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Covid-19 has made hotels alluring for private capital

Private real estate’s institutional investors are ready to engage with opportunistic strategies, and deals in the hospitality sector are an early target, writes James Jacobs, head of real estate for Lazard’s private capital advisory group.

James Jacobs, Lazard

Despite being the traditional holiday period, more investors expressed a desire to be active in August than any other month since lockdowns were imposed in March. For them, distressed or opportunistic strategies appear to be most attractive, with an expected rebound in hospitality assets being of notable appeal.

Lockdowns and travel restrictions have hit the hospitality market particularly hard. In many countries, the sector was forced to close throughout the spring into early summer. As it sells rooms by the night, there has been little to no contractual income. Hotels are also operational assets with high fixed costs. Subsequently, they were adversely impacted.

However, a return to operation could see a reverse in performance. Higher cap rates on conservatively adjusted pro forma net operating income, with limited availability of finance, may present a once-in-a-generation buying opportunity, either directly or through debt acquisition.

Indeed, the opportunity may exist not only to pick up assets at a significant discount to replacement cost and historic dollar-per-key metrics, but also to acquire high-quality assets that were in long-term ownership. We have observed an increased focus on areas of the hospitality sector we believe will bounce back more quickly.

Subsequently, we anticipate assets geared towards leisure and tourism will be less impacted in the medium term than assets aimed at the business and conference market. While businesses adjust to virtual meetings and webinars, it will be more difficult to consume vacations over the internet.

Hospitality assets fit for purpose in the new normal are most likely to attract capital. As demand changes, managers able to quickly identify the latest trends in the space will fare best. For example, there appears to be a strong preference by consumers to drive rather than fly. That was evident in Europe: the Eurotunnel between England and France saw its numbers only down 20 percent year-on-year compared with nearly 90 percent for airlines.

Quarantine measures also led to increased demand for domestic tourism. Assets within a reasonable drive of large population centers, therefore, appear to be in a strong position.

It is evident there is appetite for distress and opportunistic investments and that within such strategies, the severely disrupted hospitality market will indeed provide opportunities. However, we must warn the way in which the hospitality sector bounces back is unlikely to be uniform. It will, therefore, remain important for investors to select managers with the relevant experience to navigate through the numerous opportunities and target those likely to perform better over the medium term.