BERLIN — Core real estate investors in Europe who acquire hotels with lower risk, exercise less leverage and rely more on stable revenue streams from mature assets are not currently having things their way.
“You have to believe in [net operating income] growth to succeed,” said David Kellett, managing director and head of alternative investments in Europe at Invesco Real Estate.
“We need to see and touch the hotel and then underwrite strong NOI growth,” he said.
On a panel at the International Hospitality Investment Forum, Kellett said, “the real answer is that it is very challenging.”
“Hybrid leases with some form of fixed component? That might work well for core investors in this period of inflationary pressure, but in the wider market, no, it is not a good time, even if hotels are a good hedge against inflation,” he said.
Andreas Löcher, head of department and investment management at Union Investment, said core investment in hotels requires a bridging of the buyer-seller divide.
“We’d like to increase liquidity in our funds, and there are investment opportunities in other sectors outside of real estate, such as infrastructure. The demand for end investors is for higher yields,” he said. “By the end of the year, if interest rates settle, more transactions could continue. We are investing in hotels but at a lower rate.”
Philippe Rossini, deputy manager of hospitality at Swiss Life Asset Management, said his firm is in the same boat.
“We cannot buy at the same rates we used to. There are limits, and we have lowered our expectations. Higher interest rates do not make sense for [core investors], and [those rates] will stay — well, at least higher than 0%,” he said.
Kellett said for core investors, the spectrum of investment is currently narrower and the deal structure more important, with necessary stipulations including having the right partner and brand.
“Third-party operators do not make sense. There needs to be a closer relationship between lender and client,” he said.
Cost Considerations
Löcher said another increasing cost to be considered by core investors is environmental, social and governance.
Onerous costs result in any hotel becoming less attractive and less of a core asset, more of a value-added one, he said.
He said his fund managers now first ask questions about ESG, whereas perhaps the first question should be on pricing.
“ESG is a moving target, and it is not always so clear. Now, it feels there is a separate market between those that are ESG-compliant and those that are not,” he said.
Kellett said the biggest change he has seen in his career from the core investor side is the need to make sure hotels are future-proof.
“You must look at the data as to what is happening in the building and price the CapEx properly. Don’t just say, 'Oh, we’ll make it work later.' For many, ESG is the story. They know that is what the sale is,” he said. “Even for core money, you have to show the return and the story.”
Rossini said because of changes such as this, sharing risk is higher up the agenda.
“Core investments need to be protected on the inflationary side,” he said, adding many core investors simply are waiting things out.
“Some [investors] might just drop out, buy bonds and reenter when they feel more secure. It is about the risk profile, the need for liquidity and the flexibility of the investor,” he added.
Löcher said rising costs also play a role.
“We’re calling for higher rental levels, as we want yield, what with all the costs going up,” Löcher said. “Yields have shifted 100 to 150 basis points, although it depends on each micro-location. If 100% of the hotel is pure core, you might get a better price.”
Innovative, creative joint ventures can be one way core investors are tempted into acquisitions, Kellett said.
“Just because it is core does not mean it is boring, but sometimes it is just the right time to sell, and that is difficult if you bought for the long term,” he said.
Core in Store
The panelists said there are core-investment hotels out there that are attractive.
Kellett said the industry should expect a lot more of these deals to be off-market.
“Selling good hotels because it makes sense just for the seller will not make those hotels core ones. I see brokers at one level, and the buyers at a completely different one,” he said.
Rossini said the hotel industry also remains attractive as it has once again proved it can get through a crisis.
“We’ll see a merging of asset classes moving forwards, and there is great learning to be had from all these parts that will lead to better investment decisions,” Kellett said. “But assets that are truly core are shrinking in number.”
Kellett once again returned to the subject of yield.
“It has to be higher, an income-return play and a shorter-hold,” he said.
Rossini said when the next refinance season starts, hotels will hit the transactions market.
Kellett warned that if everyone comes in at the same time to rebalance the market, there will be a crash.