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Uncovering value at the top of the real estate cycle: European owner-operated hotels
While yields have compressed in the wider hotel market, the European owner-operator segment still offers considerable value, not least because of this area’s attractive yield premium.
Total returns in the UK and European commercial real estate markets are expected to weaken over the next five years but there are segments that remain underappreciated. These offer attractive risk-adjusted returns today, the potential for future yield compression and diversification benefits.
We believe one such area of the market to be owner-operated hotels in Europe. This sector is supported by rising demand, driven by increasing levels of business and tourist travel as a result of the mounting desire for "experience-focused" consumption, particularly from the Asian middle-classes. There is also a lack of supply, as cities impose restrictions on new hotel development or existing hotels are converted into higher-returning office or residential uses.
The investment case for owner-operated hotels in Europe
The owner-operated segment of the European hotel industry currently works on hotel management agreements (HMAs) and/or franchise agreements (FAs). Under such agreements hotel owners pay the brand a slice of gross revenue in return for the use of the brand and its marketing and reservation system. The hotel owner has full exposure to the upside and downside, and owns not just the real estate but the underlying operating business and the staff.
This is in contrast to the leasing model whereby big brands lease their property from asset owners, but retain full exposure to operations and staff, while the asset owner simply receives a largely fixed rental payment and no exposure to the operational performance.
Structural changes in demand
Spending on tourism is forecast to accelerate over the next decade, driven by a number of factors. Arguably the most important of these is the strong growth of the so-called “experience” economy (people are spending more on experiences and services than material possessions) and the rising appetite for international travel among China’s rapidly expanding middle class. Among affluent Chinese, continental Europe is regarded as a prestigious destination thanks to its diversity, history, cultural heritage and well-developed consumer markets.
While Europe may represent 29% of the current global supply of hotel rooms, its development pipeline is just 17% of the global industry total. The major reasons for slow growth in Europe’s supply of hotel rooms include the significant barriers to entry to many important markets, with suitable development sites in very short supply. Furthermore, higher rental values can typically be achieved from other uses, such as office space or residential, which limits the potential to convert existing buildings into hotels.
Consequent supply and demand imbalance
Rising demand together with limited supply has meant occupancy rates are on a strongly upward trend in Europe. These positive demand/supply dynamics are also fuelling robust growth in the sector’s key performance metric – revenue per available room (RevPAR) – and naturally underpin the long-term investment case for this asset class. Furthermore, the emergence of large online travel agents such as Expedia and Priceline has provided an additional channel for hotels to increase their occupancy rates.
Attractive yield premium
While yields in the wider hotel sector have compressed, we believe that in the owner-operator hotel segment, there is still considerable value to be generated given the yield premium relative to similarly-located office assets of 50–250 basis points (bps) across Europe.
Opportunity in owner-operated vs. leased
We see limited additional value in the leased hotel model, not least because an investor in a leased hotel is still exposed to the downside in terms of the capital value of the hotel, but gets no benefit from the upside. In Europe we see the best risk-adjusted value in the owner-operator segment where not only is there the opportunity to capture upside value from rigorous asset management, but the yield premium available is 100–150bps on average across major European cities compared with fixed leased ownership.
Understanding and accessing the sector
The owner-operated hotel model has proven challenging for many investors, including traditional real estate investors. We believe specialist skills and experience are required to identify and underwrite investment opportunities at the right price. In addition, in-depth asset management knowledge is required to inject and manage capital investment in the right areas of the hotel as well as to manage the in-house hotel staff, in order to implement the right strategy to not only boost revenue but also generate sustainable profits.
To read our full paper on European owner-operated hotels, please click on the PDF below.
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Uncovering value at the top of the real estate cycle - Part 1: Owner-operated hotels in Europe 10 pages | 926 kbDescargar