Contributed by Laura Wild and Stephen Greyling, Bryan Cave Leighton Paisner LLP
This has been a mixed year for the hotels and leisure sector in the UK. The hotel sector has performed well – 2017 saw the UK reclaim its traditional number one ranking for hotel investment from Germany, and the UK has continued to benefit from a stream of foreign and domestic tourists as the weak sterling makes the UK attractive to foreign tourists and “staycations” become more typical for the British public. The hotel deal pipeline has been strong and interest in hotel investments remains undiminished. The food and beverage market tells a different tale, as restaurant chains battle to combat rising labour costs, business rates, a fall in consumer spending and a saturated market.
Total deal volume in 2017 was largely driven by several large hotel portfolio acquisitions, including Swedish hotelier Pandox’s acquisition of the Jury’s Inn portfolio (c. £800 million), real estate investment company Aprirose’s acquisition of the 26-hotel QHotels portfolio (c. £525 million) and property investor Henderson Park’s acquisition of two Hilton Metropole hotels (c. £500 million).
2018 has started in a similar vein, with Brookfield’s acquisition of the SACO serviced apartment portfolio (c. £430 million) and Starwood Capital’s acquisition of a portfolio of seven Hilton hotels from Park Hotels & Resorts (c. £135 million). At the time of writing this trend is expected to continue, with Lonestar’s final tranche of 23 Hilton and Mercure hotels and Starwood Capital’s Principal/De Vere hotel portfolio expected to come to market.
A continuing strong pipeline of portfolio deals in 2018 is expected to lead to total deal volume growth of around 22%, from £4.9 billion in 2017 to c. £6 billion in 2018. However, investors may consider the large number of portfolio exits in 2017 and 2018 as a signal that we are approaching the end of the current business cycle, meaning a potential decline in deal volumes in 2019 of around 25% (PwC UK Hotels Forecast Update 2018 and 2019).
“Alternative” no more: Hotels are outperforming the other traditional asset groups so far in 2018, beating industrial, offices and retail. This is not a short term phenomenon either – hotels have also beaten other asset classes with better average returns over the last ten years. It is therefore no coincidence that hotels are emerging as a trusted alternative asset class. Once the domain of specialist advisers, attention is now flowing from more generalist investors. Institutional investors have also shown an increased risk appetite, with some stepping in to take on operational risk by entering into hotel management contracts.
Changing investor profiles and operating structures: The shift in hotel investor profile, from the traditional private equity groups to more institutional investors, has prompted a change in preferred operating structures from owner-operated or brand management contracts, to long-term operator leasing and franchising with potentially cheaper and more flexible third party management.
Hotel leases making a comeback? The trend over the years has been for hotel operators to pursue an “asset light” model, divesting themselves of their real estate assets and replacing them with management contracts. However, that is not to say that hotel leasing is a dead operating model. Indeed, hotel leasing is experiencing newfound popularity due to the current position in the economic cycle, as they can offer investors reduced risk and long-term secure income (Five Reasons Why Developers and Owners Love Hotel Leases – Peter Szabo HVS).
Serviced apartments: Demand for serviced apartments in the UK is high (and increasing) but supply is lagging well behind other, more developed markets. With serviced apartments currently making up a small percentage of the UK’s accommodation supply, and with more than half of overseas visitors to London staying for four nights or more on average, this is likely to be an attractive asset class for investors over the next few years.
Food and beverage: The press has been filled with underperforming restaurant chains entering into company voluntary arrangements (CVAs), where restaurant operators seek to escape their unprofitable leases. Chain restaurant groups started small and have then sought backing from a venture capitalist or investor. Their aim was to build the business up in scale and then sell it but the casual dining market has underperformed, due to increasing labour costs as the UK minimum wage has gone up each year, longer-term decline in real wages leading to a reduction in consumer spending, rising prices and a crowded market. There are a few chains bucking the trend, and certain operators who know the local market continue to shine.
Food and beverage also remains a challenging revenue department for hotel operators, who have started to adopt alternative strategies to drive profitability, ranging from outsourcing to third party restaurateurs with better F&B brand recognition, to acquiring established restaurant chain operators to help attract millennials to their hotels.
Competition: The UK’s Competition and Markets Authority (CMA) has announced that it is taking enforcement action against several hotel booking sites over potential breaches of consumer protection laws. Complaints include how hotels are ranked in search results, pressure-selling tactics aimed at rushing customers into making booking decisions, artificial discounts which do not offer a fair comparison for customers, and hidden charges which are not displayed on the site when booking.
Technology: Technology remained a key theme at hotel conferences this year, with operators highlighting a need to focus on customer interaction. Operators want to interact with guests more than just a few times a year, and are acknowledging the value of building a relationship with their guests on a basis more akin to some of the tech giants like Facebook and Amazon. They also want to gather as much personal information as possible from their guests so that they can better tailor their experience at the hotel. But…
GDPR: The General Data Protection Regulation (GDPR) came into effect on 25 May 2018, requiring all organisations to review how they collect, hold and process personal information, as well as how they communicate with individuals. It has significant implications for hotel owners and operators given the amount of personal information collected through bookings and marketing activities, and given the fact that this personal information is collected not only by the hotel owner or operator but also by third party intermediaries including OTAs and franchisors/franchisees.
As with 2017, the UK hotels and leisure sector shows increasing deal volumes with strong appetite for hotel assets continuing into 2018. However, the outcome of the Brexit negotiations remains uncertain, with a “hard” or “no deal” Brexit still a possibility. Investors may view the large number of exits from the sector as a sign that the current business cycle is starting to enter its end phase. There have also been signs that an increase in hotel openings in London is leading to a fall in hotel occupancy and room rates in the capital. The future does remain uncertain and a strong 2018 may be followed by a more challenging 2019.