Newsletter Q2 2018
Hotel real estate in Europe
A popular alternative
Traditionally, investors have perceived hotel real estate as an alternative asset class. But of all the different alternative assets, hotels are among the most popular. In a recent PWC poll, the share of investors interested in hotel real estate reached 28%. The investment volume in hotels and the share taken by hotels in the total volume of real estate investment has significantly increased in recent years.
Investment geography – focus on Britain, Spain and Germany
In 2017 three countries - Britain, Spain and Germany - accounted for almost two-thirds of the total volume of hotel real estate investment. This distribution depends on numerous factors – changing asset prices, market size, real estate quality, legislation, regulation, etc.
High yield, low risk
Yields on hotel assets remain higher than those on office and retail real estate. Often the valuation of such assets is performed simply by adding a premium of 1-2% to the capitalisation rate for offices. At the same time, only business tourism can be directly connected to the dynamics of the office market. And business tourism as a percentage of general tourist traffic does not exceed 50% for most major centres, and averages around 25% in Europe. The actual cost of hotels in recent years has fluctuated significantly less than the cost of traditional classes of real estate. This leads to an atypical risk-return relationship.
For comparison, in the US market the same asset classes demonstrate quite a classical risk-return relationship:
Customer diversification – the key to industry stability
The main reason for the hotel real estate stability is the significant geographical diversification of tourist traffic. Hotel guests, on average, have fewer connections to the local economy than tenants of offices and retail spaces.
It should also be noted that tourist flow from China, although it has more than doubled since 2011, constitutes only around 2% of the total tourist flow in Europe. Whereas Chinese tourists account for over 10% of the total international tourist flow.
The role of specialised funds in hotel real estate
Specialised funds have always played an important role in the real estate market. They account for a smaller proportion of transactions, but since they have greater expertise they affect the prices of more complex assets and overall market efficiency. This is especially important for hotel assets as the product’s complexity, combining several diverse units (the hotel itself, restaurants, spa, conference rooms), meets increasingly complex relationships with operators offering various hotel formats and choices of contract (management contract, leasing, hybrid leasing) each with numerous options. Currently, the number of funds specialising in hotel real estate in Europe is much lower than in other classes of real estate and other regions. This may be one of the reasons for the pattern of risks and returns that we have observed.
The impact of the internet and the joint consumption economy
Traditional classes of commercial real estate are facing changes as the lifestyle of consumers changes. For example, online shopping has had a significant impact on retail real estate and more people working from home has affected office real estate. For the hotel market, greater flexibility in customers’ work schedules is more likely to have a positive impact. However, a potentially negative impact can be seen from the rapid development of the Airbnb business platform. But an analysis of the current situation shows that alternative accommodation can only take 10% of the market, and no more than 50% of all alternative accommodation can put up direct competition to the services that hotels offer. In addition, the hotel market is expanding and beginning to compete with Airbnb, as it brings high-quality hostel networks (such as Meininger and Generator) to the market. And Airbnb itself has started cooperating with developers and operators, potentially giving real estate investors direct access to the alternative accommodation market.
Expectations – rising rates
Over the last few years, the potential risk of money market rate increases and the accompanying growth in capitalisation rates has become a concern for investors in European real estate. Accordingly, investors have begun to shift the focus of their investments towards high-yielding strategies. Such strategies require greater expertise, which will in return lead to increased investment in specialised real estate funds.