Hotels
Hotels
We only have to look at London to see evidence of the luxury hotel boom dominating the landscape. From the opening of The Peninsula, the city’s first billion-pound hotel, to the arrival of the GBP1.5 billion Raffles London in the Old War Office in Whitehall, big-name hotel brands are making their debuts in droves. And bringing about the biggest surge in openings since the 2012 Olympics, according to property information company CoStar.
In 2023, Knight Frank said that the UK hotel sector “remained resilient and reinforced in its ability to bounce back” and noted that “investor appetite for the sector remains strong”. It’s not just the UK market. According to Lodging Econometrics, there’s a sharp increase in hotels planned within the global market over the next few years, with 909 new luxury projects worldwide, with the US and China leading the way. For investors looking to make their mark in the hotel sector, understanding market demand, finding the right location, and choosing the appropriate operating model to avoid possible disputes are just a few of the key factors to consider before making a purchase.
Growth in worldwide wealth vaults luxury travel to new heights resulting in an acceleration of global luxury hotel demand and increased investor interest.
The Evolution of Global Luxury Hospitality Report, JLL Hotels & Hospitality Group
Why hotels and hospitality?
Deloitte’s 2023 European Hotel Industry Survey named London as the most attractive European city for hotel investment in 2024, followed by Lisbon and Amsterdam. Four out of five investors surveyed by Jones Lang LaSalle Inc. say they plan to be net buyers of hotels over the next 12 months – the highest rate since the commercial real estate firm started polling investors in 2000.
So, what is so compelling about the hotel and hospitality sector that private wealth investors just can’t resist?
A hedge against inflation – the ability to pass higher costs on to consumers by increasing room rates or prices for experiences, especially in the luxury segment.
Underlying fundamental drivers – pandemic-related lockdowns accelerated the underlying trend of increasing demand for experiences, travel and hospitality.
Higher yields – hotel yields have proven to be generally higher than other operational real estate assets.
Asset flexibility – there are multiple devices an owner can use to increase income and profitability; for example, you can change the brand, market positioning, or operational model, reduce costs, refurbish, and introduce new elements, such as a novel food and beverage concept or an upgraded spa or health and wellness facility.
Resilience – the challenges to the sector, whether environmental, economic, or geopolitical, have been seemingly endless, yet the sector has proven its deep resilience and ability to adapt and react.
Mixed-use – developments that have multiple uses and revenue sources are increasingly popular, combining co-working offices/spaces, retail, leisure and food and beverage with a hotel. Often, the hotel is a key component of these schemes.
Branded residences – these are a real growth market with high demand from purchasers willing to pay a premium for a branded residence and a corresponding increase in developers and luxury hotel brands keen to match this demand.
The key issues surrounding buying a hotel
Location, location, location
It’s often considered that the three most important factors for a hotel are ‘location, location, location’. This is probably truer today than it ever was as social media gives potential guests a chance to not only see inside a hotel and explore its facilities through other visitors but to explore its location and compare its neighbourhood competitors.
Furthermore, investing in locations that retain their attraction long-term or spotting potential opportunities for those in areas that are on the rise could generate a significant return.
Operating model: lease vs management agreement
First things first, consider your operating model. Do you want to act as the landlord of the hotel, operate the hotel business yourself, or have it operated for you by a third party?
Rental income under a lease can be a fixed rent with reviews during the term of the lease, though increasingly, given the inflexibility of such a structure in the face of unexpected market challenges, it is often a mix of a fixed-base rent with an additional rent linked to turnover. Some leases can be purely turnover based. The greater the level of risk the landlord accepts in relation to its rental income, the higher the potential return.
One option, if you are an experienced ‘owner/operator’, is to operate the hotel yourself. More common for an investor, though, would be to appoint an operator to run it for you under a hotel management agreement (HMA). Luxury hotel brands, such as Four Seasons Hotels & Resorts, do not own any hotels; they manage all their hotels under a long-term HMA on behalf of the owner. HMAs are widely used, particularly with luxury hotels.
HMAs generally achieve a higher yield than a lease, given the variations in profit versus fixed (or mostly fixed) income.
Management agreement: owner perspective
Advantages:
- The owner owns the hotel and benefits from any profits.
- The owner benefits from any capital growth.
Disadvantages:
- The owner’s ability to control the operator is indirect (ie through an HMA).
- The owner is liable for all expenses, losses and working capital.
Management agreement: operator perspective
Advantages:
- No financial investment is required by the operator.
- The downside risk for operators is only lost fees and reputation.
- The operator maintains all operational control.
Disadvantages:
- Dependent on the owner’s financing.
- The operator does not benefit from any growth in capital value.
Lease: owner perspective as the landlord
Advantages:
- The owner continues to own the property and benefits from any growth in capital value when the lease ends.
- The owner has certainty of income/rent.
- The owner has no operational responsibilities.
Disadvantages:
- The operator (tenant) has no incentive to maintain the property/invest in it towards the end of the lease.
- The certainty of rent is linked to the financial strength of the operator and how successful it is in operating the hotel. The owner does not benefit if the hotel is more profitable than expected.
Lease: operator perspective as the tenant
Advantages:
- The tenant retains control over hotel operations.
- If the hotel performs well, the tenant has all the benefits.
Disadvantages:
- Leases are a liability on the balance sheet. If trading declines, the rent must still be paid.
- The tenant incurs all the financial risk and has all the obligations to maintain and insure the property.
Market segment: boutique or luxury?
There are many different types of hotels, ranging from budget hotels, mid-market hotels, boutique hotels, lifestyle hotels, upscale hotels and resort hotels to luxury and ultra luxury hotels. What is right for your hotel?
Increasingly, there is a bifurcation of the market. Many investors are focusing on budget and extended-stay hotels, where there are lower operating costs (often due to the relatively low number of employees needed to run the hotel) and good operating margins. At the other end of the market, they’re spending on luxury and ultra luxury lifestyle hotels. These assets are relatively immune to rising operating costs since well-heeled guests are increasingly willing to pay a premium for a luxurious stay, where slick service is coupled with bespoke experiences and top-notch food and beverage.
The Bellagio Hotel and Casino in Las Vegas was sold for
USD4.25 billion
in 2019, making it one of the largest hotel sales in history.
A notable proportion, 31% of UHNW individuals indicated an interest in investing in the hotels and leisure sectors for the year.
Source: Knight Frank Wealth Report 2024
To brand or not to brand
It’s important to decide whether your hotel should be ‘branded’, and part of one of the well-known international brands (such as Four Seasons, Ritz-Carlton, or Mandarin Oriental), or whether the hotel has other attractions or unique features and so doesn’t need the backing of a recognised brand name.
There are many examples of this, such as Claridge’s in London and The Plaza in New York, where the hotel is so well known it becomes a ‘brand’ in its own right.
That said, we live in an increasingly branded world and hotels are no different.
Branded: the pros and cons
A strong brand drives reservations and revenue for a hotel.
With a strong brand, the hotel benefits from general advertising by the brand; the cost of any promotion is shared across several hotels.
Management fees, licence fees, centralised service charges and sales and marketing fees are payable to the operator for running the hotels under the brand. In ballpark terms, these will amount to over 5% of gross revenue and, in addition, around 8%-10% of gross operating profit.
Hotels must comply with brand standards and all the changes to them over time. The owner has limited control and must comply.
The operator runs the hotel on behalf of the owner. The owner is reliant on the performance of the operator.
Unbranded: the pros and cons
Reliant on the individual ‘brand’ or reputation of the hotel to generate reservations. Potentially, they are also more reliant on expensive OTAs (online travel agents) to generate bookings, resulting in a higher cost of sales.
An unbranded hotel will need to do its own advertising and promotion.
No management or licence fees are payable if the owner is running the hotel itself. However, if an unbranded operator is used, management fees will be payable, though these will be lower than for a branded operator.
Unless the owner is running the hotel itself, a third party ‘unbranded’ operator will be running the hotel, so the position is similar to having a branded operator, though ‘unbranded’ management contracts tend to be more favourable to the owner, and therefore the owner has more control.
The owner decides what the brand standards are and what changes they wish to make.
Choosing the right brand
Finding the appropriate brand for the hotel will depend on a number of factors. For example, if your desired brand is already in use by another hotel nearby, we would advise you to look at alternatives; there are literally hundreds of different brands to choose from.
Each needs to be carefully considered in light of the proposed market positioning of the hotel and, importantly, the number of bookings that will be driven by the brand’s loyalty programme or booking engine. Remember that ‘branding’ your hotel will result in said brand imposing a number of obligations along the way – including how it’s operated and the standards to which the hotel must be maintained.
Who’s going to look after the owner’s interests?
This is an area that is often overlooked. Many ill-advised buyers consider that they do not need to be closely involved in the hotel after they have appointed someone to run it for them.
We always advise buyers to appoint an ‘owner’s representative’ and/or an asset manager. The operator will report to the owner’s representative, who is often a close confidante of the owner; and the asset manager will be an expert in the management of hotels and can provide objective professional advice to the owner on the performance of the hotel.
Hotels: when issues arise
Given the complex nature of the hotel business and the multiplicity of parties, it’s unsurprising that there is such extensive scope for disagreements to arise.
Many disputes arise as a result of a guest’s stay at the hotel. There can be complaints about the hotel room, the quality of the experience and other soft factors. Another significant area of dispute is ‘slips and trips’ – accidents or incidents that occur during a guest’s stay, such as falling in the shower or the theft of a valuable item. These disputes are common and are very much part of the day-to-day business of a hotel.
Much higher-value and larger-scale disputes can occur between the hotel owner and hotel operator.
Reasons for disputes between owner and operator include:
The operator requiring the owner to spend money upgrading the establishment to comply with new brand standards. For example, adding a new spa or buying new fixtures, fittings and equipment.
The owner having to inject additional working capital into the hotel due to poor financial performance.
The operator failing to meet the expectations of the owner in financial terms.
What remedies are available?
The owner can seek to revise the terms of the HMA under which the operator will continue to manage the hotel, for example:
- changing the brand
- putting a more effective sales and marketing strategy in place.
Alternatively, the owner can negotiate an exit and stop working with the operator.
Either way, it’s important to get advice from lawyers with a deep understanding of the hotel industry and experience in these types of situations. Obtaining this advice early on can minimise the complexities. If the legal team has acted for both owners and operators, they will be able to anticipate potential issues and plan remedies several moves ahead.
Asset performance
According to the JLL Global Hotel Investment Outlook 2024, global hotel performance soared last year. RevPAR (Revenue per available room) recovered completely from the pandemic, with 2023 levels 19% higher than those registered in 2019, just before the pandemic, with the Middle East, Europe, and the Americas leading the way. In addition, the Outlook reports that the sector attracted many first-time hotel buyers last year. Their 19% market share was the highest on record, ‘underpinned by significant dry powder on hand’. As a result, private equity made up the highest proportion of hotel investment.
Key points to remember
Before an offer is made, make sure you enquire about the following:
- Undertake appropriate research to ensure that you choose the right brand/hotel operator and location for the market.
- When appointing a hotel operator, ensure the interests of both parties are aligned from the outset.
- Ensure the agreed upon commercial terms reflect the needs of both the owner and operator – ie ensure that the hotel operator puts in place an appropriate sales and marketing strategy and that proper financial controls are included within any HMA.
- Ensure that your HMA sets out in clear terms the rights of the owner and the obligations that will be placed upon them to maximise the profitability of the hotel.
- If you find yourself involved in a dispute with a hotel operator, ensure you involve experienced lawyers as soon as possible.
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