Stop worrying and learn to love the hotel

A real estate asset you need to re-lease every day sounds too risky for many institutional investors – but they are beginning to check in.

A quip once attributed to various investment managers was “I always have one hotel in the fund, just to remind me why I don’t own more,” but this is far from the case today.

Global hotel investment volumes have been fluctuating in recent years; last year saw $62 billion of deals, according to Real Capital Analytics, below the post-GFC high of $90 billion in 2015. However, institutional investors, including pension funds, endowments, insurance companies and sovereign wealth funds have been taking a growing share of the market.

JLL Hotels data show institutional investors are expected to account for nearly 15 percent of global hotel acquisitions in 2018, compared with less than 4 percent in 2014. This trend has continued in 2018. Just two months into the year, one of the sector’s biggest transactions occurred, including some of the biggest institutions active in the market. Investors GIC Private, Saudi Arabia’s Public Investment Fund and Crédit Agricole Assurances featured prominently in the consortium that bought a 55 percent stake in AccorInvest for €4.4 billion in February. AccorInvest is the real estate arm of the French hotels group AccorHotels and owns 891 hotels, mainly in Europe. The group operates all AccorInvest hotels under a 50-year contract for the luxury properties and a 30-year contract for the mid-range and budget hotels.

“Hotels play an important role in balancing investment performance in a mixed real estate portfolio. Furthermore, hotels consistently trade at a higher cap rate than other income generating assets”

Mark Batchelor

The deal generates capital that will help Accor boost market share while the new shareholders in AccorInvest “gain exposure to AccorInvest’s large and well-diversified portfolio, with resilient cashflows and attractive opportunities for value creation,” GIC said in a statement.

Surveys of investors have pointed to a growing pace of investment in the hotel sector in coming years. For example, German investment manager Universal Investment’s annual investor survey, published in October 2017, found a target allocation of 14.5 percent to hotels, double the figure for 2016. However, Universal also found only 2 percent of transactions in the year to May 2016 were hotel deals, suggesting investors are making slow progress in hitting their allocation targets.

Balancing performance

Diversification is an important driver for institutional investment in the sector. Mike Batchelor, Asia chief executive for JLL Hotels, says: “Hotels play an important role in balancing investment performance in a mixed real estate portfolio. Furthermore, hotels consistently trade at a higher cap rate than other income generating assets.”

Higher yields are a consequence of increased volatility: a hotel is re-leased every day, while an office property might only need a letting agent once every two years.

However, as investors become more familiar with hotels they also become more comfortable and adept at dealing with the risks, says George Nicholas, global head of hotels at Savills. “Hotel ownership and operations have become more sophisticated; investors and GPs understand ways to mitigate the market risks involved. Leases and management agreements are evolving to allow investors to share the upside and to limit their downside risk.”

The frequency with which hotel rooms are leased and re-leased also has a value for investors, as this means prices are matched to demand almost instantly, he adds. “Hotels are a great and natural hedge against an inflationary environment. So it’s a great sector in a rising market.”

The AccorInvest transaction was atypical in its size and in that the institutional investors in the buying consortium took the lead, but the type of asset acquired – branded, corporate properties – was typical of the institutional preference.

Christophe Vielle, chief executive officer and co-founder of GCP Hospitality, the hotels platform of Gaw Capital Partners, says: “Generally, first tier cities remain the priority for investors and, in general, larger corporate properties. It is usual for hospitality real estate funds to have a restriction on the number of resort properties they can acquire as investors may have liquidity concerns about this type of asset – although from the operator’s point of view they are no less desirable and profitable.”

Institutions are also expected to be allocating capital to hotel real estate funds. Only a few small hotels funds closed in 2017, none attracting more than $500 million.

However, managers are launching new vehicles in response to increased interest in the sector. In August, hotels specialist Trinity Investments and Oaktree Capital Management formed a $3 billion joint venture to invest in Hawaii, Japan, California and Mexico. Henderson Park, whose backers include Kuwait Investment Authority, raised €950 million at the first close of its debut fund in October and a large proportion of its equity has been allocated to hotels transactions in the UK and France.

UBS, meanwhile, plans to raise $400 million to invest in Japanese hotels, while Internos Global Investors raised €113 million at the first close of its second hotel fund in June. Invesco Real Estate launched an open-ended European hotels fund with initial capital of €179.5 million in July.

“Vietnam is finally beginning to realize its potential and there are some good properties being built in Ho Chi Minh City. Da Nang is booming and we see a lot of tourists from Hong Kong and Korea. The potential for Chinese tourism there is huge”

Christophe Vielle

Perhaps more significant than the institutional capital being invested in specialist funds is the increasing participation of generalist funds in the hotels market. Batchelor says: “The past few years have marked an increase in buying activity from private equity and institutional investors, signalling a growing trend of hotels being purchased by investors with portfolios involving multiple asset classes, as opposed to specialist hotel investors. In 2017, over 70 percent of hotel transactions (around $45 billion) were purchased by these generalist investors, compared with 62 percent back in 2014.”

Investment managers such as Blackstone – the largest buyer of hotels in the past 12 months according to Real Capital Analytics – Apollo Global Real Estate and Starwood Capital are investing substantial capital in the hotels sector. The vast majority of this capital has been raised from institutional investors in the US and further afield.

Buyers of an Asian persuasion

A significant proportion of the institutional capital invested in cross-border hotel deals this year will come from Asia, says Batchelor. “In 2018, Asian investors, notably from South-East Asian countries, are expected to dominate the offshore investment landscape. This is all driven by renewed interest in diversification, both in terms of location and product.

“Despite government crackdowns on outbound investment, Chinese investors still have the appetite to invest in mature markets across North America, the UK, Western Europe and Australia. However, their investment criteria have changed considerably. While overseas investments under $300 million are still permitted, we expect there to be a big decline in the acquisition of high-profile trophy assets and large-scale portfolios in the short term.”

While there is widespread institutional interest in hotels around the world, a number of markets are attracting more attention. In the Asia-Pacific region the key markets are Australia and Japan, which have been popular destinations for capital for a few years. This is likely to remain the case, but locations such as Vietnam are also piquing investor interest.

Investing in hotel debt

Institutional investors in real estate debt are increasing, and the hotels sector is no exception.

This follows a tightening of loan issuances from traditional banks, which are now more risk-averse. Debt funds provide more flexible capital requirements and higher loan-to-value levels compared with traditional bank lending.

George Nicholas, global head of hotels at Savills, says: “The debt side of the hotels real estate market is growing, with private equity investors and institutions allocating more capital, primarily to Europe and the US. Typically, a debt investor would offer whole loans of up to 70-75 percent LTV and then sell down the senior portion.” Debt investment offers downside protection and lower frictional costs (such as transaction costs) but is largely undertaken by investment managers rather than institutions directly. Some larger institutions have also backed debt platforms: Japanese insurance company Tokio Marine has backed Acore, a US real estate debt platform with around $2 billion of capital, for example. It is understood that about one quarter of Acore’s loans have been backed by hotel assets.

Japan has seen visitor numbers rise dramatically to a record 28.6 million last year, four times the level of five years previously. Next year’s Rugby World Cup and the 2020 Tokyo Olympics are expected to boost those numbers further and the nation is tipped to see 40 million visitors by 2025.

GCP Hospitality’s Vielle says: “Japan has seen significant growth in tourism numbers, driven by more visitors from China and the weaker yen. There has also been some restructuring in the industry, which has improved management overall.

“Over the past four or five years or so cap rates have fallen to 3 percent from 7.5 percent due to demand from investors. Japanese real estate investment trusts have been big buyers and their low cost of capital makes it hard for overseas investors to compete.

“Vietnam is finally beginning to realize its potential and there are some good properties being built in Ho Chi Minh City. Da Nang is booming and we see a lot of tourists from Hong Kong and Korea. The potential for Chinese tourism there is huge.”

Natural disasters struck the US hospitality market with a number of blows last year and investor interest has been flat. Mark Woodworth, head of US research at CBRE Hotels, says: “We are not seeing a significant volume of institutional capital coming into US hotels at present. However, the top 10-15 largest markets continue to attract investor interest, as have resort destinations.

“Hawaii, because of the expansion of inbound traffic from the Asia-Pacific region, remains an extremely attractive market for investors.”

Sean Hehir, chief executive of Trinity Investments, also sees institutional interest in Hawaii, where his firm bought the $230 million Hilton Garden Inn Wakiki Beach and the $317 million Westin Maui Resort and Spa on behalf of institutional capital last year. “There is no new supply of hotels in Hawaii but demand remains strong,” he says.

Activity in Hawaii suggests resort hotels are gaining popularity with investors and this is also the case elsewhere. In September, GIC bought a 51 percent stake in the Sheraton Grand Tokyo Bay, which is next to Disneyland Tokyo, for $900 million. Savills’ Nicholas adds that “investors have become more interested in resort properties, in locations such as Mexico, California, Queensland and Southern Europe.”

Investors are also interested in leisure park properties, as well as “sun and sand” resorts. Nicholas says: “There is growing demand for leisure park properties, such as Centerparcs and Parkdean in Europe and the UK. Investors like these because they are extremely resilient in a downturn. Families that might normally holiday abroad will use leisure parks at home to keep costs down.”

Europe remains a popular destination for institutional capital, unsurprising as six of the most popular nations with overseas visitors are in the region and France is the most popular tourist destination in the world, with 89 million visitors last year.

JLL Hotels cites France as a more popular destination for institutional capital this year, as investors will be reassured that terrorist attacks in recent years have not deterred visitors. Meanwhile, Vielle expects more institutional interest in southern European markets such as Spain and Italy. He adds:
“The UK is an easy market to understand for investors and thus it has been popular, but there are very few opportunities and only for long-term core capital.”

The most significant trend in the hotel industry in the past few years has been the increase in tourist arrivals from China and professionals in the hotel real estate business seem to agree it will be the main driver of growth going forward, but the general outlook for the sector is fair.

As allocations to real estate have grown over the past five years – Hodes Weill now puts the average institutional allocation at 10.3 percent, up from 8.9 percent in 2013 – capital has been invested in a wider range of real estate sectors. However, professionals argue that the tap to this capital is unlikely to be turned off, even if market circumstances change.

Supply of hotel rooms worldwide is increasing, but modestly, according to JLL data, with rooms equivalent to only 0.1 percent of total stock under construction in 2017. Most of the growth is in Mainland China and the Middle East and Africa, with growth elsewhere below the global average, suggesting oversupply will not be a major concern for investors.

As such, M&A in the hotel sector is set to continue as operators drive for supply growth, operational efficiency and profitability through scale, which, in turn, ought to present opportunities for hotel real estate investors.

Trinity’s Hehir says: “We expect to see more transactions like the AccorInvest deal and more large transactions generally. They work well for investors as they give them tremendous diversified cashflows and they allow the hotel operators to invest in building market share.

“As the whole business of hotel real estate matures, we will see more core capital in the market worldwide.”