If you were on Twitter or following live media blogs on 24 August this year, you’d be forgiven for thinking some kind of apocalypse was unfolding around the world. As the Shanghai Stock Exchange crashed on what was quickly dubbed Black Monday, Damian McBride – former adviser to British Prime Minister Gordon Brown – encouraged people to go out and buy enough bottled water and tinned goods to survive a month indoors.
The slump in the world’s second-largest economy came after months of instability in another crucial part of the global economy: the eurozone. The possibility of a Greek exit from the common currency had been with us for years, but when the country’s banks were forced to shut down for three weeks in July, the continent appeared to have reached the most dangerous and frightening stage of the crisis yet.
To someone observing these events from outside the hotel industry, it would be fair to assume the sector – or any for that matter – would be struggling. The hotel market is, after all, linked to GDP, and the global economy – if you follow world news – appears to be struggling.
Beyond the headlines
According to the latest figures by Jones Lang LaSalle, however, half-year transaction volumes for 2015 are 85% higher than the same period last year with €13.2 billion – a mixture of single-asset and large portfolios – already transacted. The situations in Greece and China may look like a crisis, but for the European hotel market, the economic conditions appear to have created a perfect storm.
"We’ve had a five-year run of positive GDP in the UK and Germany, and now people believe that France, Italy and Spain have hit the bottom and are coming up too," says Timothy Lloyd-Hughes, head of European hotel, leisure and gaming at Deutsche Bank. "At a macro level, everything is moving in the right direction. With low interest rates and positive GDP the key matrices of the hotel business – occupancy and room rate – are all back to pre-crisis levels. And because we’re coming out of a crisis, there’s also very little new supply."
As well as trading conditions that are suited to the hotel market, the past few years have seen a general flight to real-estate assets that investors perceive to be among the safer investment bets. Hotels have not traditionally been high up on an investor’s shopping list. But with yields under pressure across Europe and hotels offering higher returns than office, retail and residential real-estate, the asset class has become considerably more mainstream.
"Investors see hotels as an attractive asset class because they are yielding much more than cash or equities," says Lloyd-Hughes. "They see it as real estate backed in Western European countries that are politically safe with reasonably good macro prospects and yields of 5-6% versus nothing in the bank."
Of course, not everyone is totally confident in the market’s ability to carry on performing at the current operational and transactional level. Speaking earlier in the year, Russell Kett, chairman of HVS London, said that despite the thirst for European hotel assets, the peak of the industry cycle may well be closing in.
"The general view is that we are close to what might be in hindsight the top of the market," he argues. But with interest rates remaining low and business or leisure travel growing, it’s hard to see the interest in hotels and retail estate cooling off anytime soon.
"At the moment, we see no clear sign why this should be the top of the market," says Christoph Harle, EMEA CEO at Jones Lang LaSalle. "We have more capital available looking to invest into real estate as an alternative investment form, so we see things very positively. The most recent downturn on the stock market may result in even more people looking at real estate as a safe haven. As long as the interest rate strategy doesn’t change and there is the availability of debt then the transaction market will stay very active."
Trade secrets
Though trading conditions and investor appetite may continue to climb or sustain their current levels, at some stage the market will obviously reach a peak. For Lloyd-Hughes, the trick is working out when to look at the US.
"The US market is normally 18 months ahead of the European market," he says. "We’re definitely seeing a bull-bear, pull-push situation over whether the cycle is peaking. I don’t think that jury is going to come out one way or another until the last quarter of this year. So I think the issue for Europe is whether it’s going to peak at the back end of 2016-17 or maybe go on a little bit longer. Outside of Paris and London, there is still plenty of room for growth."
A number of different investors have been active in the European hotel market so far this year. Middle Eastern capital has remained reasonably active but in the same high-end trophy segment it’s known for. The uptick in investment capital from Chinese companies has continued with the country’s Ministry of Commerce changing the bureaucratic approval process for overseas investments. The EMEA region has already seen $1.9 billion invested by the hotel company Jin Jiang for the Louvre portfolio and more deals are expected to close in the last quarter of the year. North American private equity – a major contributor in the market this year – also continues to find interest in European hotels.
"The US market heated up quite dramatically two years ago, which meant transactions became pretty pricey for private equity," Harle says. "Europe, last year and this year, looked very attractive by comparison and the growth story is still very much there from an economic standpoint. The exchange rate looks strong too for dollar-based investment companies."
Rule Britannia
The UK – up 172% according to half-year volumes – has proved particularly attractive to private equity so far this year. According to figures from Jones Lang LaSalle, 57% of all regional UK portfolio deals in H1 have involved North American private equity and investment funds, reaching a total of €1.1 billion. Lonestar Funds – the most active private equity investor in the UK – has already spent over €1.7 billion this year on more than 13,000 rooms across the country.
"The UK is attractive to private equity because it was hit hardest during the downturn in terms of operating results," Harle says. "With most of the portfolios controlled by banks we didn’t see many investments. For a private equity investor, they could acquire debt reasonably cheaply and with RevPAR down so dramatically in 2009-11, they could tap into a major operational upside story."
As well as having high-yielding assets, owners and investors are also benefitting from a more balanced relationship with operators. Before the crisis, the balance of power between the two was stacked towards operators with a large number of projects for them to pick from. That shifted during the tougher economic times with less money about and operators more willing to be flexible in order to secure capital, but today the relationship is altogether more harmonious.
"I think the balance of power is fairer today," Lloyd-Hughes says. "The owners are more sophisticated now and the operators, because of that, are much more sensitive and commercial than they used to be. In fact, I think one of the major issues for owners and operators is not the relationship between themselves, but the relationship between them and the online travel agencies that are still taking a large part of the market and are charging 20% commissions. They either need to take them on and/or get commissions down. Likewise, they need to address the likes of Airbnb and the sharing economy."
Though travel agencies may pose a deep challenge to hotel companies, with trading conditions and investor appetite as strong as they are, it’s unlikely to dampen the optimism that 2015 has brought to the European hotel market.
The acquisition of Cambridge City Hotel
In a prime example of overseas investment funds looking towards European real estate beyond traditional primary markets, Singapore’s CDL Hospitality Trusts announced its first foray into the European hospitality space this September, acquiring the Cambridge City Hotel for a reported £61.5 million.
"This acquisition in Cambridge, is in line with our strategy to invest in markets with good growth potential," says the trust manager’s CEO Vincent Yeo. "Cambridge has been one of the strongest performing hospitality markets in theUK and the burgeoning life sciences cluster will support the growth trajectory of the market. This acquisition of Cambridge City Hotel is a rare opportunity for us to acquire a prime asset in a tightly held investment market."
The sale follows an £8.2-million refurbishment of the 198-room hotel, which was completed in April.
