Midmarket hotels have always played an important role in the hotel sector, blending affordability with quality. However, many of these assets across the UK now find themselves in dire need of a refresh.
The potential obsolescence of midmarket hotel assets has been a popular topic of discussion, and with the midmarket segment representing around 37 per cent of hotels in the UK, investors and stakeholders are now seeking ways to effectively refurbish or reposition the underperforming stock in this segment in a way which maximises earnings and - in a time where ESG has been pushed to the forefront - benefits planet and people.
“Fundamentally, the mid-market has underperformed the general market year-to-date 2023 versus pre-Covid,” says Richard Dawes, director, hotel capital markets at Savills, also noting that in terms of deal volume over the last 18 months, 10 to 15 percent of total transaction volumes have been in the mid-scale space, highlighting the interest in refurbishment projects.
Muriel Muirden, CEO at The Wee Hotel Company adds that the midmarket segment, especially in rural locations, has an image for being tired. However, she argues that these assets present opportunities due to their proximity to areas of natural beauty.
“They're close to water bodies, they're in national parks and they've been developed historically in locations where you wouldn't get planning now. So there’s a need for a vision to try and see how to bring these assets back to life.”
She adds that many of these properties, especially in rural areas, have very large grounds and come with a lot of acreage, presenting the opportunity to expand and increase room numbers.
“The possibility of increasing the rooms inventory in more creative ways; with lodges or pods or shepherd's huts etc. It may have 12 rooms but there may be potential to grow that to 20 or 25 rooms.”
Dawes says that there’s also opportunity in the size of the average midscale rooms, drawing attention to lifestyle offerings which focus more on common areas because room needs are much more reduced.
“This is where lifestyle is really lifting some of these traditional, older mid-market hotels in terms of repositioning,” he says.
But there are a lot of things to consider when considering the repositioning or refurbishment of an asset, experts warn, the first being location.
“Location is really important. You need to look at this through the lens of ‘what are the demand drivers near this piece of real estate?’ or ‘here's a location that we really want to be in so now let's go find a building that we can do that in’, says Chris Penny senior vice president at Starwood Capital Group.
Muirden further stresses the importance of properly considering, not just the location but also the labour market in the area as well as the building’s architecture itself.
“It’s easy to be transfixed by a scintillating location but we need to be grounded and ask questions like ‘does this location have a local labour market?’. You don't want to end up with a property where you're also buying residential homes to house your staff as that can be a big burden on the P&L,” she says.
She adds: “It’s also essential to see what the flow is within the building because a lot of them will have been tampered with and extended and moved around.”
Experts add that cost is a huge challenge when considering repositioning/refurbishment projects, noting that capex for these projects always seem to balloon as time progresses.
“Once we get into the project, what was budgeted and what we were advised we needed can be very different from what is actually needed. There’s a lot of old hotel stock out there and we need to be very cognizant of the fact that if these buildings were built in the 60s, 70s or 80s, there may be systems that are nearing the end of their useful life, which may be very costly to replace,” Muirden says.
Andrew Katz, consultant at Prospect Hotel Advisors says this is where its beneficial to get capital expenditure done early as well as ensure the presence of competent teams who can deal with issues which may crop up.
“If you're going to expand, there's lots of land related issues and there's lots of pitfalls that you don't even think of. You just have to do your due diligence and hire good advisors.”
He adds that when looking at branding, it’s also important to properly consider potential new competition in the area.
“It always takes longer and it always costs more,” Penny says, adding, “It's really important to work very closely with your operators to figure out what operational model you’ll end up with. Because that's what actually drives your cash flow, which drives the value at the end of the day.”
“If you're buying an old country house, there's a lot of work that goes along with that and the refurbishment and the capex spend is going to be much more,” he says, further explaining that that if the asset is an old building without enough back-of-house space to service it, then work-arounds will be needed which will further increase costs.
“If you can't actually operate it efficiently and profitably, then you're going to impair your value at the end of the day,” he says.
But while old buildings come with their own set of challenges – not least of all, protected/listed status – they also come with their own advantages and opportunities, experts say.
“Listed buildings come with a personality and a history that some private domestic investors want to tap into and there are some beautiful buildings that need some loving TLC,” Dawes says.
He adds: “I think the challenge is today, with the cost of finance where it is, there is more perhaps more risk and unknowns than with soft refurbishments. But it's that heritage that people like to tap into and there is capital out there that’s looking to deploy into transformation of these assets.”
Penny agrees, noting: “If you have good advisors, you know what you're getting yourself into and a building being listed is not necessarily a barrier.”
As concerns about ESG come to the forefront, with the high cost of energy following closely at its heels, experts stress the refurbishment process also presents the opportunity to invest in making the concerned building more efficient and therefore increase value.
“Installing better BMS systems, installing better insulation and making sure there’s LED lighting are simple things but there’s a lot of value created there. Making your building more efficient drives bottom line, which drives value,” Penny says.
Looking outwardly towards other sectors, with offices becoming increasingly harder as an investment class, experts say there are opportunities to turn office stock into much-needed hotels, particularly in large cities like London and Rome where the tourism market is booming but the office sector suffers.
Looking ahead, Dawes says that while he doesn’t believe on average that the midmarket will perform significantly strongly compared with other segments, there will be winners in the segment who will steal share from those around them. He adds that there’s a wealth of capital and a breadth of buyer types chasing midmarket refurbishment opportunities or buying offices for transformation into hotels.
“There is a wealth of domestic private capital that are looking to realise some of their dreams about converting some of these beautiful assets. As a team, in London alone we've sold over £100 million of conversion projects this year and there's more capital looking to get into that. Pricing is a little skittish but it will be interesting to see how that evolves over the next six to 12 months.”