European hoteliers looking to acquire hotel assets, distressed or otherwise, are largely still waiting to act.
Acquisitions must mirror company strategy, and even while hoteliers speak of having a long-term view of the hotel industry, geopolitical and macroeconomic events produce enough turmoil in the short- to mid-term environment to rattle even the calmest minds.
Real estate transactions are on the rise, but that might be due to the inevitable uptick after the ending of the pandemic and because a wall of capital still exists.
At a webinar hosted by business advisory HVS, Chris Sheppardson, managing director of EP Business in Hospitality, said transactions in Europe do “seem to be on the rise, with more private investors entering the market.”
Private equity is not the most active player in hotel transactions as such investors are hindered by their shorter hold strategies. Meanwhile, high-net-worth individuals and sovereign wealth companies are being more robust with their acquisitions. Investors continue to favor deals involving Europe's luxury hotels, as they have in most markets globally.
“There will be 1,900 more luxury rooms in London by 2025. However difficult it is, there is optimism and encouragement,” Sheppardson said.
Sabina Wyss di Corrado, vice president of development for Europe, Middle East and Africa at Aimbridge Hospitality, said everyone is aware of the “opportunity to take over hotels that suffered in the pandemic, those who need the [capital expenditure] for a brand to come in.”
She said hotel companies and brands that have a solid relationship with banks are at an advantage.
“We see an opportunity to secure more upmarket hotels in our portfolio, as well as the midscale properties we are known for. It is all about maintaining high standards in whatever segment your hotel is in,” she said.
It's also important for investors to make decisions quickly, Wyss di Corrado said.
“We can transition a hotel in a few weeks. That requires regional teams, not just everything going via Texas,” she said, referring to Aimbridge’s headquarters in Arlington, Texas.
Acquisitions must mirror company strategy, and even while hoteliers speak of having a long-term view of the hotel industry, geopolitical and macroeconomic events produce enough turmoil in the short- to mid-term environment to rattle even the calmest minds.
Real estate transactions are on the rise, but that might be due to the inevitable uptick after the ending of the pandemic and because a wall of capital still exists.
At a webinar hosted by business advisory HVS, Chris Sheppardson, managing director of EP Business in Hospitality, said transactions in Europe do “seem to be on the rise, with more private investors entering the market.”
Private equity is not the most active player in hotel transactions as such investors are hindered by their shorter hold strategies. Meanwhile, high-net-worth individuals and sovereign wealth companies are being more robust with their acquisitions. Investors continue to favor deals involving Europe's luxury hotels, as they have in most markets globally.
“There will be 1,900 more luxury rooms in London by 2025. However difficult it is, there is optimism and encouragement,” Sheppardson said.
Sabina Wyss di Corrado, vice president of development for Europe, Middle East and Africa at Aimbridge Hospitality, said everyone is aware of the “opportunity to take over hotels that suffered in the pandemic, those who need the [capital expenditure] for a brand to come in.”
She said hotel companies and brands that have a solid relationship with banks are at an advantage.
“We see an opportunity to secure more upmarket hotels in our portfolio, as well as the midscale properties we are known for. It is all about maintaining high standards in whatever segment your hotel is in,” she said.
It's also important for investors to make decisions quickly, Wyss di Corrado said.
“We can transition a hotel in a few weeks. That requires regional teams, not just everything going via Texas,” she said, referring to Aimbridge’s headquarters in Arlington, Texas.
Key Changes
The requirement for transactions to show creativity in finance, development and operations has changed some aspects of European hotel business models, said Chris Martin, senior director of HVS Hodges Ward Elliot.
“Hybrid lease structures are on the rise. Leases remain a European thing, but fully fixed leases are becoming rarer, due to accounting requirements and balance-sheet implications,” he said. “Stock markets and investors want operators to be operators, not owners or tenants, and that puts pressure on the situation. Also, many traditional lease investors now want some of the upside.
“Turnover rents have become more common, as they do provide more upside to the owner and they reduce the balance-sheet impact and risk for tenants.”
Martin said there's additional creativity in deals that more closely align risk or add risk but come with a lower minimum rent.
He cited as an example “basically a hotel management agreement with a minimum guarantee, although legally it remains a lease and the tenant or operator employs the staff,” Martin said.
The effect of the pandemic on such arrangements cannot be underestimated. Martin said leases did not protect owners against major economic shocks such as COVID-19.
“You cannot replace a tenant. I mean, who would step in?” Martin said. “Increased security can help owners, but that is very much against the trend of capped guarantees, and this therefore negates one of the major attractions of leases, that being the acceptance of a lower return for a lower risk.”
James Fowler, senior associate at legal firm Bird & Bird, said franchise agreements “are usually very pro-franchisor.”
“Now, franchises are more common in full-service and larger hotels, where traditionally they were in limited-service and extended-stay hotels, but they are not in luxury. Another thing we see is a flip to franchise. Some brand owners are more resistant to this, but an increasing number are attracted to the flexibility of [managed and franchised hotels],” he said.
The requirement for transactions to show creativity in finance, development and operations has changed some aspects of European hotel business models, said Chris Martin, senior director of HVS Hodges Ward Elliot.
“Hybrid lease structures are on the rise. Leases remain a European thing, but fully fixed leases are becoming rarer, due to accounting requirements and balance-sheet implications,” he said. “Stock markets and investors want operators to be operators, not owners or tenants, and that puts pressure on the situation. Also, many traditional lease investors now want some of the upside.
“Turnover rents have become more common, as they do provide more upside to the owner and they reduce the balance-sheet impact and risk for tenants.”
Martin said there's additional creativity in deals that more closely align risk or add risk but come with a lower minimum rent.
He cited as an example “basically a hotel management agreement with a minimum guarantee, although legally it remains a lease and the tenant or operator employs the staff,” Martin said.
The effect of the pandemic on such arrangements cannot be underestimated. Martin said leases did not protect owners against major economic shocks such as COVID-19.
“You cannot replace a tenant. I mean, who would step in?” Martin said. “Increased security can help owners, but that is very much against the trend of capped guarantees, and this therefore negates one of the major attractions of leases, that being the acceptance of a lower return for a lower risk.”
James Fowler, senior associate at legal firm Bird & Bird, said franchise agreements “are usually very pro-franchisor.”
“Now, franchises are more common in full-service and larger hotels, where traditionally they were in limited-service and extended-stay hotels, but they are not in luxury. Another thing we see is a flip to franchise. Some brand owners are more resistant to this, but an increasing number are attracted to the flexibility of [managed and franchised hotels],” he said.
More Creativity Needed
Martin pointed to other ways of creatively negotiating key franchise terms when entering hotel management agreements, including:
Martin pointed to other ways of creatively negotiating key franchise terms when entering hotel management agreements, including:
- Less fixed, more variable agreements to stop the clock on development deadlines and tech-services fee increases;
- Owners being able to borrow from FF&E (furniture, fixtures and equipment) reserves;
- The possibility of short-term loans from operators; and
- The ability to change the business model if deemed necessary.
Third-party or white-label operators find their place in this heady mix because they can bring shorter terms, more flexible termination, lower and more incentivized fees and a stronger focus on cost control, Fowler said.
Martin said in 2008, 40% of international branded hotels in Europe were franchises, while in 2020 that percentage increased to 60%. Flipping to a franchise provides flexibility to the owner or the white-label firm.
He said such agreements can provide guarantees with annual caps and franchisors being asked to guarantee white-label leases.
Guarantees with annual caps usually cover only projected management fees, or often just incentive fees.
“Then you would also need termination protection against ‘zombie’ operators who are earning no fees,” Martin said.
In agreements in which franchisors guarantee white-label leases, branded hotel companies might be asked to provide an agreed percentage of excess operating cash, to be placed in an escrow account that will replace the franchisor guarantee over time, and which guarantees that if the white-label lease fails, the franchisor will step in as the operator.
“From the beginning, make sure the franchisor is fully on board, especially in regard to trading risk and forecasted profitability targets,” he added.
Wyss di Corrado said the new hotel transaction environment requires everyone to be more creative.
“We have a few partners that we’re looking to partner with in long-term hotel initiatives. The plan is that this might bring us a few brands that might not have been comfortable looking at a company such as ours,” she said. “Operators must work with owners to find solutions, especially when there is a need for CapEx,” she added.
Martin said in 2008, 40% of international branded hotels in Europe were franchises, while in 2020 that percentage increased to 60%. Flipping to a franchise provides flexibility to the owner or the white-label firm.
He said such agreements can provide guarantees with annual caps and franchisors being asked to guarantee white-label leases.
Guarantees with annual caps usually cover only projected management fees, or often just incentive fees.
“Then you would also need termination protection against ‘zombie’ operators who are earning no fees,” Martin said.
In agreements in which franchisors guarantee white-label leases, branded hotel companies might be asked to provide an agreed percentage of excess operating cash, to be placed in an escrow account that will replace the franchisor guarantee over time, and which guarantees that if the white-label lease fails, the franchisor will step in as the operator.
“From the beginning, make sure the franchisor is fully on board, especially in regard to trading risk and forecasted profitability targets,” he added.
Wyss di Corrado said the new hotel transaction environment requires everyone to be more creative.
“We have a few partners that we’re looking to partner with in long-term hotel initiatives. The plan is that this might bring us a few brands that might not have been comfortable looking at a company such as ours,” she said. “Operators must work with owners to find solutions, especially when there is a need for CapEx,” she added.