With much of a challenging Q1 behind us it feels to be an appropriate time to take stock and look forward to the rest of 2023. Hopefully, there is only a positive trajectory for hotel transaction market for the year ahead with the consensus being that H2 2023 will see more activity across the real estate market. With several factors at play, some new and some old, it will be interesting to see whether these expectations are indeed fulfilled...
How will the hotel P&L develop this year?
Off the back of Covid-19, much of the market’s focus has been on the recovery of demand and progression of the top-line, which played out above expectations through the course of 2022. Now, with revpar in most UK markets indexing above 2019, the magnifying glass turns to the middle of the P&L and how costs will develop within the sector. Utilities, labour shortages, and increased living wages pose reasonable question marks to the development of hotel trading performance in 2023. That said, GOPPOR appears to be up c. 2 per cent in the regions and c. 8 per cent in London (2022 vs. 2019; nominal).
In reality, these factors will not play out in a homogenous manner across the sector, instead being divisive, creating “thrivers, survivors, and decliners.” More than posing challenges to operations, this will continue to drive uncertainty for investors in their underwriting, widening the divergence between buyers’ and sellers’ pricing expectations, further delaying the consensus much needed for liquidity in the market.
Top-line performance has seen good recovery, however, in some markets underlying factors remain at play, for example asylum contracts supporting occupancy and questions remaining over the length and depth of a possible recession along with the very real impact of the cost-of-living crisis. The latter’s impact on consumer spending may draw under question the longevity of the rate and occupancy rebound seen last year, while corporate and MICE demand struggles to hit pre-Covid quantum in some markets.
How will pricing and the transaction market evolve in H1?
Pricing remains somewhat in a state of flux. A slow-moving pricing adjustment within the hotel sector, off the back of limited transactional evidence, continues to limit trades as question marks remain on true value – forming a Catch-22 situation. Buyers will be hesitant to enter the market unless vendor pricing reflects an adjustment to the current state of affairs within debt markets and shifts in equity return requirements after significant movements in gilt and swap rates.
With this lack of evidence, buyers will, and sellers should, look to other sectors for comparative yield movement as well as the maths of cost of capital to price assets – the unlocking of the transaction market will be dictated by sellers adjusting their view on price and the eventual loosening of debt markets. As valuers present value declines through annual reporting, owners’ views will gradually shift, and the spread of expectations may converge slightly – but this process will be delayed. All in all, the change in economics indicate a decline in value in the region of 15 per cent, however, and as mentioned above, there is no homogenous approach, and each asset has its nuances.
Prime assets may hold yield profile, more so, but it is difficult to envision the upholding of such tight yields on prime assets seen in the last few years while five-year SONIA swap rates sit above c. 3.5 per cent. What we may well see, however, is the unlocking of prime assets that would otherwise not have been available in a stable economy, which could yet provide us with a handful of interesting trades in 2023 – although not necessarily at the discounts that many buyers would like or expect to see.
Thus far in 2023 liquidity does appear to be stronger at the ends of the quantum spectrum as the sub-£15 million private market continues to see movement driven by a lesser requirement for debt, flexibility in decision making, and less IRR driven investment strategies. At the other end, larger portfolio M&A opportunities also appear to see good appetite, supported by lenders and investors keen to write larger cheques on single transactions – however, the fate of such deals launched Q1 remains to be seen.
How will lender appetite impact transaction volumes?
Refinancing events can also be expected to deliver sporadic activity within the transaction market, with lenders questioning LTVs and DSCRs on the back of the ongoing, but unclear, repricing occurring in the market. Fortunately, we do not expect distress to be market-wide, but instead to occur on a micro-level as loans mature and solutions are sought on a case-by-case basis.
Traditional lenders will be keen to avoid negative reputation in the sector and will seek to distance themselves from aggressive foreclosures, resulting in a surge in mezzanine debt structures or whole loans sold off to debt funds. Given the pricing enigma, some lenders are more open to financing acquisitions rather than re-financing existing debt, given the transparency of market value during a live sale. Thus opening the door for traditional equity investors to pivot toward providing re-financing solutions as a means to enter the capital stack, while in some cases still delivering double-digit IRRs.
Where is current focus for buyers?
Long leasehold assets within the market remain troublesome but may present good value on equity returns for all-cash buyers, on the condition that ground rents can be proven to be sustainable. Lenders remain averse to the ownership structure which will push out yields for such assets and may present more attractive pricing. Opportunities may also arise from the collapsing of structures and the marriage of freehold and long-leasehold interests. Given the softening of yields within the ground rent sector this could present accretive opportunities for creative buyers.
Leisure has been the primary leader of the recovery and as such appetite for leisure-centric hotels and resorts remains strong. Alongside this, and in slight contradiction, a focus on “beds” has also prevailed with more risk averse capital seeking a more rooms weighted revenue mix. This has led to a reasonably distributed level of appetite among the sector in terms of segmentation, however, the unsurprising “flight to quality” has continued with a focus on primary and secondary city centres and quality leisure destinations. The latter has resulted in a comparatively larger outward yield shift for non-prime regional stock and a smaller buyer pool (unless the price is right…).
How does the current state of the market compare to the GFC?
The investment market trends appear to be less aggressive than in the aftermath of the GFC, but also less apparent. We are seeing more creative solutions and deal structuring, supported by a wall of capital poised for deployment within the sector, combined with an increased comfort in the asset class and wider buyer pool when compared to the late 00s and early 2010s. A key factor here is experience and the relative institutionalisation of the sector, supported by the increased availability of data from the likes of STR, CoStar, and Hotstats, creating transparency less available in other asset classes. That said, we remain somewhat behind other sectors in terms of institutionalisation, with a great deal of fragmentation.
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All in all, there are several undeniable headwinds facing the hotel sector, but the industry is one of great resilience – well-illustrated in the rapid post-Covid recovery we have seen since 2020. While we may well be in a state of flux, there is an inkling of stabilisation on the horizon and a more active H2 to look forward to.
Jack Wallsworth is a Senior Consultant with Cushman & Wakefield's Capital Markets team in London