Lots of family offices are drawn to hospitality through experience.
They know what good quality is. They know who the good operators are. They know the pitfalls of good and bad service. They know which bits of the market they find attractive, which bits they find too risky. It makes it a bit easier, or more intuitive at least, than investing in logistics facilities let to Amazon.
They know what good quality is. They know who the good operators are. They know the pitfalls of good and bad service. They know which bits of the market they find attractive, which bits they find too risky. It makes it a bit easier, or more intuitive at least, than investing in logistics facilities let to Amazon.
You can see this particularly in smaller, European family offices who might own the best hotel in that region, not out of vanity, not just out of wanting to own something where they’re from, but because they really know it, can test it, experience it and help fix it if it’s going wrong.
One of the reasons hotels are different from the more traditional asset classes is that there are more stakeholders and more ways of making the transactions interesting. You’ve got operators, managers, franchisees and franchisors, and if you’re in partnership with people who are good — and where interests are aligned — those extra slices can create more opportunity, more cash flow and more yield.
It can mean more complexity, of course, and more cost, but this is what makes hotels a specialist asset class.
There is risk, of course. It is a daily trading business with brand and reputational risk, but if you’re comfortable with that, then the yield can and should be significantly higher than leasing.
In our operating model for Resident Hotels, we have been able to remove one key risk: food-and-beverage operations. These are difficult, volatile and harder to convert revenue from very efficiently. We have instead created a model loved by guests that is rooms-led, converts revenue to earnings before interest, taxes, depreciation and amortization very well indeed.
A combination of real estate fundamentals, best-in-class locations and measured operational risk is a neat combination for an increased return.
Then, if you’re comfortable with the operational risks, there's a whole other piece around brand value. For a family office to have direct access to brand value can be difficult, but if you’re happy to take the risk and create something yourself, then you are adding to your real estate value, to your investment. It layers up in quite an interesting way and is one of the reasons we concentrate so much on guest feedback through things such as Tripadvisor and net promoter scores.
One could choose to be very conservative on the investment side, but very dynamic operationally, and the two can be a great combination. Family offices are probably more dynamic in partnership, more conviction-led and more trusting than more short-term or, let’s say, typical fund investors. It’s more about preservation of capital, long-term growth and sticking with trusted partners.
All family offices have their own version of risk, and our limit is to have approximately 30% of the family corporate’s net asset value in hotels, but pre-COVID-19 they contributed 45% of the annual dividend because of the operational cash flows being so strong in combination with our value add and development risk on the real estate side.
One of the key risks that you can eliminate when taking more operational risk is over-gearing in the real estate.
Typically, our office assets are geared at about 50% of value, but the hotels are 40%, because there is more volatility in the cash flow, that is, it is more seasonal.
COVID-19 illustrated how binary that operational risk can be. Our office tenants continued to pay their rent during the pandemic, even though they couldn’t go to the office. Hotel guests don’t pay for hotel rooms when they’re not going to the hotel rooms.
I would imagine that family offices on the whole would use less leverage in hotel investing because of that volatility, less predictable cash flows and a historically softer yield on operational assets.
If you own a seasonal hotel in the south of France, where there’s no cash flow in December, January and February, you have to manage your debt service. But risks, when well-managed, do enhance returns, which is why people take them and not just for fun.
A perhaps overlooked consideration of being a hotel investor with operational risk is that typical hotel operational structures are better at regularly reinvesting in capital expenditures than the office sector. With hotel ownership, there are inbuilt FF&E (furniture, fixtures and equipment) reserve models, which people are very used to, so you are less likely to be exposed to a cliff edge of having to spend lots of money on the asset all at once or stuck in a debate with a departing tenant about dilapidations.
That is important when an asset is a long-term hold, as there is less likely to be an interruption in the cash flow to refurbish or because a tenant leaves an office building, creating a CapEx requirement and a lease, cash-flow void.
Typically, hotels can be seen as quasi-inflation-proof.
If you lease an office building, the rent doesn't change for five or 10 years. Whereas with hotels, it’s daily trading. And if market rates go up, you get daily access to those rises, too. Of course, this applies on the cost side, too, and costs have been a pressing issue in the sector of late.
There has been increasing amounts of insurance money going into hotels, and insurance companies share many traits with family offices, which aim to throw out a regular dividend for their shareholders.
Insurance companies have actuarially assessed liabilities that they need to match with income, again, being inflation-proof, so we are not surprised by this trend.
Looking at the market over the next couple of years, my sense is that there won’t be a huge wave of failures and sales like there were in 2009.
There will instead be more recapitalizations through partnerships. There is a lot of money waiting to be deployed, and that money has to go somewhere. I think family offices are really good at these partnerships, probably better than private equity, because private equity can mean aggressive short-termism, and even if that’s not the case, then that is the perception.
Family offices tend to be good partners. They’re more patient and understanding. While they’re not commercially naïve, they are interested in the relationship lasting a long time rather than making a quick trade.
Softening yields, rising interest rates, increased operating costs will likely mean troubled capital stacks and the necessity for some to de-leverage, and that will mean an opportunity for partnerships to be formed where an outright sale does not appeal.
One of the reasons hotels are different from the more traditional asset classes is that there are more stakeholders and more ways of making the transactions interesting. You’ve got operators, managers, franchisees and franchisors, and if you’re in partnership with people who are good — and where interests are aligned — those extra slices can create more opportunity, more cash flow and more yield.
It can mean more complexity, of course, and more cost, but this is what makes hotels a specialist asset class.
There is risk, of course. It is a daily trading business with brand and reputational risk, but if you’re comfortable with that, then the yield can and should be significantly higher than leasing.
In our operating model for Resident Hotels, we have been able to remove one key risk: food-and-beverage operations. These are difficult, volatile and harder to convert revenue from very efficiently. We have instead created a model loved by guests that is rooms-led, converts revenue to earnings before interest, taxes, depreciation and amortization very well indeed.
A combination of real estate fundamentals, best-in-class locations and measured operational risk is a neat combination for an increased return.
Then, if you’re comfortable with the operational risks, there's a whole other piece around brand value. For a family office to have direct access to brand value can be difficult, but if you’re happy to take the risk and create something yourself, then you are adding to your real estate value, to your investment. It layers up in quite an interesting way and is one of the reasons we concentrate so much on guest feedback through things such as Tripadvisor and net promoter scores.
One could choose to be very conservative on the investment side, but very dynamic operationally, and the two can be a great combination. Family offices are probably more dynamic in partnership, more conviction-led and more trusting than more short-term or, let’s say, typical fund investors. It’s more about preservation of capital, long-term growth and sticking with trusted partners.
All family offices have their own version of risk, and our limit is to have approximately 30% of the family corporate’s net asset value in hotels, but pre-COVID-19 they contributed 45% of the annual dividend because of the operational cash flows being so strong in combination with our value add and development risk on the real estate side.
One of the key risks that you can eliminate when taking more operational risk is over-gearing in the real estate.
Typically, our office assets are geared at about 50% of value, but the hotels are 40%, because there is more volatility in the cash flow, that is, it is more seasonal.
COVID-19 illustrated how binary that operational risk can be. Our office tenants continued to pay their rent during the pandemic, even though they couldn’t go to the office. Hotel guests don’t pay for hotel rooms when they’re not going to the hotel rooms.
I would imagine that family offices on the whole would use less leverage in hotel investing because of that volatility, less predictable cash flows and a historically softer yield on operational assets.
If you own a seasonal hotel in the south of France, where there’s no cash flow in December, January and February, you have to manage your debt service. But risks, when well-managed, do enhance returns, which is why people take them and not just for fun.
A perhaps overlooked consideration of being a hotel investor with operational risk is that typical hotel operational structures are better at regularly reinvesting in capital expenditures than the office sector. With hotel ownership, there are inbuilt FF&E (furniture, fixtures and equipment) reserve models, which people are very used to, so you are less likely to be exposed to a cliff edge of having to spend lots of money on the asset all at once or stuck in a debate with a departing tenant about dilapidations.
That is important when an asset is a long-term hold, as there is less likely to be an interruption in the cash flow to refurbish or because a tenant leaves an office building, creating a CapEx requirement and a lease, cash-flow void.
Typically, hotels can be seen as quasi-inflation-proof.
If you lease an office building, the rent doesn't change for five or 10 years. Whereas with hotels, it’s daily trading. And if market rates go up, you get daily access to those rises, too. Of course, this applies on the cost side, too, and costs have been a pressing issue in the sector of late.
There has been increasing amounts of insurance money going into hotels, and insurance companies share many traits with family offices, which aim to throw out a regular dividend for their shareholders.
Insurance companies have actuarially assessed liabilities that they need to match with income, again, being inflation-proof, so we are not surprised by this trend.
Looking at the market over the next couple of years, my sense is that there won’t be a huge wave of failures and sales like there were in 2009.
There will instead be more recapitalizations through partnerships. There is a lot of money waiting to be deployed, and that money has to go somewhere. I think family offices are really good at these partnerships, probably better than private equity, because private equity can mean aggressive short-termism, and even if that’s not the case, then that is the perception.
Family offices tend to be good partners. They’re more patient and understanding. While they’re not commercially naïve, they are interested in the relationship lasting a long time rather than making a quick trade.
Softening yields, rising interest rates, increased operating costs will likely mean troubled capital stacks and the necessity for some to de-leverage, and that will mean an opportunity for partnerships to be formed where an outright sale does not appeal.