The HAMA Europe Asset Management Achievement Awards, in partnership with IHIF and HAMA Europe, provide an opportunity to formally recognise results of successful asset management strategies accomplished by the winning companies across three categories; Single Asset Strategy, Portfolio Strategy and Sustainability Strategy. We sat down with Jochen Schaefer-Suren, CEO, Principal Real Estate Europe, to discuss their achievement as Portfolio Strategy Award 2020 winners, sponsored by HotStats.
1. Describe your project.
Successful portfolio management requires that from the design of the fund concept, its investment strategy, related capital raising, acquisitions and portfolio building to its financing, asset management and exit strategy all are executed successfully and benefit from benign hotel trading, real estate and capital markets. This is what we achieved over the life of Principal Hotel Real Estate fund I which I conceived shortly after the global financial crisis in 2010/11 when liquidity was scarce and investors wanted straightforward, easy to understand fund structures for coherent group of investors, which at the time where very risk averse and returns were relatively high. The fund was thus specifically designed for German institutional investors, with a well-established German KVG structure with a conservative investment strategy. Therefore, the fund’s investment strategy was initially focused on the core eurozone countries with low risk, income oriented, institutional quality 3-4* hotels and hotel operators in major city centres with leases and only 40% LTV financing with target returns of 7.5% income and 10% IRR over its 7 year life. This conservative fund strategy and structure was very popular with its German investor target group as we achieved the fund’s first closing in mid 2012 with € 75 Mio. Equity, which we thereafter, more than tripled to over € 240 Mio. equity raised as we were able to quickly deploy capital till 2016.
2. What made the project so successful?
As referred to earlier, our Hotel Fund I was so successful as its strategy and structure were in line with investors’ expectations on the capital raising and the hotel investment market side where generally investors were still risk averse to hotel trading. Accordingly leases with high levels of guaranteed income and variable rents were common and cap rates still comparatively high. As a result, on the capital deployment side until 2016/17 we were able to invest nearly € 500 Mio via separate purchases of 16 hotels across Europe with astute market timing and good asset selection consistent with our strategy at initial cap rates of 7-8%.
Simultaneously we enhanced these well-chosen, successful acquisitions with attractive financings based on our excellent relations with banks active in the hotel sector. This allowed to obtain financings with very small margins and benefit from ever lower interest rates due to the monetary easy policies started by the ECB from 2012. Our average cost of debt at the end dropped to ca. 1.35% p.a. This enhanced in particular our running income return as well as long term IRRs.
This successful investment and financing phase was combined with well-designed and executed asset management initiatives including renovations totalling over € 60 Mio., changes of brand or operator and lease renegotiations with hybrid rent structures allowing to participate in the trading upside after renovations and upward market trends. This included over 20 asset management initiatives to increase income and value across all assets in the portfolio.
These critical asset and portfolio level measures were supported and enhanced at market level by improving hotel market trading, continuously lower interest rates and increased liquidity driven by the ECB which soon led to negative interest rates. This improved the hotel real estate investment market which together with increasing investor interest in income generating trading assets like hotels led to hotel cap rates between 4.0-5.0% by 2018/19 driven hotel values even higher.
The final critical element in the success of the fund was that; since we had completed all asset level initiatives, as hotel market performance improved and investment markets moved higher and higher, we started selling assets from 2018 on. This culminated in the final portfolio sale initiated in early 2019 and completed by December 2019/ January 2020 for a premium price of a 11 hotel portfolio at a cap rate of 4.2% on portfolio rents that had increased by over 50% since our initial acquisitions.
Altogether, over the fund’s life from 2012 till 2019 this led to an average income return of 8% and an IRR of 17.2% for the fund net after taxes and all costs for investors. So the fund’s IRR target return was exceeded by over 70%.
In conclusion, the key drivers of our success were; a good investment strategy, good asset selection in the acquisition process, attractive financings and successful asset management initiatives as well as attractive timing in terms of the economic cycle as well as the capital markets development of investments at the start of a portfolio’s life as well as at the point of divestments at the end of a portfolio’s life. All of which came together perfectly which was not only the results of a well thought out strategy and hard work but also some “good old” luck, especially in hindsight as the Covid crisis started only months after our final portfolio sale.
3. How has the Covid crisis affected the project and the way its been managed?
As we sold the entire portfolio of sixteen hotels due to the buoyant market conditions in the 18 months prior to the Covid Crisis culminating with the portfolio sale of 11 hotels in December 2019 the fund was not affected by Covid.
4. How do you expect the role of hotel asset managers to change in the future?
Clearly the role of hotel asset managers will become more important in the future as the Covid crisis has highlighted the risks in the sector and more and more operators will push these risks onto investors. Understanding the risks in hotel real estate and operations, being able to evaluate different hotel operating concepts, as well as knowing how to reduce the risk profile of hotel assets will highlight the importance of hotel asset managers and their role.
We expect there to be significant change and disruption in the next few years as the different stimulus and support measures by governments that have shielded the industry from the hardest consequences of the pandemic will end. The resulting disruption and trends at the industry level are still unclear or emerging but it will be even more important for hotel asset managers to understand and anticipate these over the coming years, especially as this will vary dramatically by market, location and hotel type, and materially impact performance, returns and values of hotel operating and real estate assets.
5. What do you see as major trends emerging in hospitality real estate post pandemic?
It’s very early to predict the trends emerging for hospitality real estate post pandemic. However, let me try! Firstly, the pandemic allowed new technologies advances that had been around already, like video conferences, gain market share and recognition within 18 months that otherwise would have taken 5-10 years. This will have a long lasting, profound impact on demand for individual and especially group business travel like MICE which will suffer for quite a while. Understanding this is critical for investing in hotel real estate, market and risk analysis and valuations.
Secondly, risk management and risk allocation will be the focus for the sector as operators reduce risk and cost in their sectors, try to push it onto investors who will try to avoid it. Hotel concepts will be re-evaluated to reduce the high fixed cost components in full service concepts thus trending towards more limited service hotels. Resort hotels due to the more reliable rebound in leisure travel will appear more attractive although one should be weary about the very different nature of the real estate underlying resort hotels and the related limited liquidity. Pressure is likely to build on hotel management and franchise contracts with their high fees against no commitment on results. Banks will be more selective in hotel lending and some will not lend to the sector for a while. Luxury full service hotels in the world’s top metropoles will come under more scrutiny from investors as they and their markets will suffer longer than other hotel assets and destinations. Generally, hotel concepts will evolve more towards the residential concepts like aparthotels or serviced apartments as they have less costly food and beverage and other facilities.
But this will be a long drawn out process which will take a few years to play out and we will all be surprised by some of the outcomes of the pandemic which has been the most severe crisis for the hotel and tourism sectors since decades.