The funds and the faithful

The past year has shaken the foundations of the hotel industry in Europe and it remains to be seen when it will once again find a firm footing. Hotel operators are scrambling to make investments that will enable them to recover and thrive when normal conditions return, but that is no easy task.

The outlook on when normality might return paints an uneasy picture. The recently published UK Hotels Forecast 2020–21 from PwC, for instance, shows that hotel occupancy rates in 2021 are expected to be at 55% across the UK and might not return to pre- Covid levels for another four years. After ten years of growth since the global financial crisis, the industry had reason to be optimistic, but it must now face a harsher reality. “We put our line in the sand,” says Samantha Ward, hotels sector leader at PwC UK. “Benchmarking began back in 1979 and if you add together all of the downturns since then, they don’t match the downturn in 2020. The impact on the hotels sector is unprecedented.

“There has been a dislocation of all the factors on which the hotels sector depends,” she continues. “You need people to travel but leisure travel is not possible, unless it is domestic. For international travel, I believe that people are still exploratory and want to see new places, but the issue is how quickly the airlines can bring their planes and pilots up to speed again.”

Ward further estimates that a significant proportion of business travel – perhaps as much as 20% – may not return. Corporate travel has been in decline and companies that were already looking at their carbon footprint have now adapted to an environment of limited international travel. Other analysts, including Andreas Scriven, partner and head of hospitality and leisure at Deloitte, take a more positive stance.

“We have not seen anything like this in the past 100 years,” Scriven says. “There have been other disruptive events, but the scale, severity and speed of the Covid-19 outbreak have been greater than any other event to hit the industry. For some, it created a zero-revenue environment. Nevertheless, I am an optimist. Before the pandemic, all long-term growth indicators were positive, so I would expect the industry to bounce back.”

Europe’s perfect storm

The pandemic’s effect is felt most keenly in Europe, which is highly dependent on long-haul international travel, but the US and China, driven more by domestic traffic, could see a swifter recovery.

“There were some green shoots in August,” says Scriven. “The south-west of England, for example, saw higher demand but that quietened even before the second lockdown in England was announced. It is hard to see a full recovery until a healthcare solution is found, to get people travelling again.”

Hotels have gone to great lengths to adapt – refunding bookings and implementing operational changes – but recovery predominantly depends on an airline sector. Deloitte’s customer confidence surveys show that, at present, 40% of people feel safe enough to stay in a hotel, but only 25% feel safe enough to travel by air. When a market hits rock bottom, which few doubt it has, investors usually sense an opportunity in the form of distressed assets. The institutional investors that hold assets for stable returns may sell to more opportunistic investors looking for a quick turnaround and a high rate of return.

“There is a lot of capital sitting on the sidelines looking for an opportunity to buy into the sector,” notes Scriven. “In previous cycles, banks took control of a lot of hotel assets and sold the real estate assets to opportunity funds. Now, there is so much government support that the industry can carry on, for now.”

When private equity houses and hedge funds come in as investors, there is a change in dynamic in the industry. Those investors are likely to put in capital early on before sweating the asset and selling it on to an investor with a long-term horizon.

“What we are seeing now is much discussion among debt providers about the prospects of recovering their debts,” Scriven remarks. “The investors are skewing towards opportunistic funds and private equity houses, and away from institutional investors. Distress is good for PE funds.”

“Those investors can improve on the product,” says Ward. “They can, for example, make it leaner, meaner and better focused on a younger generation. They adapt and improve on the assets. That is easier in a rising market.” Invariably, the disaggregation of hotel brands, management and owners means that brands do not always own properties, which are largely run by franchisees. Short-term investors in those properties could inject greatly needed capex in rebranding and refurbishment before looking to cash in.

“Hotels need constant investment and refurbishment,” remarks Stephen Broome, hotels consultant at PwC. “But I worked in the hotels sector both as a consultant and an operator, and it is better and easier to work for a long-term investor.”

A prime example of the fund model is Lone Star’s entry into the UK hotel market in 2014, when its purchase of the £5.2bn Rock and Salt non-performing loan portfolios gave it control of three hotel businesses – Puma Hotels, Somerston Hotels and Curzon Hotels. It subsequently acquired the Jurys Inn business and three Hilton Worldwide-leased hotels in 2015, followed by 21 hotels operating under Accor’s Mercure and MGallery brands. Fast forward three years and, in 2018, it sold its last remaining UK hotels for close to £600m, closing out its market exposure for a healthy profit, with the assets going to long-term investors attracted by steady income streams. Now, the influx of funds is likely to gain pace, with some new players in the sector eyeing up strong assets at distressed prices. This is typical behaviour in a depressed market, when investors are those that are willing to take the risk and have the capital to do so. At the same time, some hotel developers sense an opportunity to upgrade their sites in cities like London or Paris, where premium locations are normally hard to come by.

“In the previous financial crisis, a lot of loans to the owners of large brands were traded, sometimes as nonperforming loans, to hedge funds and private equity houses,” remarks Ward. “They were looking to create value and generate return, then they sold at the height of the market to more long-term investors, among them listed hotel companies.

“The difference between this downturn and the GFC is that most hotel owner groups are not as heavily geared as they were before, though many have more complex financial structures that are distressed from a capital perspective,” she adds. “So, some owners are having to put in equity to ride out the storm. Even those with the best capital position will have difficulty getting through because they will be short on liquidity.”

The horizon gets no closer

In the early days of the pandemic, many hoped that the recovery curve would be as steep as the decline. Opinions have changed dramatically. “Few are still talking about a V-shaped recovery,” says Scriven. “Recovery may take a long time. Our hotel investor sentiment survey shows that disruption is expected all the way through 2021 and we won’t be back to pre- Covid levels until 2022 or later.”

Even that outlook is optimistic, certainly when compared with PwC’s forecast. “Some analysts expect London and regional areas to recover by 2022, but I struggle to see that,” says Ward. “For those areas in the UK that rely on international travel – London, Oxford, Cambridge, Bath and others – there will certainly be an impact on rates if not occupancy. A lot of hotels also rely on conferences and events, and it will be a long time before they come back.”

“Some domestic leisure localities did pick up over the summer,” notes Broome. “Devon and Cornwall had a better summer in 2020 than in 2019. So, we might see recovery in the provinces by 2023, but it will take longer for London, which might see recovery in 2024 by the latest forecast.”

Forecasting by its very nature is a dangerous game. However, the announcement by drug companies Pfizer and BioNTech that their vaccine can prevent more than 90% of people from getting Covid-19 was nothing if not a positive step forward for the hospitality industry. Billed as a ‘great day for science and humanity’, it was an encouraging day for hotel investment too. That news sent stocks on airlines and hotels soaring – in some cases by more than 40%. Coupled with the announcement from pharma company Moderna that trials of its vaccine confirm it has 94% efficacy, hoteliers and hotel investors have every reason to believe that there is finally some light at the end of the tunnel.

For now, though, level heads must prevail. The hotel market needs investors that understand the industry and can invest for the long term, but equally it needs a short-term injection of capital. When recovery comes, the last ones standing will have been those able to ride out the storm with enough capital to buy into the risk.

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