Hotel executives in the United Kingdom and Europe are seeking solutions in a challenging environment for financing acquisitions.
Much of the conflict in the hotel industry transactions market is centered around a lack of distress, which discounts pricing and narrows the contentious bid-ask gap between sellers and buyers.
Distressed pricing hasn't been a consistent part of hotel acquisitions unless the hotels at play showed signs of stress before the onset of the pandemic, according to panelists who participated in a hospitality financing webinar hosted by HVS, Bird & Bird, AlixPartners and EP Business in Hospitality.
Due diligence in hotel negotiations is key. Scott Wolfe, director of investments at Pro-invest Group, said deals come down to the quality of the asset, and if there's goodwill on both sides, it moves ahead to finding a solution to the financing.
Why Underperforming Hotels Are Attractive
Distress is often a result of hotel owners being unable to service debt on a property. But another reason for discounted pricing in hotels put on the market is that the assets are underperforming.
Neil Kirk, chief operating officer at London & Regional Hotels, said even underperforming assets can be attractive, and solutions for them come down to proportioning returns across the capital stack.
“We think long-term,” he said, noting discipline in underwriting and operational diligence is essential.
“If we get that right, we can get underperforming assets to work, but that might work against firms such as ours that look for long-term holds,” he added.
David Fattal, founder and chairman of Israel-based Fattal Hotels, said his firm bought some hotels that were deemed distressed but had no success with them.
“We are looking for underperforming assets and adding our operational knowledge, which will bring us the value. Usually there is a reason for distress. That could be bad management, but most usually is it just a bad asset,” he said.
Ramsey Mankarious, founder and CEO of Cedar Capital Partners, said buying underperforming hotels only works in the long run if the buyer is willing to invest to make them better.
“We buy underperforming hotels and then add [capital expenditure investments], so it has always been about cash flow. Getting the numbers right becomes a bigger issue when you are selling,” he said. “Lenders are looking at the market in different ways. Not everyone has the same concerns and worries.”
He added that hotel acquisitions and financing are under normal cyclical pressures.
“Last year was our busiest ever. We bought good assets, and they were done with preferred equity. Yes, further down the food chain, maybe there will be more distress if that is the asset you are looking for,” he said. “Reality has settled in that the world has changed and if you wish to sell, you have to have a lower price, but that is not exactly distress.”
Mankarious said there's pressure from interest rates in the U.K., which are higher than the interest rates in mainland Europe.
Fattal is hopeful interest rates will begin to fall soon.
“Sixty-seven percent of our loans were fixed when interest rates were low, and we are now enjoying [the benefits]. Going forwards, we will not fix, as we believe [interest rates] will fall,” he said.
What kind of financing structure is best? Wolfe suggested adding stretch-senior capital, a type of debt that provides higher loan-to-cost and/or loan-to-value percentages to deals. Meanwhile, Louise Gillon, head of hotel finance at bank Leumi U.K., said placing mezzanine debt on top of a deal can often be a challenge.
Cost Control
Rising labor costs are edging out financing concerns, Wolfe said.
“There is to be another minimum wage increase in the U.K. in April, and supply (competition) is coming back a little, too. The one gracing factor around supply is that construction costs are making them more expensive, especially new builds,” he said.
Kirk said disciplined management is required to negotiate the lag between when inflation increases and additional costs hit the hotel industry.
“You have to drive operational returns as cap-rate suppression will not help you,” Kirk said.
He added the industry is becoming ambivalent toward revaluations.
“It is all about [debt] serviceability now. Bankers will be more concerned about coverage than loan to value, which will change dramatically over the term of our ownership,” Kirk said. “Where do the banks see their hedging requirements? If interest rates fall but you’ve locked one in, then you can get in trouble, too, or at least not enjoy the upside.”
Katie Morton-Lee, head of hotels at bank NatWest, said debt can make a hotel more transparent but will not affect the hotel unless it's close to a refinancing period.
Additional triggers are in place to alert lenders to underperforming assets and concerns over debt serviceability, Gillon said.
“Regional hotels have suffered because cost increases have hit the bottom line and their demand is due to discretionary income. That has not affected London as much,” Gillon said.
She added that every party needs to be comfortable with an asset’s debt scenario.
Another positive is that hotel demand is still outweighing supply, Fattal said.
“This year will be a good year. We see lots of transactions, but it is about the quality. Lenders have more appetite, so these two things will bring more deals,” he said.