In Europe, the lease model is growing in popularity in Europe's hotel industry and undergoing a few structural changes.
The lease model's growing popularity in Europe comes in spite of hotel segments in other parts of the world where leases are viewed as a much more volatile income stream. One structural change to leases in Europe is that they now include clauses that help balance risk.
David Kellett, managing director and head of alternative investments for Europe at Invesco Real Estate, said his firm leans more toward the hybrid lease model, which he added is rare with branded hotel firms.
“The pandemic certainly changed how we structure leases, and hybrid leases suit the type of capital we have,” he said during a leasing, hotel management and franchising webinar hosted by HVS London. “The model comes down to the risk-reward appetite of the capital against the investment choice. We look for good real estate that people are not going to walk away from. With hybrid, you take out a little, but there is still a good percentage of guaranteed rent even if no one walks in the door.”
Kellett said Invesco has defined what he called a “sandwich lease,” a model in which a property is leased from an owner and then leased to a third party, with fewer fixed-rent deals but more variable-rent structures.
Increased costs and higher interest rates have put pressure on leases, especially those on longer terms, said Jacob Rasin, senior vice president of transactions at hotel firm Pandox.
“If you still have a fixed lease with an operator that came in with limited experience, I would be now very worried. Hopefully, out of the pandemic, they are more lean and hungry,” he said. “Variable leases are faring slightly better today and are good for both owners and operators, but both have seen increased costs. If you align the operator with many of the [hotel management agreements], as we have done today, you both have the risk.”
Philippe Bijaoui, Accor’s chief development officer for premium, midscale and economy brands in Europe and North Africa, said he is content with the lease model.
“A lot of things have changed since the pandemic, but not our business model. We are 60% leases,” he said.
Felicity Black-Roberts, vice president of acquisitions and development for Europe at Hyatt Hotels Corp., said that Hyatt was pushing hotel management agreements before the pandemic, but now franchises are increasing, especially in Western Europe.
“Hyatt historically had few franchises in this part of the world. Our first was in 2017,” she said. “That is likely to increase to 60% of our portfolio.”
Black-Roberts added Hyatt brands Andaz and Park Hyatt probably would not go the franchise route.
“We readily franchise our collection brand, and we’re comfortable with a couple of operators at Thompson, but we’ll put on the guard rails on a quarterly basis on some hotels where the operators might not have the experience but whom we believe will get there,” she said.
Bijaoui said Accor will happily franchise all its premium, midscale and economy brands.
Flexibility is key to mitigating risk in all forms of hotel operating agreements, Kellett said.
“The macro risk is much bigger now. Shorter, more flexible agreements are something I want to see and that I believe will allow a better alignment of interest,” Kellett said.
Underwriting Plus
Black-Roberts said many requests for proposals crossing her desk are for leases but that “people are keeping their options open to see where the underwriting works best.”
She said risk is starting to shift away from owners to brands, not just on commercial terms but also on commercial guarantees, “even if the brands say, look, we’re not property managers.”
She added the balance of risk needs to find its new level.
Kellett said his initial thought during the pandemic was that operating agreements would undergo a huge change, but that did not happen.
“Now it is about underwriting from the perspective of an owner, regardless of the business model. Maybe a move towards lower fixed rents. We’re seeing more protections and structures that are very well-aligned,” he said. “The focus is on profitability, not branding.”
It's possible that some luxury hotel operators are not sufficiently focused on delivering a bottom-line return on investment, Kellett added.
“Macro-level risks are now much bigger, leading to a trend in shorter, more flexible agreements,” he said.
Since the pandemic, Pandox has acquired six hotels, Rasin said.
“We did three deals where the alignment is perfect and the operator has local knowledge. Combine that with global distribution, and you have the best of all worlds,” he said.
Office Exodus
New investors, many moving their capital from other real estate classes — especially offices — are entering the hotel industry.
Rasin said that some new entrants cannot take on operational risk when structuring a lease. He added Pandox has had more competition for variable lease agreements.
“We have always loved variable leases, and we will always love them,” he said.
Two major changes are the huge increase in leisure demand and the requirements for environmental, social and governance observances in clauses.
Black-Roberts said Hyatt recently signed two management agreements containing reporting clauses on ESG, not just those reporting on financial targets.
“These are being mandated by lending organizations, but one problem is that we do not have an industry standard. We are feeling our way, and no one wants to put themselves out there. It is a very pressing issue,” she said.
She added she has also noticed a huge increase in guests booking suites, which are no longer only a loyalty prize.
Kellett said ESG had nothing to do with COVID-19, but that is the next big thing entering the contract.
“Brands really need to step up, as they are not always willing to enter the conversation. Across the board as investors, we have so much regulatory pressure, and everyone needs to be included,” he added.