The market volatility and economic uncertainty caused by the pandemic and exacerbated by the Russian invasion of Ukraine, has created an unpredictable landscape for opportunistic investors. However, the glut of distressed opportunities initially forecast has been nowhere near as extensive and those who have been waiting for a prolonged period on the lookout for distress are stuck in a limbo.
While distressed opportunities seem elusive, they're not entirely absent, experts advise. However, they note that identifying potential opportunities isn’t an easy task. And therein lies the question: how can hungry investors source and capitalise on these opportunities?
Where the opportunities are
“Distress already exists in the market but it’s not down to operational challenges, it’s really about capital structure,” Kristen Kozlowski, managing director at PineBridge Benson Elliot says, noting that as debt obligations rise, increased pressure from lenders may create promising opportunities for investors.
Laura Wild, partner & global co-leader- hotels & hospitality at Bryan Cave Leighton Paisner agrees that patience is waning for many lenders but notes that while there hasn’t really been an upsurge in lender enforcement, lenders have been subtly encouraging sales.
“What we are seeing is exit solutions; so lenders soft-pedalling sales. These sales will be borrower-led but obviously the lenders will be very close, by the sidelines, pushing that,” she says.
Looking at the European hospitality industry, Benjamin Habbel, CEO of Limestone Capital says there’s a plethora of opportunities due to the fragmented nature of the European market as well as the high proportion of family-run businesses. Many of these businesses are grappling with the fallout of Covid-19, leading to increased stress and a pressing need for solutions, thus opening the door to potential investors.
“In Europe, around 80 per cent of hotels and hotel rooms are family-owned small businesses. We invest in lifestyle, boutique assets and 19 out of 20 times, when we look at something, it’s a family that has a whole range of issues to deal with.
Post-Covid, there’s a lot of stress. The reality is that if someone has to trade an asset to solve whatever problems they have within their family and they have a certain timeline, I would define that as stress or distress. So, especially in sales in Europe, we see a lot of opportunities,” he says.
He notes that in many of these jurisdictions, the banks can find it difficult to enforce and therefore is very excited about a new investor stepping in.
“In the end, it’s the white knight buyer that solves the situation. In our experience, it’s really a combination of the buyer willing to make a deal and the bank willing to make a deal. The opportunity is in more complex situations where you have to take a bit more risk than you would expect.”
However, Christophe Beauvilain, managing partner at Pygmalion Capital notes timing is a really important factor in deals like these.
“If you come in too early, you've got a debtor who's really not incentivized to do a deal. If you come in too late, it may already have gone to some kind of auction, which then becomes competitive,” he says.
He advises that the trick is to come in at a stage where the relationship between the creditor and the debtor has soured to a pretty high level and the next step is the bank taking drastic action towards enforcement and the borrower is facing the potential outcome of losing completely control.
Kozlowski agrees, adding that when sourcing deals, Pinebridge is increasingly adopting preferred equity structures where there’s a big bid ask spread, the lender wants action, and the borrower believes in the asset and doesn’t want out.
“Groups like us can come in and create a win win win situation. So for the new equity, you're getting some real downside protection but access to real estate that you believe in. The original borrower gets to stay in and they have the hope of values increasing and ending up in a better position. And the lender gets what they want which is their position paid down.”
However, she notes relationship building is a key part of this. “People aren't looking to someone they have no experience or relationship with.”
Opportunity in luxury
Turning to the luxury segment, Beauvilain says that contrary to popular belief, distressed opportunities exist. However, these mostly fly under the radar.
“Not many people know that the bank was semi-recently, about to enforce on a prime luxury hotel in Ibiza and a new investor came in; it was completely below the radar.”
He adds that in the luxury segment, he sees more opportunities in situations where there was overspend in the development phase.
Necessary skillsets
So what skill sets do investors need in the current market to source distressed deals?
Kozlowski says creativity and ingenuity are great things to have, drawing attention to another problem the real estate industry is grappling with: what to do with the huge number of offices which are no longer viable as offices.
“In London alone, there’s almost 10 million sq ft of office space like these. While we should question if it will be viable as an hotel when it’s not viable as an office, this is a 100-year flood event for the real estate industry as a whole. We don’t want these buildings sitting vacant; someone’s going to find a solution and they’re going to make a lot of money in the process because the pricing is going to have to be really low in order to compensate for the risk.,” she says.
Looking ahead, Wild expresses optimism, noting that there are definitely tubes of life and continued interest in the sector.
“We have a number of clients wanting to deploy capital and new entrants to the market. Some of them may have been investing in offices but are now switching to more operational real estate such as hotels. We’ve been busy taking calls from Asian investors who are now back in the market and they're definitely looking for a bargain.”
Kozlowski advises that investors should refrain from being short-sighted in their wait for pricing to bottom out.
“Our institutional investors keep saying ‘I don't know if I want to deploy my capital because I don't know if we've hit the bottom of the cycle’. However, I think it’s about determining where you believe long term values for real estate are going to be in three, four, five years, and if you’re a long-term holder, in ten or twenty years.
There are plenty of clues out there. We can look at what corporate bonds are going for. You can look at where interest rates have moved. It’s about where do you think you're going to land in value and then be disciplined in your underwriting.”
Habbel believes transaction activity will start to pick up in the last quarter of 2023 after the excitement of summer trading dies down.
“Looking at what’s on the books, this summer will be a strong one, especially in seasonal destinations like the Mediterranean. So I don't think there will be a lot of deals. I think people will wake up again when weather starts to get grey and they get more stressed again about the realities of life. That's when I think a lot of things will come back on the market.”
All those quoted in this article appeared on stage at the International Hospitality Investment Forum held in Berlin between May 15 and 17, in a session called: Distress Call: What Are the Options for Opportunistic Investors?