Hotels are an alternative property type that many lenders are eager to bank, writes Lauren Parr
Hotels remain a popular ‘alternative’ real estate sector for investors and lenders alike. European hotel investment activity in 2016 totalled €20.4 billion, above the long-run average despite a 7 percent dip from 2015, CBRE research shows.
A driver of the market, particularly at the prime end of the hotel spectrum, is the diverse make-up of the investor base. Alongside conservative institutional investors, European hotels remain popular with sovereign wealth funds and high-
net-worth individuals from around the world.
Trophy hunters with lengthy investment horizons from Asia and the Middle East maintain a strong conviction about the long-term asset value of prime hotels in London, Paris and Italy, regardless of the economic climate.
“If it’s the right hotel with an international brand, demand is there and yields to date don’t look to have softened,” says Gilles Polet, head of real estate finance, CIB at BNP Paribas.
Financing hotels differs from mainstream asset classes due to the fluctuating income they generate. Loan pricing can therefore reflect a 50-75 basis points premium to other core properties, market players say.
The starting loan-to-value of hotel financings, typically calculated at 7-10 times EBITDA, tends to be lower than for prime offices or retail, they add. Covenants can also differ in that they might focus on wear and tear to properties.
“It doesn’t matter too much if an office starts getting tired – people will turn up and work in it. Not true of hotels,” says Christophe Murciani, global head of real estate at French debt fund manager ACOFI Gestion, which has experience in the hotel sector. The higher risk profile of hotels translates to higher returns, says Murciani.
“It’s an overnight lease which means riskier cashflows but you can monitor more frequently and react quicker to deteriorating performance,” he adds.
“Other than making sure to split the opco and propco, we would take the same security package as we would on a loan secured against a mainstream asset class and be concerned by how long the management agreement might be, making sure identified capex needs are covered from day one.”
From a high-yield lenders’ perspective, pre-let hotel development financing can offer a good risk/reward owing to the limited amount of senior development debt in the market.
“We can go quite deep into the capital structure so our investment is, in one instance, the same quantum of mezzanine as the senior. Whilst perhaps a high percentage of cost, this provides a big buffer against where we see value, and still provides our investments with healthy returns,” says Andrew Macland, head of UK at PGIM Real Estate.
Germany was Europe’s strongest hotel market in 2016, with €5.1 billion of investment deals closed, says CBRE.
Bettina Graef-Parker, head of hotel properties at Aareal Bank, says that the performance of the German hotel market closely matches that of the wider German economy.
“At the moment, UK investment is suffering from the uncertainties around Brexit. If you look around, France has endured terror attacks and there are problems in southern European countries; hence investors seeking a safe haven choose Germany at present,” she says.
However, Graef-Parker acknowledges that there are lending opportunities in the prime hotel sector across several European markets.
“We focus on cross border portfolios, large ticket sizes and management agreements,” she adds.
Operating asset classes are back in favour with lenders across the board. “In the past it was a play for debt funds but now almost everybody is looking at hotels,” says Savills’ head of debt advisory in Germany, Björn Kunde.
UK hotel investment volumes dropped markedly during 2016, with CBRE showing a 53 percent drop in volume to €4.37 billion, due to uncertainty surrounding the EU referendum.
However, Legal & General Investment Management’s head of real estate lending, Ashley Goldblatt, believes hotels remain a stable asset class.
“Although hotels tend to come with a tag of being a cyclical industry, if you look at IPD numbers, peaks and troughs in valuations are lower than some mainstream asset classes,” he says.
Despite the Brexit vote, customer demand for UK hotels is strong. “London is becoming such a destination that prime central London hotels, unless you overpay, are being seen as a safer way to deploy money, even in a post-Brexit world,” says Goldblatt.
The fall in the value of sterling has had an impact. “We now see a lot of people from the UK staying in the UK for vacation while international travellers are increasingly booking trips to the UK and international conferences are starting to look at the market again,” says Graef-Parker.
Since the referendum, Aareal has financed two hotel portfolios in the UK and two large single asset transactions, all with a focus on London.
“These were well diversified portfolios and prime assets in good locations, backed by very good sponsors,” Graef-Parker
A fixed rate, five-year senior UK hotel loan would have a sub-3 percent coupon at present, while a 10-year loan would be at priced at sub-4 percent, some say.
The performance of France’s prime hotels, concentrated in Paris and the Riviera, has been badly affected by the terror attacks in Paris and Nice in 2015 and 2016 respectively. Revenue per available room in Paris declined by 12.5 percent last year, according to hotel data provider STR Global.
Graef-Parker admits that 2016 was not a good year for the French hotel investment market.
“Investors have adopted a wait-and-see strategy, but Paris is always going to be Paris and we already see bookings for next year picking up significantly. There may be a slight pickup in transactions this year, but volumes still won’t reach historic highs in France,” she says.
The impact of lower tourist numbers could cause problems for hotel owners when debt needs to be refinanced, suggests ACOFI’s Murciani.
“Assets may have changed hands five or six years ago and debt terms may be hard to meet. There’s an opportunity stemming from semi-distressed propcos that may trigger a handful of sales in the next few quarters,” he says.
Lease versus management agreement
Loan structuring is crucial when financing hotel assets, given the way hotels are operated. Many lenders only look at hotels on a leased basis, that is, a hotel operator takes out a lease with the hotel owner and the hotelier receives a fixed rent payment. “The risk is with the lease,” explains Aareal’s Graef-Parker.
Under a management agreement, on the other hand, a manager gets a fee that is a percentage of revenue and the rest goes to the owner. “In a bad year the owner gets less, so the risk is with the owner,” Graef-Parker says. “In a financing your direct contact is the owner so you need to be aware of the risk you are underwriting.” Particularly in Germany lenders are insistent on security of lease.
The French market is a little more complicated since property collateral and the operating company are often co-mingled within a single operating company. “You need to be careful how senior ranking the management’s position might be relative to your credit facility, so structuring must separate the opco from the propco, so a mortgage is taken on the property itself and you have a separate pledge on the business,” says Murciani of ACOFI.