The hotels market has been getting hotter over the past 18 months, with several large portfolios entering the market as owners and operators shed their assets and private equity firms churn their portfolios.
In 2005, European hotel-investment volumes seemed to have peaked after rising by almost 60% to €15.7bn. But by the end of last year, that figure topped €20bn. And 2007 is anticipated to be another year of rising investment in the sector.
While interest in hotels from high-net worth individuals and private property groups – including London & Regional and Consensus – is no new phenomenon, this year has seen increasing interest from more traditional property investors.
With properties offering a yield of around 6% – compared with the sub-5% through offices, retail and other forms of property – it is not surprising that hotels have become more attractive to these buyers.
Some commentators have started to predict that the real estate investment market as a whole may be reaching the top of the cycle. But leisure – which encompasses hotels – still seems to have legs and is getting second and third looks from investors who are chasing higher yields.
Maintaining interest
The latest Hospitality directions report from PricewaterhouseCoopers says that interest and investment in the hotel sector should continue well into 2007, driven by strong trading fundamentals and deep pockets of capital. But it warns that there is a risk of oversupply, which could affect trading and thus investment.
David Harper, director of hotel agency Leisure Property Services, says that hotels have traditionally been undervalued as assets, with their worth not really being realised until 2001. It was at this time that hotel groups began selling off their assets to concentrate on the operational side of the business, resulting in a move to sale-and-leaseback deals.
The InterContinental Hotels Group has led the split of the property assets from the management systems in the hotel business, selling more than £3bn of assets in the past five years.
Paul Bartrop, a director at Colliers Robert Barry, says that other key drivers behind the flood of hotel assets onto the market is the need for privately-owned, highly-leveraged hotel operators to release equity in order to expand and compete.
“There is also the continuing issue of demand over supply and the wall of available capital seeking a home,” adds Bartrop.
“Traditionally, hotels were only of interest to hoteliers,” says Harper. “That led to pricing based upon returns required by operators, which was higher than across other parts of the property market. But with the changing market perception of hotels making them appear less risky than had previously been considered, came an influx of investors keen to benefit from the excellent returns available in the hotel market.”
Bartrop agrees: “Historically, purchasers of hotel property were solely owner-operators with traditional debt-to-equity-geared structure, which was restricting to growth. There has been a lack of understanding about hotels and their security as a property asset class. But now there is an increasing realisation of the many benefits of hotel real estate ownership.”
These benefits include the relatively low cost of hotels compared with other asset classes good returns a boom time in the operational market, with even stronger performance predicted this year (see p118): and great residual values.
“How many 500-year-old office buildings are still in use today, like the Lygon Arms in the Cotswolds?” asks Harper. “These are the type of residual values that are possible, as hotels are constantly being updated so that they can trade.”
“Traditional property investors have started to see these benefits,” adds Harper. “Not just the recession-proof budget market or the wealth-preserving deluxe five-star market, but the less sexy mid-market has been discovered to offer massive potential for capital growth.”
Adrian Archer, associate director in hotel and leisure valuation at Savills, agrees. He says that the better returns that are available from hotels are driving increased interest in the sector. “Hotel returns have performed well against all property returns. Hotel yields were typically higher compared with other property sectors, which were too expensive or there was no stock available. Hotel investments are now an accepted asset class of their own, providing investors with another basket in which to place their eggs.”
Rob Seabrook, executive vice-president at Jones Lang LaSalle Hotels, adds: “There is also a general trend of ‘my peers are doing it so I should do it too’. People have seen that the early entrants into hotel ownership are getting good returns.”
Increased competition in the traditional real estate market has also made the hotel sector more attractive, with more investors piling in and pushing up prices.
Alistair Brooks, director of hotel and retail agency CRESL, says that huge demand for hotels – from investors, with increased interest from REITs, and operators – especially with investment banks buying management companies to make a profit on underperforming management – has led to owners putting stock on the market to see if it can command a high price.
“The unprecedented level of demand for hotels has led owners to offer their properties at very high prices just to see if the right buyer is out there for them,” says Brooks.
The right buyer now seems to be the traditional commercial property player, with several of the most recent high-profile portfolios being sold to traditional office and retail buyers.
Celebrity-backed fund manager aAim spent £290m buying the Principal Hotels chain, which has also bought Sir Rocco Forte’s St David’s Hotel & Spa in Cardiff through CBRE Hotels for £32.5m. Forte is also selling his Lowry hotel in Manchester. aAim also teamed up with Robert Tchenguiz’s R20 to buy Menzies Hotels for £180m.
Large transactions
Other recent transactions include Moorfield Real Estate Fund’s purchase of 24 Macdonald hotels for £400m, boosting its portfolio to more than £600m. Land Securities Trillium made a big call on the hotel market, buying a £439m portfolio of 30 hotels from French hotel giant Accor. Chief executive Ian Ellis says this deal is the first in what it hopes will be an active future with Accor.
Moorfield’s Marc Gilbard says the sector is appealing because there are often latent asset opportunities in hotel acquisitions. Both of the portfolios that it owns – Macdonald and WS Shearings, which targets the over-55s market and was bought for £110m in 2006 – have refurbishment and development potential. The Macdonald portfolio comprises several country houses that are in need of refurbishment while, says Gilbard, WS Shearings came with a huge amount of residential and leisure development potential.
But can this increased interest from the traditional players continue?
Hotels are a volatile market and although they may be seeing a boom time in terms of trading, with leisure- and business-travel on the up, there are a some legislative changes that could have a negative impact on trading. How the smoking ban will affect business is yet to be tested, as is the proposed introduction of a bed-tax.
For now though, most agree that interest from investors is more than sustainable. And while the traditional commercial property players may not always be checking into hotels, there will always be someone wanting to bed down in the sector.
Hotels are looking hotter in 2007
Hotels are set to outperform the remainder of the commercial property sector during the next five years.
The sector, which is becoming increasingly popular with traditional commercial property investors, will produce an annual return of 8.4% between 2007 and 2011, compared with 6.7% for all UK property, according to the latest UK hotel investment report from Savills.
This year, the agent is forecasting a return of 11.3% for hotels, compared with 10.1% for all property and rental growth of 4.5%, compared with 4.1% for all property.
“Hotels will increasingly become a core property class,” states the report. “In the longer term, the 2012 Olympics have the potential to drive even stronger income growth in hotels and will present stronger positive returns.”
