There has never been a better time in history for hotel investment and finally it seems that “hotels” have been validated as a core real estate asset class. In 2005 we saw transactions reach a record high of $45 billion globally, with $20.6 billion of these deals transacted in Europe. The key factor driving hotel investments is the abundance of capital available and perhaps the more attractive returns available compared to other property classes. As a great number of public operating companies sell their hotel assets, private equity firms and the introduction of REITs globally are at the forefront of a shift in hotel ownership.
A key factor underpinning the strength of private equity firms is the availability of cheap debt and their appetite for significant levels of leverage—up to 95 percent. These firms typically infuse capital for improvements in order to unlock further earnings potential, apply rigorous asset management in order to drive greater efficiencies and improve a hotel's trading performance, thereby increasing the enterprise value of their properties. They typically seek an IRR of at least 20 percent, acquiring assets with clear exit horizons. Their holding period can be as short as 18 months, but is more typically three to five years. They favor large portfolio transactions where they can put their money to work faster and with less competition. Recent examples in Europe include the acquisition of 73 hotels from InterContinental by a consortium comprising Lehman Brothers, GIC and Realstar and the public to private transaction by Starwood Capital Group of Société du Louvre (14 luxury assets and 874 budget assets).
In Europe private equity is the dominant source of investment in the hotel market. Capital flows into Europe were largely driven from the US ($6.8 billion) with $1.5 billion coming from Asia, and just under a billion from Middle Eastern investors. Last year saw private equity companies acquire a 40 percent market share in Europe, a massive increase since 2000 when the total transacted volume through private equity was only 1 percent. Included among Europe's top hotel owners, as estimated by Jones Lang LaSalle Hotels, are Starwood Capital (930 hotels), Whitehall (112 hotels), Royal Bank of Scotland (99 hotels) and The Blackstone Group (20 hotels).
Many of the assets acquired by the private equity firms have been full-service, branded properties in gateway cities, disposed of by the large, publicly quoted hotel companies. The investor landscape across Europe is mixed with some countries, namely France, the UK and Germany, seeing a wealth of private equity deals, while other countries in Southern Europe are still dominated by domestic deal makers.
THE FUTURE LANDSCAPE
Exploring the exit strategies of private equity firms is central to establishing what the future ownership cycle might resemble. These options will broadly include: break up portfolios and sell as smaller groups or single assets; spin off and re-float hotel portfolios as an operating company; remove assets from the hotel market by converting them into condominiums or retirement villages; or exit via REITs or similar listed vehicles.
If we look to the more sophisticated hotel investment markets of the US and Australia, within the last decade, we have seen hotel ownership shift from publicly listed hotel companies, which de-listed to facilitate the split between operations and ownership, into REITs and, most recently, back into private equity firms.
During the first round of private equity buyouts, REITs were used as an exit vehicle, but in recent months we have seen private equity firms take REITs into the private domain. The current low cost of debt being accessed by private equity firms appears to outweigh, at present, the tax advantages attached to REITs. The shift from REITs to private equity firms is illustrated through several acquisitions by one prominent US firm, the Blackstone Group. Since March 2004, Blackstone has acquired MeriStar Hospitality Corp for $2.6 billion, Extended Stay America for $3.1 billion, Prime Hospitality Corp for $800 million, Wyndham International for $3.2 billion and LaQuinta for $3.4 billion. Recently Westmont Hospitality Group followed suit, agreeing to pay $416 million to acquire Cleveland-based Boykin Lodging. However, we believe this may be a short-term arbitrage opportunity, due to favorable debt markets and REITs trading at a discount to net asset value.
In Europe it is likely that the preferred exit plan by private equity investment in the hotel sector will be through REITs. The option of re-floating as a public company will be expensive and requires very particular market dynamics. The IPO market, for instance, would need to be buoyant. Likewise, the option of converting assets would be convoluted and would not provide a clean exit as it becomes reliant on the attributes and the potential of single assets. However, REIT structures in the two most developed European markets of Germany and the UK are yet to be established, though the legislative process has begun. This may see private equity players holding on to assets for longer than anticipated or indeed exercising the option of secondary trading, arranging their assets into smaller portfolios and single assets for maximum pricing.
Belgium, Luxembourg, France, Greece and the Netherlands already have official REIT structures in operation. France is an excellent example of the benefits of adopting REITs. The portfolio of Fonciere des Murs, a French REIT, which is listed on the Paris stock exchange, contains 128 hotels operated by Accor, with hotels representing about 78 percent of the entire portfolio. Currently Fonciere des Murs is in the process of purchasing a $752 million Accor portfolio that includes 59 hotels, five Thalassotherapy institutes in France and 12 hotels in Belgium.
Private equity firms are actively pursuing deals in Central and Eastern Europe and we expect them to have a significant impact on the ownership landscape in these regions. Saturation of the European market is likely to be followed by a move East as their attention turns to Asia. Secondary trading may see private equity firms sell on their assets to pension funds or institutional investors who have been watching and waiting in the wings and who may feature as the new faces of hotel investment in Europe.