31 January 2013 | InterContinental Hotel, Park Lane, London
EY Real Estate and Hotels Workshops
‘Setting a course for the future’
Get back to basics to find the right investors
There appears to be a clear feeling in the industry that the number of hotel transactions will increase in 2013, with EY conference delegates nearly two-to-one in favor of that proposition. But where are these investors coming from? And who is to blame for the sluggish level of deals at the moment?
Delegates put the blame squarely on sellers, a viewpoint echoed by Derek Gammage, Head of Hotels, EMEA, at CBRE.
“Equity was delusionally priced,” he says. “Your buyer wanted to have his cake and eat it, but as the weight of capital has increased, we’ve seen a significant shift in buyer expectations.”
This reluctance to reduce value expectations is feeding the reluctance by the banks to lend into the sector.
“Banks have lost confidence as to what the true values and sustainable earning powers of hotels are,” commented Adrian Turner, Managing Director of Crownway Capital, who led the sale of the UK & Ireland Jurys Inn Group in 2007, just ahead of the credit crunch. “They have been misunderstood, for a whole host of reasons, as to true long-term Capex requirements — not just on maintenance but on the inevitable complete overhaul required every 7 to 10 years: even what were good hotels in 2006 are now looking tired, and lots of people are realizing that the sale opportunity is just not there — it can be easier to build new than buy existing.”
For Desmond Taljaard, CEO of Starwood Capital, the current market challenges are essentially symptomatic of a return to good practice.
“A lot of deals transacted in 2006 and 2007 were not carried out with adequate due diligence,” he says. “We may be old fashioned but our view is that this is not new but has gone back to what always should have been.”
This does, however, mean that deals are now taking much longer to secure.
“Lenders are taking extra care to ensure as best they can that a borrower’s cash generation is broadly stable because it is this, rather than a perception of capital value, that is the primary source of repayment for borrowed money,” says Bob Silk, Relationship Director of Barclays Bank’s Hospitality & Leisure Team.
“From a purchaser’s perspective, when considering whether to acquire a UK provincial hotel asset or portfolio of assets in particular, many reckon that now is a good time to buy because we seem to be at/around the bottom of the cycle. Whether that is really the case and values have truly ‘bottomed out’ remains to be seen; time will tell. However, many consider that they will look back in, say, five to seven years’ time and marvel that they could have acquired assets at such a keen price.“
It’s clear that the prevailing mood at the moment is conservative, and that this is limiting expansion. According to Carlton Ervin:
“Acquirers are really interested in existing stable assets, many of which have brands on them anyway,” he says. “Other than that constant stream of US reinvesting, we don’t see new investors coming in.”
Where “new kids on the block” are coming in from the Middle East, China or elsewhere, the acquisitions are often luxury assets with normal yields.
“We see a great many ultra-high-net-worth Asian investors who want to buy on very thin yields,“ says Silk. “It’s more of an emotive acquisition.”
At the start of the downturn, many owners took the view that they could sit on assets until the cycle played out and values recovered, as they had in previous recessions. The continuing stagnation in UK GDP has meant that this recovery hasn't materialized, and owners are now finally facing up to the fact that their desired values just aren't achievable in the foreseeable future.
Executive Director — Transaction Advisory Services, EY, UK
“On this side of the world, where bank balance sheet lending is so important to the hotel sector you get the impression that all the lending that will be done to the hotel sector, has been done — it is just a question of moving capital around,” says Turner. “In the US, dedicated hotel REITs are moving a lot of capital off from banks’ balance sheets, which is in turn refueling the banks’ ability to lend new capital to the sector.”
“At the moment, the natives can’t get access to cash (or at least the debt component), so there’s a comparative advantage over domestic buyers — we will see US investors come flooding in,” Gammage remarks.
“What that shows is what having a large and liquid real estate bond market and a liquid quoted REIT market can do — this side of world is screaming out for that,” adds Turner.
Nevertheless, there is a feeling that in the UK at least, as Gammage puts it, “all the stars are aligned.”
“Mainland Europe has fundamental problems with labor costs and employment law restrictions, while in the UK we still have a relatively flexible labor environment,” Desmond Taljaard comments. “A lot of assets are currently starved of capital, but I think we’re close to that inflection point.”
But this tight climate does create opportunities for outside investors to come in, particularly from the US, where margins are squeezed. The general consensus was that overseas investors had much more free access to capital than their European equivalents.
Who is to blame for the continuing low level of transactions in the hotel sector?
Source: Delegate poll results from the EY Hotels Workshop 2013