CapMan: ESG is part of the Nordic DNA

ESG has long been part of the narrative within the Nordics and it is only a matter of time before it impacts cap rates, say CapMan Real Estate’s Thomas Laakso and Simon Hultén.

This article is sponsored by CapMan Real Estate

Two years ago, international travel was brought to a halt as countries across the globe introduced restrictions to minimize the spread of covid-19. As a result, the hospitality industry suffered deep disruption; according to STR data, the European hotel market recorded an unprecedented revenue per available room (RevPAR) decline in 2020, down by 70 percent to approximately €24 due to covid. This was fueled by a drop of around 63 percent in occupancy to 27 percent, while ADR also fell by 18 percent to €92.

However, despite continuing disruptions, international travel is eventually expected to bounce back. This will in turn have a positive impact on hotels, argue CapMan Real Estate’s investment director Thomas Laakso and investment manager Simon Hultén.

As demand for hospitality rises, what opportunities do you see in the space?

Thomas Laakso: Some investors may have been put off by covid-19’s impact on the industry, but the long-term fundamentals are still very sound. In many cases the pandemic has only reinforced and accelerated many of the macro trends of recent years, such as ‘bleisure’ travel and ‘staycations,’ more focus on wellbeing and sustainability or increased personalization and digitalization, to name a few. With this we see repositioning and adaptive re-use/conversion opportunities. Some investors might appreciate the investment opportunities in hotel operating businesses, which have come under duress but have good growth prospects going forward as the industry recovers.

Simon Hultén: Throughout the pandemic, leisure travel has continuously led the industry’s post-pandemic recovery, and as business travel gradually returns the demand for combining business and leisure travel will strengthen as more companies embrace a hybrid work environment, which has also had a positive impact on the average length of stay. It is therefore increasingly important for hotels to understand their guests and effectively cater to their needs and wants throughout their stay, which might change depending on the time of day – whether they are on- or off-duty – if hotels want to benefit from the bleisure effect going forward.

Amid other challenges, covid-19 has left many hotels with fewer staff and higher labor costs. How is best to manage this labor crisis?

TL: The last couple of years have been very challenging and our operating partners and tenants who operate the hotels have been forced to become leaner and more efficient. Finding talent was already a challenge even before the pandemic, and not just in the hotel industry. Therefore, it has become even more important for companies to take care of their employees and adopt new technology – in that order.

With inflation and interest rates rising, how will pricing and returns be affected?

TL: Low to moderate inflation should not materially influence hotel returns, but inflation has a direct impact on hotel operating costs (food, energy, payroll, etc) and if a hotel is not able to find efficiencies or pass these added costs onto its guests via price increases, then this will naturally have an adverse effect on profitability.

However, hotel assets in general experience less pricing friction than other types of commercial property. A hotel room is typically rented on a short-term basis and hotels have therefore inherently more flexibility – market conditions permitting – to adjust pricing dynamically with some pre-negotiated exceptions.

Due to these short-term pricing dynamics – both upward and downward – hotel assets should, according to conventional wisdom, respond quicker to interest rate changes, which in turn can affect cap rates depending on how much, how quickly and for how long interest rates increase, which is difficult to predict with current world affairs.

SH: However, in the case of a core-plus fund like our CapMan Hotel Fund II, investors are primarily investing in stable bond-like long-term lease income with an index-linked minimum rent component which acts as an inflation hedge. This allows investors to passively invest into the sector without in-depth industry knowledge. For more active investors, owning and operating luxury hotels could be of interest as they tend to be the least inflation sensitive due to the clientele they cater to, whereas budget hotels may not always be able to raise their prices at the pace of inflation without risking loss of occupancy.

How does the investment landscape differ in the Nordics compared with the rest of Europe?

SH: The Nordics are quite a close-knit community with many transactions taking place off-market. It can therefore be quite challenging to enter the market if one is not well connected with a local presence.

Hotels in the Nordics are almost exclusively financed with lease agreements, hence the most common operating model, although with some differences as opposed to the rest of Europe. For example, in the Nordics, furniture, fixtures and equipment investments tend to be paid by the hotel operators, compared with a turnkey approach more prevalent elsewhere.

Hotels operating on management agreements are still underrepresented in the region – an operating model that is the most prevalent globally and in parts of Europe. This model is also preferred among international hotel brands which also is one of the main reasons why they are somewhat underrepresented in the region.

As such, white label hotel operators have gained some traction, a concept that is well established in North America, growing rapidly in Europe and is accepted among many institutional investors. These companies take on operating responsibilities under a franchise with hotel chains and in turn have an operating lease in place with the property owner. We expect this trend to continue going forward, with more white label operators entering the scene to help to further diversify the rather homogenous hotel landscape in the Nordics.

Nordic countries are considered global leaders when it comes to sustainability. How can ESG add value to hospitality assets?

TL: It is true that social responsibility has long been part of the cultural DNA in the Nordics, but aside from doing the right thing, we see direct financial benefits when we, together with our operating partners, can help reduce water and energy consumption, generated waste and greenhouse gas emissions, and be a positive influence in our local communities by doing right by our employees, guests, partners, neighbors and of course the environment.

We also believe that it is only a matter of time before ESG will have an impact on cap rates, especially at the extreme ends of the ESG spectrum, either in the form of a premium or as a discount.

How can data be used to decarbonize real estate assets?

TL: In addition to continuous energy consumption, share of renewable energy and operational carbon monitoring, embodied carbon-related data is very important. Lifecycle assessments are an excellent way of getting emissions data from the full lifecycle of a building. The assessment is a good way to understand which areas are key in reducing carbon and to identify suitable measures to take. Since some data needs to be tracked individually building by building, we are currently reviewing the need to install additional measuring devices in our hotel portfolio to have more reliable data, as buildings could vary greatly in terms of their energy efficiency and need for improvement.

How well is the industry doing when it comes to incorporating sustainability?

TL: The short answer is that very few know how well the industry is really doing with these measures. That is why it is important to have more clarity and accountability within the space and to choose the right partners and tools in order to have meaningful measurements and reliable results.

SH: That’s why CapMan Real Estate has chosen to report annually to GRESB, a global ESG benchmark for real estate at a company, fund and asset level. We have also committed to the Science Based Targets initiative (SBTi) and are in the process of preparing a roadmap for defining short- and long-term carbon reduction targets and an action plan on how to reach these targets and for the hotel fund to become classified as Article 8 under the Sustainable Finance Disclosure Regulation (SFDR).

Can a Nordic approach work elsewhere?

TL: There will be certain ‘Nordic’ fundamentals we will maintain as we expand into Northern Europe, such as our ESG aspirations, but it is important to adapt to local market conditions where necessary if one wants to meaningfully grow outside of the Nordics – or even within the Nordics, as there are some differences between the Nordic countries, as well.
Understanding and celebrating these differences and finding common ground is what makes this job so interesting and allows us to create value for our investors.