The Tide is Turning…
In recent years, the hotel sector has undergone a tumultuous journey, facing complete closures during the pandemic followed by a robust recovery driven by revenge travel . Despite the sector’s strong operational rebound, the European hotel investment market has been impacted by unprecedented increases in financing costs and economic and geopolitical challenges. The hotel transaction activity in Europe surpassed €10bn during the first 9 months of 2023, (-10% YOY) 26% below the 5-year average (2018-2022). Nevertheless, the decrease in transaction activity has been less pronounced compared to the broader real estate sector which saw an overall decline of 54% in transaction volumes. This resilience can be attributed to various factors, with a key driver being the ongoing trend of investors shifting towards alternative asset classes, benefiting from structural changes in the economy and society. Looking ahead, while the robust fundamentals performance is expected to ease in 2024 amid economic and geopolitical challenges, it is anticipated to endure. Additionally, investment activity is projected to gradually increase, particularly in the second half of the year.
Country breakdown reveals Spain, France, and Portugal, have witnessed a surge in hotel transaction activity. Investors are especially interested in acquiring resorts and hotels in prominent gateway cities with robust tourism demand, such as Paris, Barcelona, Madrid, and Rome. The primary attraction lies in the flexibility of hotels to enhance income in a higher inflation environment, coupled with the long-term prospects of capitalizing on structural shifts. These shifts include a growing population with increased leisure time, technological advancements improving operational efficiencies and transportation, a shift from expenditure on goods to experiences, and the evolving mobile lifestyle, leading to more time spent in transient forms of accommodation.
The Quest for Higher Yields
While long-term convictions take precedence, the inherently “higher yield” nature of hotels as operational real estate holds significant importance. In the current high-interest rate landscape, deals must offer an appealing yield premium to justify financing costs and achieve positive leverage. This somewhat favors hotels, given their range of risk and return opportunities, spanning from fixed leases to fully variable income structures. Moreover, hotels, being operationally intensive and complex, provide ample chances to unlock value through active asset management. With increased financing costs, deals must present both a healthy initial yield and a notable upside opportunity to be financially viable. Given the limited distress sales in most sectors, investors are directing their available capital to operational real estate, particularly hotels, with a focus on value-add transactions. Although such opportunities are scarce, they appear more prevalent in the hotel sector compared to others. Unsurprisingly, markets characterised by a broader array of hotel operating structures, like Spain or France, continue to maintain investment activity. In contrast, markets dominated by “dry” leases, such as Germany, remain subdued, a trend likely to persist into the next year until interest rates decline.
Despite a considerable amount of capital waiting on the sidelines, finding a product in the market with the right price and income growth potential for sufficient returns has proven challenging. This difficulty arises from the notable yield decompression driven by the cost of financing, as owners are reluctant to realise losses. In challenging situations, such as a need to deleverage, respond to fund redemptions, address the denominator effect, or raise capital for future acquisitions, owners may choose to sell well-performing assets that are less sensitive to yield increases.. Moreover, hotels have been experiencing robust income growth in many markets, allowing for yield decompression without a significant reduction in value, thereby narrowing the bid-ask spread. Current trends, as indicated by the hedonic data series from RCA, suggest that hotel yields in Europe have already expanded by approximately 125 basis points, with the UK leading the way (an increase of 178 basis points), excluding London, which continues to hold its value. Although hotel yield decompression in the UK is expected to slow down with increased activity, considering the market has nearly reached a record spread going back 15 years, the rest of Western Europe has been lagging and may witness further decompression.
Pricing is likely to remain under pressure at least until interest rates begin to decline, expected in the second half of 2024. During this period, smaller deals below EUR 3 million are more likely occur due to lower dependence on debt, decision-making flexibility, and less IRR-driven investment strategies. Conversely, larger portfolio M&A opportunities are also gaining interest, with lenders and investors willing to invest substantial amounts in single transactions. However, the outcomes of such deals initiated earlier in the year remain uncertain. As a significant amount of hotel debt matures in 2024, some activity will result from refinancings, where lenders evaluate loan-to-value ratios (LTVs) and debt service coverage ratios (DSCRs) amid ongoing market repricing and income volatility. Distress is expected to be sporadic rather than widespread, surfacing on a case-by-case basis as loans mature.
Buoyant Reasons for Optimism in the Hotel Sector
Despite obvious concerns about the hotels’ performance going forward, there are several reasons for optimism.
The labour market remains healthy, and consumers still have some excess savings. The unemployment rate across the euro area in September 2023 remained relatively low at 6.5%, just a 0.1pp increase from August and 0.2pp below the same time last year. Nominal wages in H1 2023 grew by 4.5% in Europe and by5.3%% in US (important source markets). Plus, according analysis by Financial Times[i], there still may be over 25% of excess savings left in the US, and Europeans are reported to hold even more surplus savings[ii], albeit partially in illiquid assets. Furthermore, several consumer surveys indicate a continued desire to travel despite the economic challenges. According to the European Travel Commission’s (ETC) latest report, 71% of Europeans choose to either maintain or boost their travel expenditures[iii].
The impact of China’s re-opening in mid-2023 has so far not been as robust as expected due to their domestic economic challenges. However, as Chinese travelers have not released their “revenge travel” to Europe yet, the arrivals are forecasted to increase by 82% in 2024, according to Oxford Economics, generating over 33 million overnights. This is likely to boost the hotel performance in key tourism hotspots for Chinese travelers, such as London, Edinburgh, Rome and Paris.
Business travel and in-person conferences are recovering. According to MasterCard’s research, 88% of travel decision-makers believe that business travel is critical for driving their organization’s growth. As a result, operators are reporting growth of corporate business in their hotels. This is confirmed by the data from our sample of 93 full-service branded hotels in the 14 key European markets. In Q3 2023, the revenue generated by individual corporate travelers has reached 87% of 2019 levels. Moreover, a growing number of business travelers are incorporating leisure stays before or after business trips ‘blended travel/bleisure’, opting for hotels due to long-distance commuting or working while on vacation ‘workations.’ Marriott’s recent report reveals that the share of corporate arrivals to their hotels on Wednesday or Thursday and staying past Saturday increased to 18% in the second quarter, up 5pp from the same period in 2019. A recent Global Business Travel Association (GBTA) report predicts that the business travel industry will surpass 2019 travel levels by 2024, two years earlier than its previous forecast.
A positive development for hotel owners and investors is the ongoing restriction on hotel supply growth in most markets, driven by elevated construction and financing costs. Our research indicates that supply growth in the top 20 largest European markets from the rest of 2023 to 2025 is projected to reach approximately 56,000 rooms, representing a Compound Annual Growth Rate (CAGR) of 2.1%. Dublin, Frankfurt, Vienna and Lisbon are expected to grow most rapidly, while cities like Barcelona, Amsterdam and Milan have minimal hotel construction underway. Although the conversion of outdated office buildings into hotels is emerging, it is unlikely to be a significant supply driver due to its complexity and the limited number of suitable office buildings. Supply is further constrained by authorities cracking down on short-term rentals to prevent the displacement of residents from city centers and safeguard the long-term rental market. Barcelona, for example, has prohibited all short-term room rentals in private homes, while cities like London, Paris, Amsterdam, Vienna, and Copenhagen have implemented limits on the number of nights a property can be rented out per year. Austria plans to introduce a similar cap in 2024, and Italy is contemplating nationwide rule tightening.
Sailing into 2024: A Year Set to Chart New Waters
Leisure has been the primary leader of the recovery and investors will continue to hunt for opportunities in this sector, especially with a value-add angle. In addition to resorts, the travel demand is growing rapidly in primary and second-tier urban markets with strong cultural offerings, allowing for longer season and more balanced mix of source markets. This is likely to attract investors who want to benefit from the long-term growth of leisure travel but also want to avoid the challenges with seasonality and the complex operation of resorts.
The pressure on wages, lack of staff, and rising operating costs is deepening investor interest into the extended stay sector that is less labour-intensive. On the other side of the spectrum, luxury hotels have proven to be an effective hedge against inflation and economic downturns with the additional benefit of owning a distinctive physical asset. For those seeking opportunities among the overlooked subsectors, the pandemic cast a lasting shadow on airport hotels, once highly favored by investors. However, with passenger movements now exceeding pre-pandemic levels, airport hotels are recovering and could offer promising investment prospects.
Lastly, ESG poses a significant challenge for the entire real estate sector, including hotels. As operational real estate, hotels offer investors substantial opportunities not only to deploy capital but also operational expertise. This can lead to significant reductions in utility costs and improvements in sustainability, providing a competitive edge as corporate and transient guests increasingly prioritize these aspects. Our research indicates the potential to enhance asset value by approximately 10%, achieved through a combination of improved income and yield compression. However, the window of opportunity is closing rapidly, as investors are now willing to pay premiums only for rare attributes. With increasing regulations, many hotels are at risk of becoming stranded. While institutional buyers prioritise assets with the highest ESG credentials, value-add investors are interested in acquiring hotels requiring significant retrofitting but with appropriate “brown” discounts.
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 Revenge travel describes a journey that had been postponed or canceled during the pandemic but is now being undertaken.
About Cushman & Wakefield
Cushman & Wakefield (NYSE: CWK) is a leading global commercial real estate services firm for property owners and occupiers with approximately 52,000 employees in approximately 400 offices and 60 countries. In 2022, the firm reported revenue of $10.1 billion across its core services of property, facilities and project management, leasing, capital markets, and valuation and other services. It also receives numerous industry and business accolades for its award-winning culture and commitment to Diversity, Equity, and Inclusion (DEI), Environmental, Social and Governance (ESG) and more.