and their shareholders), and banks must be open with each other.
Which investment markets will come back first?
With much of the population still wary of air travel, many have opted for ‘staycations’, boosting the performance of domestic leisure locations. Several participants noted that their domestic leisure locations are performing extremely well in contrast to urban locations. As such, investors feel more comfortable underwriting these deals and there have already been notable transactions in the space, such as KKR’s acquisition of Dutch holiday park operator, Roompot.
Another sector which participants predict will fare well out of the crisis is the extended stay market. These properties include kitchen facilities for guests, allowing them to socially distance, which makes it an attractive option. The crisis may present investment opportunities for extended stay owner operators, one participant explained, as they can take advantage of discounts in the market by converting large short stay hotels into extended stay properties. Budget and limited service hotels may also benefit from an increase demand. The recession is expected to take a toll on the general population’s finances, increasing the need for affordable options.
When it comes to city centre locations, there is some hesitation. One participant noted that while their portfolio of small hotels across France is performing well, the hotel assets they own in Paris are ‘a disaster’. However, some were optimistic that city centre locations will bounce back and were hopeful that the risk would deter their competitors.
In terms of geographical markets, our participants expected there to be opportunities across Europe but expressed concern about the impact of government messaging and travel restrictions. One UK-headquartered owner operator saw the bookings in their Spanish hotels decrease dramatically when the government re-instated quarantine measures for returning travellers.
How available is financing for hospitality assets?
It depends where you look. Bank financing is still available but in a much more limited capacity. One of the leading lenders in the hospitality space commented that while they were still looking at hotels and had done new hotel financings since March, the majority of their competitors were not. If you are able to secure bank financing, you can expect decreased LTV levels and some kind of safety net for the first 1-2 years, e.g. interest reserves or guarantees.
However, there are a lot of alternative financing options for hotels. Some investors see the lack of available bank financing as an opportunity to make near equity returns through offering debt funding to hotel companies who need cash to resume their operations or development. Banks are receiving up to ten calls a week regarding this and one participant at a private equity firm told us they had already developed a strategy for debt investments in the hospitality space.