Compared to the gradual recovery we are seeing in other sectors, there is still only modest mid-market hotel transactional activity. With a range of challenges converging – from a difficult lending environment to a squeeze in occupational demand and operational costs – are we likely to see a recovery any time soon?
Macro-economic climate is stabilising slowly but (when you exclude migrant occupancy) is still trying to recover across the sector
Statistics in London suggest occupancy rates are returning to pre-pandemic levels but figures across the board – particularly considering that an estimated 5% of UK hotel beds are currently servicing government migrant contracts – are not so positive.
A temporary boost afforded by a boom in UK ‘staycations’ has dwindled as international tourism returned and the cost of living pressure has made ad hoc luxuries, such as city stays, less prevalent. For hotels more reliant on business travel, changes in working behaviour have also impacted. We are not yet seeing industry conferences and awards return at the same scale as businesses focus on getting people back into the office and cost-saving, albeit this year has started to see some movement in this area.
In a challenging contrast to stilted occupational demand, operational costs have grown rapidly. The same cost of living pressures chipping away at guests are equally affecting the costs of running hotels and restaurants with wage, energy, food and general capital expenditure demands all up substantially from five years ago.
These factors have an inevitable impact on hotel lending – both in terms of actual yield and the lender’s perception of value within a deal.
There are, of course, some exceptions to the inactivity. There are always a few large deals at the top and bottom of the market that buck the trend. For instance, bridging lenders work on volume models with an expectation of certain default levels, making a profit through the majority of their deals which perform. For the mid-market however, we are continuing to see reduced levels of deals particularly in terms of acquisitions.
The biggest lending cost determiner continues to be high interest rates
With yield shift, properties are worth less than they were five years ago. For owners with higher equity stakes or cash to inject and the authority to do so, this may pose a (hopefully) temporary glitch. In real terms for the raft of 2019/2020 deals approaching re-financing in 2025 (Christies estimate this figure to represent £43bn, referenced here), many borrowers face a double funding conundrum: the prospect of being able to raise less debt against their asset whilst also being able to borrow less to satisfy the interest cover requirements of lenders.
Are we about to see a mass sell off as we approach a re-financing ‘cliff’?
Well… probably not. We have yet to see a volume of forced hotel sales through insolvency. The last thing a lender wants to do is enforce – especially if it is clear that the borrower is doing everything they can to make an asset perform. Higher interest rates mean that borrowers are presently finding themselves over-leveraged against the income their asset is producing. This does not necessarily mean they are doing a bad job. From a lender’s perspective, could someone else do better? If the answer is no the majority of lenders are standing by their borrowers albeit potentially with increased pressure on borrowers to pay off sums early, particularly where they may have been minor defaults and where lenders who made loans before the spike in interest rates are nervous about the refinance risk.
When will we see activity – an unstoppable need to deploy versus an immoveable market?
An aggravating factor for transactional volumes is that many decision makers in the market have not seen lending costs this high before. From 2008 to 2022 we have seen sub-1% base rates and for many now in charge of deploying capital, this period will represent the majority if not all of their career to date. It is unlikely that we are going to see any quick return to far lower borrowing costs or a hospitality boom.
A buoyant market is ideal for activity, and even a bad market will have some movement but what is worse all round is uncertainty. With the markets pricing in interest rate drops by the end of the year and inflation moving slowly in the right direction, we might hope that we are starting to see light at the end of the tunnel in this regard. What impact a Labour government has in particular given the noise around a hole in government finances and the related risk of tax rises remains to be seen.
However what is more likely to change before current market conditions is attitude. Borrowers will reconcile with the reality that they can borrow less and it will cost more meaning a less profitable deal than 2019, is still better than no deal at all. Investors will get more adept at structuring transactions in a profitable way, whether via alternatives in the capital stack or stumping up more equity.
In the last couple of years we might perceive an attitude of ‘if we do a deal and get it wrong, it may cost us our jobs so it would be better to do nothing’. With increasing pressure to deploy cash, we are likely to be approaching a time where doing nothing is viewed as the riskier option.