Shayla Walmsley explores institutional investors' appetite for hotels on both sides of the pond.

Investment activity in the European hotel sector has picked up substantially, as evidenced by AXA Real Estate Investment Managers' recent €132.9m portfolio acquisition for French institutions. But only last month, the Quebec state pension fund sold its nearly 50% interests in five Westin hotels as part of a tactical shift away from hospitality and toward office.

What does this tell us about institutional appetite for hotels? It should be noted that the unidentified buyer of the Quebec fund's five assets is understood to be another pension fund. Furthermore, Bill Tresham, chief executive at SITQ, Quebec's property subsidiary, said he had "no intention" of moving out of European hotels.

Nor do European investors, it seems. Jochen Schaefer-Suren, head of hotel and leisure investments at Internos Real Investors, reckons the current uptick in the hotel market reflects not only a broader recovery across the real estate market, but a relative advantage. "The reason hotels are attractive to institutional investors is because yields are relatively attractive," he says.

They're also relatively low risk. "Hotels are a specialist asset class, but investors are after core-type assets, with proven cash flow and a track record," he adds. "In other words, they're after assets that are as much like core as they can be within a specialist asset class."

According to Jones Lang LaSalle, investment in the European hotel market rose by 73% in the first half compared with the same period last year. If you look specifically at German hotels, investment totalled €325m in the second quarter - an 82% increase over the previous year, according to Colliers International, which cited the impact not only of recovery in the real estate market but in the wider economy. If deals currently being negotiated complete by the end of the year, Colliers is forecasting year-end German hotel transaction volumes of €1bn-1.5bn.

Yet Andreas Trumpp, Colliers' head of research for Germany, points out that exceptional volumes in the German market in the second quarter were skewed by three large deals each worth more than €60m - an indication that it is a niche investment sub-asset class dominated by a niche, if international, group of investors. Hotels made up just 5% of total first-half property transactions worth €11bn.

The giant Canadian pension schemes invest via joint ventures with hotel operators. So do their European counterparts, as evidenced by the recent three-way institutional deal via AXA REIM to acquire hotels in France and Belgium. AXA REIM has a 99-asset, €2bn hotel portfolio of its own.

As portfolios go, this one - sourced off-market - had a lot going for it. AXA REIM hotel investment head Gael Le Lay identified as rationale for the acquisition long-term income prospects without the need for capital expenditure because each of the assets had recently been refurbished. The leases are linked to turnover.

"When you buy a hotel portfolio, you buy a hotel business," he says. "It's important you have a relationship with a hotel operator because, in this case, the value is strongly driven by the value of the business. You need to know your budget from your luxury, to know your leases and management contracts and to maintain the business as well."

He adds: "Many investors are not ready to do it directly, but we can bring expertise to the client, and we can also make them see that it's not such a secretive and volatile sector."

The AXA REIM acquisition is premised on growth in central business districts. Indeed, investment appetite generally seems to be focused on hotels that cater for business travellers, with tourist hotels still suffering from an association with peripheral economies and fragile consumer confidence. Yet for all the continued focus on core, some investors are indicating willingness to compromise - if not on the location, then the quality of the asset.

A German fund manager that recently acquired a single London hotel confirmed that he would only consider long-term leases, large assets and prime locations accessible to central business districts. But he added that, at least in Germany, a prime location in a secondary city could be more attractive than a not-so-attractive location in Berlin or Munich.

Trumpp goes further. Although the bulk of investor appetite will be for five-star hotels in prime locations, he sees traction at the discount end.

"Some hotels are quite new or under construction and leased to well-known hotel groups," he says. "You have a good product, a good location, leased to a good company and on a long lease. But one- or two-star hotels will come back again. There isn't always a high correlation between the macro situation and the hotel market, but, outside of the tourist segment, when the economy gets better, companies tend to book better hotels.

"During the financial crisis, companies went for one- or two-star hotels, rather than four- or five-star hotels. Now, especially in Germany, companies are hiring new staff, but you're still seeing bed-and-breakfast-type hotels under construction. You'll see investment across the range."