The Knight Frank Hotels team’s fifth annual hotel round table, in partnership with CoStar News, saw eight industry leaders discuss the important issues and challenges facing the industry today.
This is part two of a discussion that explored the operational challenges facing hotels including energy and staffing, the lending and development markets in a higher interest rate world, the attractiveness of hotels as an asset class, and predictions for the sector this year. For part one click here.
Attendees:
- Karen Callahan, head of hotel valuations, Knight Frank
- Neil Forbes, head of hotels, Fairview Hotels
- David Anderson, divisional president, Aimbridge Hospitality EMEA
- Adela Cristea, vice-president, UK and Ireland, Radisson
- Shaun Roy, head of hotels and specialist property investment, Knight Frank
- Hilton Foster, head of debt UK and Ireland, HB Titan
Chair:
Paul Norman, managing editor, Europe, CoStar News
PN: Is there anything that's really impressed you at the moment, that innovation-wise, that you think, wow, that's going to move the dial. Just before we move on to other questions.
DA: I think there are individuals who have been backed by private equity to drive a whole process of finding a hotel, checking into a hotel, living in a hotel, getting food and beverage in a hotel without human interaction. Right. I think that's the end of the spectrum. We'll never get that way, but it's showing how far we can go and the remit there was how we can do that in order to manage margins going forward. But that was backed specifically by private equity to find a new way which will be interesting.
I was in Vegas in July for our global conference and outside the airport was a driverless car that took you to the airport. You'd see this thing with a big glass door on the roof taking people off to the airport. It's pretty scary.
PN: So where is best value to be found at the moment in the sector?
HF: It's a good question. From a lender's perspective, I think we're quite fortunate because if you lend enough money over a long enough period of time, what you end up doing is encountering many different businesses and many different owners and the reason I've stayed in hospitality financing for 10 years is I really enjoy it. I like the people, I like the assets. But every hotel owner will tell you that their hotel is the best, that they get the biggest profit lines, that they maximise their revenue, they all say the same thing and I understand that they're part of their products. But the nice thing as a banker, what you get is a proper cross section of what is working and what isn't working. And the numbers really don't tell a lie. And ultimately everything you've discussed from an ownership brand perspective is to do one thing, create a sustainable cash flow that's maximising the asset. Like everything is ultimately to that point. And one of the things that I've probably noticed a bit more is in the last two years, maybe it's a post-COVID thing, is maximising the revenue and ultimately profit per square foot of that venture. And that's to a degree driven smaller rooms, reduced facilities.
So, it's a rooms-based business, and it is your best business to maximise your profit for the square footage that you have. And to a degree your question is what presents best value? It depends who you're asking because if you ask a banker what presents best value, it's well what gets me my most amount of profit per square foot? I would say because that's servicing my debt. From a guest point of view I suppose the answer will be slightly different because it depends what that guest is looking for. But for me the key word there is value. Because regardless of what your angle is, if you are getting good value, I think if a guest is getting good value they will talk about that and they will come back. If you're financing something or you're investing in something and you're getting good value then you are happy with your investment. So everything has to be contributed to driving value and maximising value, depending on what your angle is.
And ultimately cash is the angle, right? Like, people own hotels and operate those because they love them but they are trying to build a business for the generations. You can only do that if you have a sustainable cash flow. So from a finance point of view, I always think when I meet people that are completely focused on that and they can bring the guest experience to maximise that, I feel like I've got a party that I would happily finance. And that's usually where once I don't have that, once you're talking to people and you find yourself not focused on that, there's a very good chance that a few years down the line, you're having some difficult conversations.
PN: How do you work that out then? There must be some gut instinct. You've got to go and talk to them, stay there.
HF: I suppose it’s a question of I'll speak to enough owners, owner operators, you will get a very good sense as to what the focus is and the number of hotel owners that don't have that experience, they open up a hotel in an amazing location and they literally will tell you that it is impossible to fail. And they failed. And you know, I'm going there, my money is safe. Like if I'm lending at 60% my money is safe. Is your money at risk here? But they didn't maximise the value that they could have in that location because they thought of pie in the sky, blue sky. They just missed the market.
It's hard to pinpoint exactly what goes wrong when things go wrong but the number of times they go wrong is incredible. That's probably not a very precise answer to that question of how do you know? You don't really know. You don't know what's going to happen in that first year. Sometimes it's out of anyone's control. But it's fascinating. But talking to people when you get a sense that they are completely focused on maximising the revenue and cash flow per square foot. It's then I feel like, okay, this is going to work out one way or another. It's going to be okay.
PN: Okay. That's a very individual look on an asset by asset, business by business basis, obviously, but I guess to broaden it out, where do people see particular value?
AC: I think following on from what Hilton said in terms of optimising the schemes, it's really the revenue profit per square footage that you're looking at in the end. If you want to see which segment across brands that may be translated into, I think the lifestyle segment is probably the best position. And looking at our brand, Radisson Red, which is lifestyle, is really the most in demand, most occupied.
Because it's so different, it's so quirky. The brand standards are quite flexible. And being Lifestyle, you can actually play with it. It's not really the Radisson Blu, which is standard. This is our core brand. It's been around for 60 years. It has to be this way. This is different. So you go to Glasgow, our general manager, I don't know if he has tattoos, but he's a DJ. This guy I mean, the rooftop bar at Radisson Red, Glasgow was voted top 50 in the world. We are shocked ourselves. I mean, it's nice, but, I don't know, top 50. And it's really thanks to this guy who is a DJ. So if you go there, sit there in that bar from morning till night, you're going to see the breakfast people, then coffees, then you see lunch, and then you see afternoon tea.
The ladies are having proper afternoon tea. I mean, I've not seen that in a hotel before, to be honest. So that was afternoon tea. And then comes the evening service, pizza. They have their own oven. People come from Glasgow. This is not even in the centre. And people come to pick up pizza from our hotels to go back home. I don't know. He's created something that we've not seen in other hotels. In the evening. He has famous DJs, people, they pay for tickets to go into our rooftop bar to listen to this music. And then he's created all these segments in the afternoon.
PN: This man needs a pay rise.
AC: Yeah. So this is really I mean, it's technology, but also it's really creativity, lifestyle brand. And even here, where the project we're looking at together … because we want to push F&B, it's a residential area with a lot of wealthy people, and we want them to come and eat there every day. And it doesn't have to be fancy. It could be just British eclectic, modern, a salad and a burger and some fries or something that, you know, you're in and out. And there the reception was on the ground floor, taking half of that space. I don't want to have it here. It can go to the mezzanine level because if I'm here to check in, I don't just wander around. I'm actually coming here to destination to check in. I'm going to find a reception. But if I'm here to have a coffee and I don't see you provide coffee, I'm going to go next door. So I think the F&B and what we're trying to do together actually at this project is creating this opening for the neighbours and whoever goes by and is seeing us come here to have a drink, come here to have some food. I'm going to find a reception up there with my luggage, and I'm going to find it eventually. I have to check in.
KC: It's important that F&B engages at the right level and you make sure that the product offering matches the F&B offering. I was at a hotel recently where the average room rate was at one particular price point, but the F&B pricing was targeting a much higher guest budget. If people have looked at what their budget is to stay at this particular hotel at say £100 average room rate and they go down to the restaurant and and it's £25 for a main course, you've mismatched the F&B with your guest profile within the hotel, much reducing your capture ratio. But also to your point as well, I think on that F&B, you need to be very visible to the local community, which brings in the S of the ESG Engaging with the social aspect and drawing in that local community to be a hub for the people who want to come for coffee, lunch, afternoon tea, for the people who are there during the daytime, so that you're filling that F&B outlet throughout the day and not just dependent upon the guest profile for the hotel as well.
NF: I think picking up on what Hilton said, really the first thing you've got to look at, is where is your location? So some of our hotels are secondary locations, and the food and beverage is limited purely to the people staying in the hotel. And as you rightly say, if you're paying £100 for a room, you don't want to go and spend £50 or £60 on dinner. And in some places, we look at it and we say, well, there is no external trade, the internal utilisation is going to be relatively low because you're surrounded by a plethora of restaurants where people go out. Then you have got to look at how can I get some revenue out of this space, but actually not make it cost money to operate this space.
We explored the idea of dark kitchens and letting other people do that, but we couldn't quite get comfort level with it. We are looking forward where we have a space that's not really generating income. Is there something else we can put in that? We have some hotels with bigger spaces and looking to see if we can develop partnerships with alternative use partners. But again, I am not sure this is the right time of the cycle for that. But most of our private owners are interested in the maximum return on the investment. It's a commercial investment for them and hotels at the moment give a good return. I think everybody is waiting for the bubble to burst or for administrations to start and then we may see a downturn in the property values.
SR: I would say there is value to be had from buying from the right vendor. There are all sorts of rationales to sell at the moment, be that hotels or other real estate assets, development sites, et cetera. But if you don't have to sell, you're probably not selling right now. So those that are selling have probably got a very compelling reason to do so. Equally there's a whole raft of a new profile of money that's coming into the market. Certainly the fixed-lease space is very pension fund-money, pension fund-orientated. That money no longer exists and that's being actively sucked out of the market. So what type of money replaces it? Is it private equity? Well, probably not for the fixed income side. It's probably too boring and dry. So who does go back in there? There's a lot of insurance money coming back or coming into the market in a different sort of buyout sort of profile. I think that is going to have a big impact on the market. I think that is going to definitely change the dynamics and then regular county council, local authority type pension fund.
PN: Two of the big sellers we read about are open-ended funds and local authorities. Is that going to impact the market?
SR: Yeah. It's not the local authorities, it's the occupational pension schemes. So it will be the big buyout-targeted occupational schemes that are probably in deficit for decades because of where gilt pricing has now got to that they are now in fully funded mode and they want to go through a buyout. They generally, generally have a healthy weighting towards alternatives and of that hotels will almost certainly be the largest. So we will see. But in the grand scheme of the wider hotel market it's going to be quite small but it will set the trend in terms of pricing because they will be going through buyouts and they will be selling properties where others perhaps are not.
AC: We have hotels with local authorities, we signed with Sheffield City Council and they have the best location in town, the best building in town, a listed building. They kept the facade they built from. I was actually there when there was a big hole in the ground, just this facade standing on its own and they are opening next year a beautiful 150=room Radisson Blu.
PN: This is part of the "Heart of the City" regeneration [scheme].
AC: Yes, Heart of the City. It looks beautiful. We had a call yesterday saying that this is one of the most beautiful Radisson Blus we've got. It's going to open next year. Rooftop restaurant and bar.
SR: DJ?
AC: DJ, absolutely. DJ has to go in there. And then Huddersfield, again, they own the building. Sheffield City Council may keep it or not, but Huddersfield would definitely keep it. It’s the George Hotel, built in 1850, it’s the home of Rugby League. There was a room in there rather large, which I said, oh, this is too big, can I not make three bedrooms out of it? It's a beautiful hotel, historical building by the station in Huddersfield. This building is actually going to put the town on the map again. It's going to be a Radisson Red.
We've got a similar hotel in Liverpool and we managed to put a beautiful lifestyle, rather more classy, lifestyle brand in this beautiful building in Liverpool also, at Lime Street Station, a building from 1871, that was. And built as a hotel in 1871, 300 rooms.
In Huddersfield it is owned by the council, they'll never sell it and it's going to open in 18 months time. They're now renovating it and they own it. And I'm seeing more and more, I mean, now we're looking with other local authorities to build more hotels because they've got the best locations in town, they've got so many, and they have an interest in regenerating the area. ESG is so important to them. They want to create jobs. They want to create jobs not just in the hotel, but also the supply chain.
PN: And it's that opportunity for hotels, obviously, we're seeing in the City of London now beginning to open up to hoteliers much more.
SR: The office to hotels…
PN: Office to hotels, high street, all of these different opportunities, is it continuing that? Is that a bigger and bigger factor?
AC: It seems like it, yeah. We are looking ourselves at a couple of buildings which used to be offices and now looking for hotels and also department stores, like a House of Fraser and Debenhams, a couple of them also looking to build into hotels. I think the layout of some of these department stores is not really quite suitable because you need to have an atrium, you need more daylight, but you will find a way eventually.
SR: I think there's been all sorts of funny conversions that we've seen. We've seen offices to hotels, we've seen hotels to data centre, hotels to sheds, offices to sheds. The hierarchy of capital values is changing and has changed. And when you're looking at properties, you need to be a lot more open-minded. Is that the right word? About how you perceive value or where highest use value is? It's not necessarily always residential. That always used to be the sort of rule of thumb, resi will be the highest. It's not always the case these day. Will we see more of that? Almost for certain, where local authorities will permit it. You've seen somewhere like Westminster having a big clamp down on office-to-hotel conversions, but they're going to get more and more offices that aren't viable, commercially viable, or even physically viable as offices. So what happens?
NF: Is it Westminster that's also clamping down on airbnb?
SR: Edinburgh.
NF: I thought there's one in London doing that as well?
SR: Might be. It's definitely Edinburgh. That's probably going to have a big impact on the Edinburgh market. And if you've got ownerships up there or whatever, but that will have an impact, for sure.
PN: Just on the value, just come to Karen, what exactly constitutes a distress sale? We mentioned you don't think you've seen any, and more importantly, how can you spot one in the current market? Is there a particular area you see value as well?
KC: Having seen through a few cycles, each time as we go into a period where people anticipate that there are going to be distressed sales, people later look back as the economy picks up again and we then come out the other side, the economy picks up again, and say, well, did I miss something? What happened to all these distressed sales? There was no flood of assets coming to market. But in a receivership where the distress is clear, the impact on value is very significant. And to your point, if you were on an loan to value basis, if you were at, say, 60% pre-pandemic with debt, obviously at very low cost, and then you look at where the value is with a receivership, the margin for the debt finance provider to get their money out then becomes very narrow because as soon as you put it in receivership, purchasers, obviously, are looking to capitalise on that. Therefore I think there'll still be very much a reluctance to put assets into receivership and we'll see more consensual sales. You really want to allow it to play out and I think that we won't see a flurry of blindingly obvious deals in distress.
SR: So how do you spot them?
KC: I think it's very difficult to spot. I mean, you made the point earlier, Shaun, about a lot of people have a compelling reason to sell at this point in time and I think they have compelling reasons but it's not a fire sale so it's a compelling reason but they're not going to sell at any cost. That said, there are some who will have no choice, but I don't think they're going to form the majority.
SR: A lot of those people who have taken that view have taken that view and have chased the market down so we're not necessarily selling as of October '22 and values have drifted down over the last 12 months. I think some people are actually now of the opinion “right we're probably just going to make a decision. If this is an asset we need or want to get out of, let's get on with it and execute”.
KC: But also, looking forward to the market sentiment for 2024, there's obviously a lot of speculation in terms of a change of government and that throws uncertainty into the market and investors don't like uncertainty, as a general rule. I don't think there are any radical policies that will come out of that in the immediate aftermath that might influence the real estate sector.
SR: If it is Labour.
KC: Even if it's a Labour government. But I think there'll be a period of uncertainty and people might just keep their powder dry and see what direction of travel we do actually have.
PN: Is there a sense [that] the market has already come to terms with all the different options in a General Election?
KC: I think payroll could also be a factor that probably will have the greatest impact to, say, the change of government potentially, because obviously with Labour aligned a lot with the unions, and the pushing for improved minimum salaries, where that might actually take people would have quite a significant impact on this sector.
SR: Yeah. Controversial thing to say but I sense that the American election might have a bigger impact on our economy and our industry than our own election.
HF: Just on distress, from a lender's perspective, I'll talk as if I was still at a commercial bank. So an organisation that has a banking license and therefore has regulatory requirements and reporting requirements. I would say a distress scenario is probably the worst scenario for a bank these days. Because as soon as the loan starts to head in the wrong direction, be that covenant breaches, whatever, the cost of capital that that bank has to put aside, the amount of capital that bank has to put aside, and therefore the cost starts to increase substantially. And the second thing is a distressed sale workout scenario is a long laborious process – there's no such thing as a quick distress. Having a high cost of capital for 12 months is a disastrous scenario for a lender.
I think COVID brought these things to the fore. The second thing that probably borrowers weren't aware of is, and again, it's more relevant in the world of big banks, traditional high street lenders, is the internal risk-adjusted pricing. Effectively, if you have a sophisticated model, your risk-adjusted pricing changes on a monthly basis. So if everything is going perfectly well with that loan, let’s just say that loan was at 55%, 60 [%] traditional senior debt, 55% loan to value. You might have a 30% risk weighting for that loan that would shoot to 70%. In theory, if a bank makes a loan, it's putting – rough rule of thumb – it's putting 10% of that loan aside, it has to hold the capital for 10%. If I've got a 30% risk weighting, I'm only holding 3% because my model is showing that my risk controls show that everything is fine and therefore I don't need to put 10%, I need to put 3%. If that model then changes to 100, I've got to put the full 10%. So that's the risk-adjusted pricing that banks will do. And it has a huge impact, the monthly reporting, huge impact on how much capital they put aside, therefore how much that loan is costing them. Banks probably in the last three to five years, have only really started this accurate reporting of risk-adjusted pricing. So 10 years ago, if your loan was going bad, no one came to you and said put more capital aside because no one knew. Now you have to. So because you have to, now you can see it.
PN: Does that create an opportunity for alternative lenders?
HF: I think it's probably the regulation is probably part of the rise in alternative lenders. And COVID probably brought that to the fore a lot quicker because all of the loans, their risk adjustment was quick and you couldn't deny it. If a hotel was closed, you can't sit there and go, but it's COVID, everyone understands what the problem is. You have to adjust your risk. So everyone, I think from a banking point of view did work with people. By and large, borrowers were protected, which was the right thing to do. But those banks were losing money and that probably then comes through in the fore of refinance discussions being a lot more black and white. Your facility is maturing next year and we will not be refinancing you next year.
SR: But also, what else could the banks do with the money? It was such a low interest environment that you weren't almost incentivised to call that loan in and do something about it. Whereas I feel in today's market you can make more money using money to do new deals.
HF: My last thing I would say is internally you kind of really only go to that distress scenario when your relationship breaks down. If you get the sense that your borrower is going to give you the keys back. I don't even know what that looks like. Does anyone actually walk in and give back the keys? But if the relationship is still good, I think a traditional bank and most lenders will bend over backwards, go to try and work out that situation. When it hits distress, it really means there is no relationship. And that would be the number one reason why an administrator is appointed. The other slight misconception is when you've appointed an administrator, you lose control as a bank, you don't control that process. So the number of private equity firms that call you as a bank saying do you have any loans that are in trouble because we can help you out. You can't do anything. You'd have to appoint an administrator who then is acting on behalf of the court for the benefit of the creditors. Fine. You are the main secured creditor. You're not in control of that sales process. So it's a terrible situation.
AC: You don't go bust because the business is strong anyway. Looking at mainland Europe, I'm watching Austrian news now. And then every other day I'm seeing some contractors going bankrupt. It's tough in Germany right now from what I'm seeing, but not here. Here, it’s fine.
DA: This is something which is really interesting. There's always economic cycles as we know. And we are always encouraged to be at the table when operating leases are discussed. But we will always walk away. And we see our friends take operating leases. They ride the good times, but within that 10-year cycle, there will be bad times where they need to put their hands in their pockets. And our model is that we stay away from that. And so we're not at the table on these operating lease deals. What I would say is that we did something which was quite innovative last year with Abrdn, the fund, where they had a [real estate investment trust] that they wanted to get into the hotel business because they thought it was the right sector to get into. They couldn't have exposure. So we partnered with them and they said, look, we've got a triple A location, we've got an AAA brand, and then AAA operator. So we think there's upside in this, but we would need the operating company to take the franchise rather than the owner taking the franchise. So we agreed with that brand that if we got terminated on sale, that they would be terminated too, because we didn't want to hold a franchise agreement outside of that hotel agreement.
So we would then pay ourselves, as a traditional management contract, our base fee. We would then ensure that the fixtures, furniture and equipment account would be fully allocated. We would pay our incentive fee, and whatever was left would go back to the fund. And so for them, it was their lease, their flexible lease. And for us, because of what we've just spoken about in Germany, we needed to negotiate, was if there was an economic downturn that we could terminate. And so we had a three-month termination course built into that so we can walk away. And that's created a lot of interest because it allows that type of investment fund to get into the hotel world, allows people like us who don't take operating leases because we can't consolidate on our balance sheet any risks like that. But it's found a way forward.
NF: How did you deal with the franchise agreement with that? So if you had the right to walk away, did you have a break clause in the franchise agreement?
DA: Yeah. So what we agreed with the brand was that whatever our termination terms were, they would follow suit. So that if we got terminated on sale, for example, that they would be terminated at the same time.
PN: What are you expecting to see next year?
NF: I think that we aren't going to see anything really exciting. I think it's going to be very much same as it is now. I think that the pressures will be on refinancing and getting money at a rate that owners want to pay. I don't see any reason why trade would drop significantly. I think business is the business that we get. We're fairly resilient in hotels and I've got to go back a long time to remember when it significantly dropped. Yes, there'll be a bit of pressure on rates, it depends how quickly things come back, but I think it's very much the same. If I was an owner, I'd be buying, as I think you've got to take a longer term view if you're buying a hotel. So I'm reasonably comfortable.
AC: I am optimistic. I think from a guest perspective, we've managed to get the leisure business on board. If anything good out of COVID came, it's probably the fact that you could be flexible, you could be working from somewhere else. And then people who were stuck in their homes for 18 months or so now they love to travel again, so they actually love to travel, not as much as before, but longer. And they spend more money, they really spend big money when they go because you know, life is short, I don't want to be stuck again and now is the time to go, I'm just going to live in the moment. And we've seen in our hotels, I mean, people do combine business and leisure. At times they stay for the weekend. Even our company is… actually we had a meeting in Nice and then they said, if you want to stay for the weekend, I'm giving you all staff rates, we all stayed for the weekend. And your partner comes, husband, wife, the children, they come and you stay there for a week and you spend money there. I think it's actually quite clever. And conference is coming back, meetings and events is coming back slowly, corporate is coming back. Leisure, I think, is there to stay.
So I think from a business trading perspective, it's looking good, and from a business development perspective, what I do, I already have about 10 projects that we won with the brand and they're there to be signed. So to be honest, that's really my target for the next three years. So I already have it there coming. So I think it's looking good. Despite the fact that you listen to the news, it's not really so good, but what's out there, all the bars are full, all the restaurants are full and hotels, I think it's actually quite a contradiction between what you hear and what you see.
HF: I suppose I don't have much to add in terms of what's been said already from a trading point of view. I'm not that directly involved in that. I think it will be refinancing. I don't think maybe distress, but I think refinancing will be a pressure point for businesses. But just like operations adjust to circumstances, you adjust your business to debt as well. And I think there'll be more transactions, hopefully there's more transactions in the market to just give a bit of a sense as to what the market looks like. I also hope trade doesn't drop off a cliff. There's no signs of that from all the operators and owners that I've spoken to. The demand drivers seem to be there for I think the next 12 months, it's not the operational side so much, it's the capital stack which would be a focal point.
KC: Not much to add to that but I think we'll see a lot more stability in terms of trading performance with growth rates probably trending back to the more historical typical levels that we would see on an annual basis rather than the substantial growth that we've seen particularly in ADR of late. And I think that there'll be more confidence in the sustainability of that performance, which will hopefully give more confidence to investors as to the direction of travel, of the value of the asset and obviously more confidence from the debt piece as well in that trading performance as well because I don't think we are going to see a decline in ADRs overall and therefore that will hopefully lead to more transactions in the market as people have confidence in what they're investing in.
DA: I agree with a lot of what's been said. I think if we look at trading, I think STR have forecast 1.8% growth in RevPAR next year, which is pretty pessimistic, but I think from us as an organisation we're way above that in our budgeting because to your point, I think the business mix, business group is coming back. We're seeing great [inaudible] in our business on the books going forward. We're seeing a lot more conferences coming back. They want to be together again, probably business travel. We're not forecasting an increase in that, but the leisure is here to stay. So I think trading is fine. It's how we can get inflation under control next year I think is my biggest concern where there's not the pressure on payroll that we've seen in the last 24 months and utilities, getting utilities and payroll under control to secure growth in profits going forward for us and for our own.
SR: I guess two or three sort of bulletpoint predictions: I think stabilisation in values, an increase from a low base of transactional volume predominantly driven by US private equity as UK becomes more attractive and pricing of the sector becomes more attractive. And then I think we're going to see a marked uptick in office-to-hotel conversions, mainly city centres. I think the out-of-town is going to be harder to make stack up, but I think in town, Londons and Edinburghs and Cambridges and Manchester and stuff like that, I think that is going to be a big trend. How far we would have got into that last in the next 12 months, wait and see. But it's going to be a big direction of travel.