Where next for Europe’s hotel finance market?
What have you missed most about hotels? The breakfast buffet? Time away from the kids? The work jolly? Or maybe the race to the sunbed? Whatever you’ve missed most, chances are thanks to Covid you haven’t stayed in a hotel for well over year. It’s no surprise then that hotel occupancy levels across Europe have never been lower and that investors with hotels in their portfolios find themselves facing short term finance issues despite sound assets and business plans.
This unfortunate trend, bought on by the pandemic, continues to gather pace in 2021 despite the global vaccination programme. Thankfully for those looking forward to next year’s holiday, the increased presence of alternative lenders in the market has helped to tide a number of quality hotels over until business can ultimately recover.
We are seeing increased hotel financings coming to a head in 2021 due to the changing lender environment and sentiment towards hotels. 2020 was characterised by widespread lender support, spurred by governments and regulators encouraging leniency in the midst of the pandemic. But we are now seeing this support coming to an end, as lenders take stock and government pressure for leniency starts to wane. Even the best hotels need time to stabilise - and when you add to the equation that every hotel in Europe will be stabilising at the same time – you are left with potential for downward pressure on occupancy and room rates. Although the significant levels of pent-up consumer demand and staycation activity that many are predicting will help, there probably won’t be enough demand to mitigate a performance drag.
This prolonged stabilisation is unlikely to work for many institutional lenders. Notwithstanding the reticence to hold low yielding assets in an unloved asset class, for many - certain hotel loans will have fallen outside of their investment mandates and could be subject to punitive capital charging. This creates additional internal and regulatory reporting, a dilution on returns and lost opportunity capital.
Demand for hotel real estate finance is already increasing a result. About 35% of all enquiries to our Special Situations Credit Vehicle – set up to support borrowers with funding gaps - relate to hotel finance. As we hope to turn a corner on the pandemic, with increased vaccine success and an opening up of economic activity, we are seeing polarisation across the real estate sectors. Prime office, industrial and residential will continue to be strong and have a smoother path to recovery unlikely to need further lender support, whereas many parts of the retail and leisure sectors will remain on life-support for some time. But we see hotels as sitting somewhere in the middle.
There are attractive opportunities in both the debt and equity space, where we see prime, almost trophy assets that have been dragged into this middle ground because they cannot trade in the immediate short term and are likely to take time to recover. In the debt space we are seeing a lot of hotel owners in what we’re calling ‘situational distress’, where they have ultimately strong businesses but might, for example, have loans that have reached maturity and are now proving difficult to refinance.
So, there are exciting opportunities for those with alternative lending arms like ourselves. We are in conversations with institutional lenders looking to divest hotel loans from their books, in return for what they can book as an adequate level of repayment. We are also speaking to hotel investors in need of finance, who above all need flexible facilities and time to recover.
One deal we are looking at with a borrower will see us give them almost total flexibility for two years. In return for limited loan covenants and flexibility around ‘pay if you can’ interest, we are asking for a share of the upside once the assets restabilise and the borrower is able to refinance in a more normalised lending market. This is a strategy that works well for us and borrowers, as we see acceptable future returns and borrowers get the time and flexibility they need.
There are options for lenders and borrowers. But as always there is no ‘one size fits all’ approach or silver bullet. Deals need to be assessed on a case-by-case basis and we remain particularly cautious in certain areas. Unfortunately, it may already be too late for some unloved parts of Europe’s hotel sector. Assets built in the 70s and 80s, poorly maintained and in weak locations that were already struggling pre-Covid are likely to continue to suffer and may never fully recover. Others in trouble will be those terminally wounded through over-leveraged ground rent structures which are difficult for lenders to underwrite and may prove problematic to sustain or untangle.
But the good news is that the increased liquidity and depth to the credit markets alternative lenders provide should ensure quality hotels recover strongly. Bring on the breakfast buffet!
Charles Archer is Head of Debt Investment Management at Rivercrown