European hotel investment in 2015 burst through the €20 billion mark for the first time in the history of the asset class, demonstrating the increasing appreciation of hotel real estate as an institutionally-accepted and progressively mainstream investment class across the continent.
Over the past 12 months, the institutional appetite to invest in core real estate has heightened considerably thanks to low interest rates and the associated impact on bond yields, and Middle Eastern investors continue to target luxury assets in capital cities for the preservation of wealth and prestige.
Countries where the hotel landscape is considered to be further along in the cycle, such as Germany, France and the United Kingdom, continue to register mounting deal volumes, attracting significant institutional interest and a growing weight of Asian capital.
At the end of Q3 2015, European hotel investment volumes had risen 42 percent year-on-year, with the sector accounting for 9 percent of capital invested in real estate, compared to 3 percent in 2007.
“Hotels are finally recognised as an established asset class after showing stable income returns and limited devaluations,” says Bas Jochims, head of asset management for offices and hotels at Bouwinvest. “Hotels have also outperformed other real estate classes with lower volatility, according to MSCI data. Hotel properties typically have very long leases, maybe 20 to 25 years, which are usually index-linked. This makes them a very attractive proposition to investors if they are well located and if supply and demand in their local market is healthy and well balanced.”
“Operating hotels offer investors a natural hedge against inflation, given that you can reset your rates every day, compared to an office investment where you may only have a rent review every five years, for example,” adds George Nicholas, global head of hotels at Savills. “Hotel investments also help institutional investors diversify their investments across different asset classes. Many investors now want to include hotels in their core-plus portfolios as a way to balance their investment strategies.”
Serving the punters
Leading the pack in Europe is the United Kingdom, which saw around £8.1 billion (€10.7 billion) traded in the hotel investment sector in 2015, according to Savills, marking a 31.6 percent increase on 2014’s post-recession peak volume of £6.1 billion (€8.1 billion) and missing the record total of £8.3 billion (€11 billion) set in 2006. London’s rise as one of the key tourist destinations in the world has attracted an increasing number of new international brands looking to capitalise on this expanding demand base and, with high-profile sales such as the £225 million (€298 million) LRG2 portfolio of Holiday Inn hotels exerting downward pressure on yields, the greatest compression has been seen in the franchised hotel sector, where yields now range from 5.5 percent to 8.5 percent, compared with 6.5 percent to 10 percent in 2014.
Indeed, 74 percent of respondents to Deloitte’s recent European Hotel Investment Survey believe that franchised international brands will dominate growth in both the United Kingdom and across mainland Europe.
Regional transactions accounted for more than 78 percent of total transactions and US private equity houses were behind 65 percent of hotel acquisitions in the regions, spending around £2.1 billion (€2.8 billion) last year on deals such as Lone Star’s acquisition of the Jury’s Inn portfolio for £676 million (€896 million).
Hotel investment in the United Kingdom is increasingly being touted as mainstream due to rising activity by UK institutions. However, in the context of wider ownership, UK institutions are not yet major owners even when you exclude owner-occupied stock.
The biggest barrier for entry for UK institutions is stock availability, as 80 percent of hotels are owner-occupied. The shift away from leased operational structures toward management contracts and franchise agreements, often with third-party management, is an additional barrier, due to institutional investor preference for leased assets.
On to the next opportunities
Despite European hotel investment being more pronounced in the United Kingdom, there is an expectation that this will taper off in 2016 and beyond as, according to Nicholas, “the next wave of pronounced hotel investment centres on western Europe, particularly Germany, the Netherlands and France — in that order. Western European markets are attractive to investors because of their transparency, the ease of doing deals, political stability and the perceived value of the euro versus the stronger pound.
“Germany has some of the cheapest debt in Europe, is a transparent and liquid market, and this is being compounded by increasing outbound capital from China. The Chinese notably appreciate Germany’s political stability and the country offers an alignment of manufacturing-based economy and industry,” says Nicholas.
“The UK ‘turn-around’ opportunities are largely picked over as far as most investors are concerned and now we are seeing global investors, including some Chinese investors, turn their attention to continental Europe. However, we are still seeing more risk-averse investors focus on the recently-repositioned assets in the United Kingdom and Germany to fit their longer-term investment strategies.”
But it’s not just from China that gateway European cities are expected to see a significant influx of tourists. Increased liquidity and a low cost of capital resulted in record levels of Asian investment into the European hotel sector in 2015. €1.6 billion of Asian capital flooded the hotel sector in 2015, representing 21 percent of the European hotel stock traded, which is the highest share of Asian investment across any of the mainstream asset classes and a 393 percent increase from the peak of the last cycle in 2007.
No let up in demand for travel
Elsewhere, while many predicted that the fall in global oil prices would dampen the heady tempo of investment flow from net exporting regions, Middle Eastern interest in acquiring hotel assets has not abated. Middle Eastern investors continue to seek out new hotel markets in which they can claim a stake — particularly as esteemed, five-star assets seldom hit the market. The rich culture, heritage and architecture of central Europe appear to have caught the imagination of the Emiratis, exemplified by the purchase of the InterContinental Budapest in late 2014.
“From an Invesco Real Estate perspective, we like the combination of investing into high-quality real estate while simultaneously, through the hybrid lease structure that we favour for the majority of our hotel investments, providing our institutional investors with an exposure to an exciting strategic growth sector,” says Lisa Neubueser, director – hotel fund management, Europe, at Invesco. “For example, international tourist arrivals globally reached a record high of 1.13 billion in 2014, a 51 million increase over 2013 — +4.7 percent — and the fifth consecutive year of growth since 2009, with the UNWTO [the World Tourism Organization] expecting another 4 percent in 2015.”
“We concentrate on long-term lease agreements whereby a certain minimum lease return is guaranteed to the landlord,” adds Andreas Löcher, head of hotel investment management at Union Investment Real Estate GmbH. “In this respect, hotels provide for a long-term stable income. Macroeconomically, international travel is forecast to grow substantially over the next five to 10 years.”
According to JLL’s most recent Hotel Investor Sentiment Survey, investors say that Barcelona and Milan have the most runway to grow ahead, while Hong Kong and New York have hit a peak. The survey found that sentiment in Munich remains the strongest and that Munich is firmly on the “wish list” of both domestic and international investors as it boasts some of the highest occupancy and room rates in Germany.
The situation is similar in Paris, with prime assets being viewed as secure long-term investments that attract a wide and diverse pool of both established and emerging sources of capital. The strength of the hotel market in Paris is reflected in its low cap rates, which is expected to continue despite recent terrorist events. The Parisian hotel market commands the highest levels of rate and RevPAR in Europe, sustained by a shortage of supply and consistent growth in international arrivals.
Seeking the sweet spot
Of the other major European markets, North American opportunistic capital, having targeted Spain’s economic recovery, is now also contributing to a rise in Italian deal volumes, mainly in strong tourism locations such as Venice and Rome. Irish hotel deals that seemingly monopolised the headlines over the past 24 months have centred on non-performing debt, and some of these assets are now coming back to market as equity and thus making a mark on the country’s investment volumes.
“At the moment, yields for Amsterdam hotels stand at a record spread of 450 basis points over yields on 10-year Dutch government bonds,” explains Jochims. “There has never been a better time to invest in the bricks-and-mortar future of the city’s tourist and business visitor industry. Furthermore, after the financial crisis, hotel operators started to refocus on their core businesses and continue to pursue asset-light strategies, which has resulted in more opportunities for investors.”
Hotel profitability in Greece’s capital, Athens, grew by 6 percent year-on-year for the 12 months to September 2015 due to increasing payroll costs and stable inbound international travel. Stock availability has been a catalyst in the growth of hotel investment volumes; however, allocation of capital into the space has ensured strong pricing and yield contraction against a backdrop of operator performance recovery.
Elsewhere, in central Europe, despite the limited development opportunities in the region, a number of international hotel chains are screening the region in search of opportunities to expand their portfolio of brands. In Warsaw, 764 rooms will be opened in the three- to five-star bracket in 2016; while 500 will be opened in Budapest and 727 in Prague, according to Cushman & Wakefield.
In terms of lot size, there is a broad sweet spot that investors are targeting, as Neubueser explains: “If you’re investing below €20 million, if you want to leverage, it’s hard to get debt finance as this lot size is generally too big for local banks and too small for established European players. Between €35 million and €80 million, it attracts both national and international investor demand and is thus an area that we find most comfortable.”
Pockets of fragility
However, not all European markets are as attractive to investors. JLL’s survey found that investors anticipate trading performance to decline over the next six months in Moscow, Istanbul and Budapest. Moscow continues to suffer from its fragile economy, political troubles and sanctions, which have driven away many corporate guests, as well as from the continuing devaluation of the rouble.
Turkey is not without its challenges, either. The tourist and hotel market experienced a slowdown in 2013 and 2014 due to global and domestic geopolitical events, and the uncertainty is set to continue.
Broadly speaking, the future is bright for Europe’s hotel sector. Because hotels remain a specialist asset class, they continue to command an attractive yield premium to similarly-located office or retail properties of comparable quality. Hence, this provides an accretive return diversification at low volatility, particularly given the steady income stream derived from longer lease terms than typically seen in offices or retail.
However, while sentiment remains strong for the sector, it is expected that, according to Mark Wynne Smith of JLL’s Hotels Hospitality Group, “the focus will shift from portfolios to single assets, as most portfolio sales were dealt with by the banks,” as the attention turns to other European markets outside of the United Kingdom, particularly Spain and Italy, which have lagged behind, and from where the best is yet to come.