The hotel sector may not yet have the stamp of approval as a core real estate sector, but change is afoot, delegates at the annual ULI conference in Paris heard last week.
The hotel sector may not yet have the stamp of approval as a core real estate sector, but change is afoot, delegates at the annual ULI conference in Paris heard last week.
In any case, heavyweight institutional investors such as AXA Real Estate are taking it seriously. The sector accounts for roughly €2.3 bn or almost 5% of the Paris-based investment manager’s assets under management which totalled €47 bn at end-2013. ‘It’s not huge but it’s not small either and we have a growing interest in the sector,’ reported Nathalie Charles, head of asset management and transactions for Southern Europe at AXA Real Estate.
‘We have understood that we have to be more involved on the operational side and that has been a learning curve. You need to have an understanding about what really happens in hotels. It’s not just real estate, it’s a business. But after our learning curve, we have more appetite and it fits in with our diversification strategy. Office investment may be the number 1 investment overall, but we can’t only be in offices. We have appetite for different geographies and sectors and this is a good one.’
At present, the hotel sector counts around 15 million institutional rooms worldwide while €1.5 tln is tied up in investment. With new opportunities abounding in emerging markets such as China, Africa and the Middle East, hotels will remain on the agenda at future ULI conferences, Rosemary Feenan, international director of global research at Jones Lang LaSalle promised during a panel session entitled ‘Growth of hotels as a core sector’.
‘That title may be a provocative statement, but a great floodgate of investment has opened in the hotel sector,’ she pointed out during her introduction as panel moderator.
Hotels are marked to market every night
The challenge with hotels is that they are not really real estate, Scott Woroch, executive vice president of worldwide development at Four Seasons Hotels, said. ‘Effectively, the rents are marked to market every night. That’s a challenge in itself. In trying to legitimatise the hotel asset class into the core range, you’re working with a lot of moving parts…there are challenges for both the equity and the debt guys. Hotels have a perception of risk, whether it be resort risk in Asia or execution risk in Asia.’
One of the challenges for any hotel owner is to have alignment with the real estate and the operator, noted AXA Real Estate’s Charles. ‘What we try to do is be close to our partners, the operators, to understand what their drivers and needs are. That’s how we create a difference in value: we have real estate capabilities, teams which understand the fundamentals of real estate, the financial analysis and the global view and at the same time understand the operations.’
According to Josh Wyatt, director of hospitality at US private equity investor Patron Capital, the status of a hotel investment depends on where it sits in the risk curve. ‘Sometimes it is a core asset class, sometimes it isn’t. We see it as a pyramid: if you look at the lowest base of the pyramid, you’re looking at potential returns of 4-8%. But as you move up the risk curve, the returns can potentially move up to 12%-20%.’
First-mover advantage
In terms of opportunities, markets in Africa, the Middle East and China offer the greatest rewards for first movers, according to Mark Wynne Smith, global chief executive of the hotels & hospitality group at Jones Lang LaSalle. In Asia, transaction volume trebled in 2013 year-on-year, he pointed out. ‘If you get into a city wherever it is and whatever brand you are, and there’s nobody else around, you can probably pay for your hotel in three to years. But the fifth guy who comes along will be hoping to do what the first guy did - and won’t.’
The risks are also significant, he added, pointing to execution complexity, permit procedures, construction processes and the need to import most of the furnishings. ‘These are big tasks to get around.’
Whether hotel assets are perceived as core or not, investor appetite is clearly growing. In 2013, the hotel sector saw a 40% increase in transaction volumes worldwide, with EMEA accounting for an increase of 17%. For the current year, investment in EMEA is expected to grow by more than 20% to approximately $16 bn. Experts are forecasting a need for four million extra rooms worldwide, 600,000 of which in Europe, Feenan noted. ‘It’s an extremely interesting time right now.’
Europe and the US currently lead in terms of supply, but new development is still expected to grow in these regions, according to JLL's Wynne Smith. However, the emerging markets will see the greatest growth: while supply in some US markets may increase by 2%, China and the Middle East are looking at growth figures of around 15%, he said. ‘What’s driving the increase in supply is a large increase in demand. China is seeing an increase in the number of outbound guests. We saw 100 million guests coming out of China last year, that represents growth of 15%. The World Tourism Council is forecasting about 6% growth for the sector by 2020.’
The hotel sector is currently ‘pretty healthy’ compared to other segments, Wynne Smith said. ‘There clearly is more attraction to the sector than there was 10 years ago. Generally the picture is very positive, it feels more solid than several other recoveries I’ve experienced.’
Very hard lessons
The sounder footing is partly attributable to some of the ‘very hard lessons’ experienced in the market in 2009-10 following the boom years when investors gorged on leverage. ‘The underwriting then was based on costs staying flat, but the approach to fundamentals and underwriting is so much more considered in this cycle than the last.’
Jones Lang LaSalle is forecasting a 10% rise in transactions overall this year, fuelled by private equity, sovereign wealth and institutional investors. In 2013, investment in the Americas was up 30% year-on-year, he added. ‘The fundamentals are very strong, supply is low and income is growing by 5-6%. There’s a lot more financing driving that market. EMEA is a bit back further down the curve, income dropped last year. I think we’re 18 to 24 months behind the Americas in general. Volume is increasing and prices are going down, but that will correct itself in 2014. Not in every city, but some cities are performing very well.’
Patron’s Wyatt is also upbeat on current prospects for the sector. ‘Recovery is definitely coming back, we’ve seen a lot of money flow back into the sector in EMEA. Liquidity is coming back in at all levels of the capital stack. That’s making it easier, not only for transacting deals but also for jumpstarting developments that wouldn’t have happened three to four years ago.’
Over the past seven years, Patron Capital has rolled out a low-budget hostel concept at the value-add end of the market where it has staked out empty office buildings, bankrupt hotels or broken investment projects in order to insert its own hotel solution. ‘We’ve tried to use that during the downturn to fill a bunch a buildings and we see more opportunity going forward. Not just for hostels, but also for other types of brands or concepts that can prove to be flexible. The challenge is that the financing doesn’t necessarily follow. That means we have to work a little harder and the financing may be a bit more expensive.’
Judi Seebus
Editor in chief