IHIF reflections

The annual hotel investment community gathering in Berlin comes at an inauspicious time for the UK hotel sector. 2023 saw the lowest level of deals in the sector since 2012, with buyer-seller pricing gaps largely unbridgeable, particularly given the steep rises in the cost of debt. Lenders seem to be continuing to kick the over-leveraged can down the road, and this, together with c40,000 rooms still occupied by asylum seekers, is distorting the market. Finally, whilst substantial increases in ADR post-pandemic have compensated for inflationary cost increases (particularly on payroll), 2024 has kicked off with a marked softening in trading performance, and a significant rise in the national minimum wage is now upon us.

As is generally the case each year, the major operator CEO main stage interviews tended to focus on the positive, with beneficial long term leisure travel trends in particular being repeatedly referred to. Aside from the prevailing gradual shift in consumer expenditure from material goods to experience, there are positive specific "emerging market" trends: Chinese travel to Europe still remains way behind pre-Covid levels, with recovery expected to lag 1-2 years behind the 2023 reopening of many air routes. Chinese leisure travel to SE Asia has increased significantly recently which is a cause for optimism on the assumption that they will move further afield. India is increasingly being seen as a major longer term driver of travel volumes: the point was made at one main stage presentation that the so-called Indian "upper class" will increase from the current 1% of the population to 5% by 2040. Given the size of India's population, the potential beneficial effect on global travel volumes could be significant – hopefully, the UK will produce an effective strategy to ensure we win a meaningful share of this.

In terms of transactions, there is certainly a more positive mood than last year, with some evidence to back this up. Although no new transactions were announced, the Starwood/Edwardian deal earlier this year – the first substantial UK portfolio sale since Point A in 2022 – and the prospect of potentially significant deals such as Village, Citizen M and B&B in the months to come has many commentators speaking of a return to pre-2022 Ukraine/debt crisis levels. I remain to be convinced on this: the bid/ask spread which has driven recent market inertia has narrowed but not I think sufficiently enough to match the frothy headline valuations which are out there. I recall a similar level of optimism regarding H2 at last year's IHIF which failed to crystallise. Undoubtedly, there will be an increase in volumes versus 2023, but, to be honest, it would be difficult for there not to be. That said, we are seeing more creative ways of completing deals, for instance vendors retaining equity or preferred equity stakes in order to ease financing demands, and also releasing equity through the sale of minority interests only, which may facilitate recovery.

A personal plea is for sellers to properly consider the financial information that investors require in order to complete a transaction. A broker panel noted that the proportion of Vendor Due Diligence reports seen on processes was way down on previous years. Whilst full VDD won't always be appropriate (most obviously on smaller individual assets), some upfront form of "vendor assistance" that pre-empts buyer’s vote financial and tax information requirements is always desirable, if one wants to avoid what should be a 3-4 week diligence period extending to double that length.

In terms of distress, the "wave" of which has been much anticipated ever since March 2020, still essentially nothing to report here. Banks seem to have learned their lessons from the 2008 global financial crisis: LTV levels are manageable and high street banks in particular are conscious of the adverse publicity that any enforcement action may entail. Having said that, there do appear to be signs that the era of "extend and pretend" may be coming to an end and in particular that the banks may be putting pressure on borrowers to revert in part to more expensive private sources of capital in order to reduce their own exposure. Whether this leads to any uptick in stressed opportunities coming to the market remains to be seen, but certainly the trend in recent years of private capital taking the place of traditional lenders looks set to continue.

One final much mentioned theme was – UK aside – the general lack of new rooms supply coming to the market, perhaps an overhang from the stalling of development pipelines during the Covid period. With the office property market seemingly in structural decline following the shift to hybrid working, conversion opportunities are being more frequently discussed, although meaningful planning relaxations in many cities will be needed as a catalyst. For the UK, it will be interesting to see if the near-bonfire of planning regulations promised by an incoming Labour government does come to pass, as this could lead to the redevelopment for alternative use of a plethora of under invested hotels in mainly secondary locations, a sub-category which has long been regarded by many commentators as "under-demolished" and have effectively acted as a drag on the overall health of the UK hotels sector.