Azora on why the sun is shining on the hospitality sector

This article is sponsored by Azora.

The hospitality sector may have experienced a rollercoaster over the past few years, upended by the pandemic and frequent lockdowns, but European travel is now back and booming. Bookings across the continent are starting to fill up, and airports are again doing a roaring trade, even ahead of the summer high season. 

Javier Arus, senior managing partner for hospitality and leisure at Spanish real estate investment manager Azora, and Cristina Garcia-Peri, senior partner and head of strategy and corporate development at the firm, discuss the key factors that are shaping the asset class. 

Leisure hospitality and tourism came under immense pressure during the pandemic. Two years on, how has the outlook for the sector changed?

Javier Arus: We have seen a huge willingness to travel since covid restrictions were lifted. Mobility has already returned to 2019 figures, and over the past six to nine months markets like the US and Asia have become more open to travel.

As a society, and especially in Europe, we feel entitled to our leisure time. Post-pandemic, travel has become a greater priority in terms of the share of disposable income allocation we are willing to spend. Covid might have been a huge challenge for hospitality, but it was not because people lost interest.

Cristina Garcia-Peri: Travel is in the DNA of Europeans. Famously, the chairman of British Airways once said after the global financial crisis that there are three things that the British people will never stop paying for: their mortgages, their mobile phone bills and their holidays. There is huge appetite for travel, especially in Europe. On average, people here receive around 40 days of holiday annually, which is a lot more than in either the US or Asia.

How is the current economic situation influencing the hospitality sector? 

JA: Even though inflationary pressures are present, the reality is that many people feel that they should treat themselves after two years of restrictions. We have seen spending increase and bookings are very strong, partly because of retained savings during the pandemic. Unemployment is also not a big factor, so people are taking the decision to travel now rather than wait. 

CGP: It is important to note that there is a big bifurcation of the market. The luxury end of the sector is performing very well and proving to be very resilient. The impact of rising interest rates and inflation on people’s income is felt much less proportionally than for the middle classes.

That is part of the reason we have not yet seen softening in hotels across Europe; simply put, the population has not yet been affected much. However, when we look at the more affordable end of the market, we expect to see some softening. Middle income earners are starting to suffer from sustained higher mortgages and rental costs.

JA: Demographics are also coming into play. If you consider how often millennials travel for leisure today compared with the previous generation, there is a stark difference. The baby boomer generation is also starting to retire with good health and disposable income and thinking more about travel. They are very comfortable with traveling across Europe or crossing the Atlantic. The health system across Europe is very good, so there is little fear.

CGP: When we look back on why hospitality potentially held less appeal for investors previously, there were historically three factors. One was the cyclicality of the sector, another the underlying operating component and the third element was that assets like resorts had no alternative use. 

Covid showed that while hotels do suffer during a recession, they also recover much faster than many other asset classes. On the operating side, investors are realising that with the right managers and vehicles it makes more sense to take up more risk. This allows you to realize greater returns.

And on the alternative use point, why would you want to turn a hotel on the beachfront in Ibiza into anything else? There is clearly strong demand and healthy tailwinds. Likewise, there are many locations in Europe where it is not possible to build new hotels. In these regions, high barriers to entry offer greater protection. 

You launched one of the largest pan-European hospitality funds during the pandemic. In retrospect, was this the right move? 

JA: We started fundraising in 2019 and raised €850 million of equity with strong support from our LPs. That has given us the opportunity to be very active in the market and over the last three years we have invested over €1.3 billion in assets across Europe. We have a strong presence in Spain, Portugal and Italy, and recently completed a transaction in Germany. 

Before the pandemic, the sector had strong momentum, and in general companies were well capitalized. They were not overly leveraged like during the global financial crisis. Then during covid, hospitality and tourism was protected, and many companies were able to access liquidity to refinance short-term maturities. We have since seen a strong recovery, and companies are performing very well.      

CGP: A lot of fund managers tried to get into the asset class after covid, but frankly this is an asset class that is very specialist. You are not looking at traditional real estate locations or investing in London, Berlin, Madrid or Barcelona. There is a strong operating component, so it is not easy to opportunistically jump into the asset class. You need to know what you are doing and have expertise. 

We are also now thinking about our next hospitality fund. We may find opportunities from motivated sellers if they have accumulated too much debt, but fundamentally we are investing in this sector because we take a long-term view. We believe in the long-term growth of leisure travel. 

Financing continues to be a key challenge for asset owners. Are you expecting to see more distressed assets come to market due to the rising cost of debt and recent repricing?

JA: If you have good assets, you are going to get decent pricing. It is a completely different market compared with the financial crisis if you consider valuations, liquidity and potential buyers. Companies that are under pressure can today dispose of one or two assets to solve their balance sheet situation. 

There are some private equity funds that came into the market five or six years ago and will need to dispose of some of their assets. Rising interest rates have increased costs, which makes buying more expensive. Yet at the same time, price adjustments have not yet taken place and there is a valuation gap.

CGP: I agree that we could see some distress from private equity buyers that previously relied on huge amounts of debt, particularly when they face refinancing. However, unlike other asset classes, the sector has been performing extraordinarily well and there is a lot of cash to repay that debt.

In general, this is a higher yielding asset class, so while financing has gone up it is still accretive – unlike several other real estate segments like residential or even some logistics. Financing for anything related to real estate will tighten but we are in a slightly better position than many in the market. 

Where do you see the best opportunities for hospitality investment this year?

JA: The Mediterranean is particularly attractive. The Greek market is very innovative, and we have seen some of the most creative hoteliers emerge there in recent years. The country has also improved connectivity and invested in regional airports.

Italy has huge potential in the south, especially for international travel, as it is still dominated by local visitors. Southern Europe in general has significant scope to grow. 

We also believe in city leisure. After visitors have seen the gateway cities, they want to explore the secondary cities that countries have to offer. This might mean looking beyond just London in the UK or Madrid and Barcelona in Spain.

We think the duration of hotel stays will also increase. People working as digital nomads want to spend longer at a destination and there are opportunities to be creative. 

CGP: Another trend arising from the pandemic is that many people now want more outdoor activities and access to nature, beyond just traditional resorts. Camping has been around for a long time, but glamping gives people the comforts of a traditional hotel. The beauty of the asset class is that there are always new opportunities to be creative.  

And how significant a consideration is ESG?

CGP: The ESG drive is an important opportunity, while also making this asset class more attractive to investors. Hotels and resorts are being challenged to maintain their high levels of service while reducing their carbon footprint. There is a lot of innovation appearing. For example, we have an investment in Italy using solar photovoltaic power to provide energy to one of our hotels. 

The social side of ESG also presents huge opportunities. The industry is often one of the largest employers, providing employment for migrants and people with less of an educational background. Likewise, hotels are traditionally important employers of women and have a massive impact on communities and the local workforce.

Betting on leisure hospitality

After being around 85 percent invested in its current pan-European leisure hospitality fund, Azora is already looking ahead to what is next. 

Azora´s current €815 million fund is the largest vehicle in Europe exclusively targeting leisure and hospitality assets. With an unrealized mark-to-market return in the mid-twenties, Azora has proven the merits of the sector as an institutional asset class and is convinced that the opportunity in Europe continues to be extremely attractive. 

“Fragmentation is still high, penetration of international brands is low but growing and there are still plenty of undermanaged and under-invested assets in consolidated locations,” comments Javier Arus, senior managing partner for hospitality and leisure.

Cristina Garcia-Peri, senior partner and head of strategy and corporate development, adds: “Tourism is one of the strongest industries in Europe and growing. As a real estate investor, there are few other assets classes that offer such strong fundamentals while still generating outsized returns.”