CBRE HOTELS FIXED-INCOME HOTEL INVESTMENT
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CBRE HOTELS FIXED-INCOME HOTEL INVESTMENT
FOREWORD
In our first publication on the hotel fixed-income
investment market in 2016, we anticipated an
increase in demand for long-dated fixed-income
investments. We are pleased to say that the
market has exceeded even our most optimistic
expectations at that time. The long-term outlook
for the hotel market remains positive with the
inexorable rise in global tourism and the shift of
consumer spending to experiences.
Given the current positive environment in the sector,
we have witnessed an emergence of new capital sources,
which in turn has encouraged an increase in owner-
operators considering sale and leaseback deals, both on
an occupational and ground lease basis. The scarcity of
stock has also promoted what might be described as a
boom in the forward funding market.
In this publication, we explore and provide key insights
into the dynamics and fundamentals of hotel fixed-income
investment and illustrate how this sector can enhance
investment portfolios through diversification as well as
strong risk-adjusted returns. We aim to provide you with
a complete overview of the fixed income hotel market and
more importantly, we hope that this publication illustrates
that the fixed income hotel market has now entered into
the “mainstream” and therefore shouldn’t be considered
“niche” or purely “alternative”.
The contributors to this document along with their
colleagues all specialise in the hotel sector and are able
to pool their collective knowledge and experience to
provide focussed and well-informed advice as our clients
in the sector will attest. Whilst there are a number of
uncertainties on the horizon, the UK hotel market remains
well placed to see out numerous business cycles and
therefore still provide strong risk-adjusted returns.
Please do not hesitate to contact us for more information
and support in making your investment.
CBRE Hotels
FIXED -INCOME
HOTELS
HOTELFIXED
INVESTMENT
- INCOME| 2018
1 1
MARKET CONDITIONS
Income from hotel real estate their expansion on the UK’s key cities this has been an improvement in room The future for the UK Hotels sector in net migration to the UK has manifested
investment falls broadly under two and we continue to see Premier Inn and occupancy and rates. However, RevPAR can in increasing payroll and the outcome of
areas, fixed and variable. Investment Travelodge also growing their presence flatter to deceive and the growth in hotel Over the long-term, hotel demand the Brexit negotiations could exacerbate
opportunities encumbered by an in these markets. However, there is also profitability, has been relatively lacklustre. will be underpinned by a fundamental this trend. Exposure to low-skilled, low-paid
operational lease (fixed-income) a trend of the more mature operators trend towards increasing the share of workers meant that hotels were impacted
are generally limited to the budget increasing their exposure in tertiary markets. Over the long term, hotel income growth discretionary spending to experiences. by the increase in the National Living Wage
tier of the market, synonymous with In such locations, accommodation demand has kept pace with inflation, and recent Along with the lower-cost of transport, in 2017 (to £7.50 per hour) and this is
Travelodge and Premier Inn. These can be more volatile, which makes it more performance would indicate that the UK this is expected to sustain future growth in projected to rise to £9.00 by 2020.
brands have more-recently been challenging to derive a sustainable rental could cope with increased supply. The global travel and tourism. The growth of
joined by other operators, including level. fundamental driver of income growth, the travel and tourism sector is forecast The 2017 increase in business rates was
Motel One and Dalata Hotel Group notwithstanding the economic cycle, is a to outpace that of the global economy another cause of economic stress across
Joe Stather, PLC, who are expanding in the UK Market conditions burgeoning global travel market – fuelled through the next decade, as well as other consumer sectors coinciding with a fall in
Associate Director, by aligning with the high investor by cheaper transport and increased mobility sectors, including financial and business the value of the Pound, which inflated the
Advisory Services EMEA demand for fixed-income. Based on the overall number of hotel across all generations. Yields for fixed- services, manufacturing and retail and costs of food and other goods sourced
rooms and average occupancy levels, income hotel stock are below the peak of distribution. The UK is undoubtedly well abroad. Further tightening of monetary
The fixed-income hotels market continues an estimated 190 million room nights were the previous cycle. positioned to capitalise on this trend given policy by the Bank of England, whilst likely
to grow; in terms of the confirmed UK sold in the UK in the 12-months to July its accessibility, identity and international to be gradual, could dampen demand
hotel development pipeline, there are 2018. This compares to 140 million in This may set alarm bells ringing for some; appeal to travellers. growth. Weaker UK consumer spending
over 100 hotels (>10,000 rooms) due the full-year 2008. To put it another way, however, relative to the risk-free rate, the may temper domestic travel while a
to open before 2022, that will run under over ten years, supply has increased by risk premium remains comparatively high Some consumer sectors have experienced stronger pound would likely decelerate
an operational lease. Brands in the around 16% but demand has grown by (see figure 1). One could argue that hotel a challenging operating environment in the flow of inbound visitors. However, any
pipeline include the usual suspects, whilst approximately 35%. investment is less risky than in the previous recent times, which has had some impact consequential fall in inflation would ease
Z, easyHotel, Roomzzz, Motel One and cycle, given the improved transparency, on hotels. In the UK, hotels are heavily operational cost pressures and improve the
Yotel are just a handful of smaller players At a macro level, top-line hotel knowledge and liquidity. exposed to foreign-born workers; a decline conversion of revenue into profit.
also offering investors fixed-income and a performance in London and Regional UK
chance to diversify their hotels exposure. is materially beyond their respective peaks The growth of the travel and tourism sector is forecast to outpace
Many of the smaller players are focusing of the previous cycle. The key driver behind that of the global economy through the next decade
Figure 1: Regional UK Prime Hotel Lease Yield Spread Figure 2: UK Tourism Spending Index
8.0 600 160
7.0 140
500
6.0 120
400
5.0 100
300 Index 2017 = 100
Spread (bps)
Yield (%)
4.0 80
200
3.0 60
100 40
2.0
1.0 0 20
0 -100 0
Jun 2006 Mar 2008 Sep 2011 Jun 2013 Mar 2013 Dec 2016 Jun 2018 1995 1999 2003 2011 2015 2019F 2023F 2027F
Spread (bps) Hotel lease 10-year gilt Business tourism spending Leisure tourism spending Domestic tourism spending Visitors exports (foreign spending)
Source: CBRE 2018 Source: World Travel & Tourism Council
2 FIXED -INCOME HOTEL INVESTMENT | 2018 3
WHERE ARE WE IN THE CYCLE?
Our advice for investors today Figure 4: UK Real Estate Investment 2007, £ billions
The market has come on leaps and hotel investment market share doubled
Other
bounds over the past few years, to 8% in 2017 and 2018 appears to be 1. Understanding the market 31.96bn
particularly over the last 18 months. equally robust. As a result, demand for fundamentals and market conditions
The ability to pre-let and match long-dated fixed-income hotel investments are critical – go into all deals Hotel 14%
long-term liabilities with long-dated has increased significantly, which has understanding what the potential future 6.60bn
investments has resulted in the resulted in considerable yield compression. risks such as changes in the National 4%
market moving into the mainstream. Living Wage or future supply dynamics
Industrial
17.64bn 8% Total Office
Historically, the hotel investment Given this increasing demand, will have on rent coverage ratios and £226.82 54% 121.65bn
market was considered opaque, is there scope for further yield affordability.
resulting in relatively limited demand compression? Is there an argument billion
from institutional investors. As a that the opportunity for further 2. Investors need to have an asset 21%
Retail
Marc Nelson, result, during the last cycle in 2007, capital growth has passed? management plan through their 48.97bn
Director, hotel investment in the UK accounted investment horizon and understand that
Investment Properties UK for only 4% of total investment The low interest rate environment with simply locking away an investment and
volume. gilt-edged investors has assisted in driving collecting quarterly rents will result in Source: CBRE 2018
down yields to an all time low in this cycle potential problems in the long-run –
Since the last cycle, the market has become and, with rate rises on the horizon, the jury these investments need to be monitored
far more transparent, underpinned by is out on how this is going to affect Net and reviewed on a regular basis. Figure 5: UK Real Estate Investment, 2017, £ billions
strong risk-adjusted returns and investors Initial Yields. The yield premium relative
diversifying their investment portfolios, the to 10-year gilts remains attractive and Other
the unique nature of the hotel investment 47.28bn
Figure 3: London Risk Premiums – CBRE House Yields, Prime Assets market is that fixed-income investments are 18%
underpinned by strong vacant possession
7.00% and residual values.
8%
Total 41%
Office
105.73bn
6.00% It is worth highlighting that the
Hotel
19.11bn
£256.69
5.00%
fundamentals of the hotel market remain
15% billion
4.50%
positive with the growth in global tourism
4.00% 4.00% and the shift of consumer spending
3.75% Industrial 18%
to experiences. The logic remains of
Yield
3.00%
37.41bn
investing in a long-dated hotel lease
to a credible operator with guaranteed Retail
2.00%
uplifts and strong residual values remain 47.16bn
1.39%
1.00%
extremely compelling and, given the limited
0.75% availability of stock in the market, we are Source: CBRE 2018
0.00% likely to still see upside opportunities.
Q4 2006
Q2 2007
Q4 2007
Q2 2008
Q4 2008
Q2 2009
Q4 2009
Q2 2010
Q4 2010
Q2 2011
Q4 2011
Q2 2012
Q4 2012
Q2 2013
Q4 2013
Q2 2014
Q4 2014
Q2 2015
Q4 2015
Q2 2016
Q4 2016
Q2 2017
Q4 2017
Q2 2018
Capital growth may be largely enjoyed
from rent increases as further prime yield performance and vacant possession pricing That being said, a considerable weight of
London: VP London: Lease 10-Year Gilt Base Rate London West End Office Yield
movements are only likely to be marginal. – this will drive the market into having a capital chasing traditional fixed-income
better understanding of both the underlying investments still exists and, coupled with a
Risk Premium Above 10-Year Gilt Base Rate What do you see changing in the risks as well as future opportunities. This scarcity of available stock, we expect to see
London - Vacant Possession (VP) 3.11% 3.75%
investment market over the short sector of the market is no longer solely more forward funding deals and pricing
to medium-term? dependent on being just a covenant play, that will hold for the foreseeable future.
London - Hotel Lease 2.61% 3.25% it is likely that we will see more operators
London - West End Office 2.36% 3.00% Given that the market is far less opaque offering up a sale and leasebacks and
than it once was, buyers are becoming investors will look to diversify in terms of
Source: CBRE 2018 more savvy and focusing on trading covenant exposure.
4 FIXED -INCOME HOTEL INVESTMENT | 2018 5
NEW EMERGING CONCEPTS
The investment appetite for hotels We have seen some operators looking to Is it difficult for new brands to Many transactions have been For the majority of institutional investors,
subject to a fixed lease is arguably at reduce their lease exposure through either enter the market? forward fundings and forward we have spoken to, forward funds are
an all-time high. The ability to secure shorter terms or capping their covenant commitments, how does this risk more attractive than forward commitments
long term, indexed linked leases with exposure. The UK has a very strong and mature impact pricing? whereby the investors can gain the security
strong covenants and the benefit of hospitality market attracting global brands. of purchasing the land and receive a coupon
strong underlying vacant possession Are the concepts changing with New brands find it more difficult to enter Appetite for long-dated indexed linked during construction. Forward fundings
value have been the key factors the new entrants? the market if they are exclusively offering leases is currently strong, especially from of hotels have been dominated by UK
behind the demand. With questions management agreements. Although annuity funds that are unlikely to divest in institutional funds but we are starting to see
around the uncertainty of future In urban areas, particularly London, improving, the number of operators the short term which is limiting the supply the emergence of European investors willing
performance in a number of other we have seen the introduction of compact willing to enter into a lease agreement of investment opportunities. Investors have to take development risk.
assets classes, especially retail, this bedrooms. Premier Inn created the Hub therefore had little choice but to turn to
Lewis Corby, appetite has only increased. concept with bedroom sizes as small as This efficient use of space allows developments, purchasing off plan, typicallyWith this lack of supply and
Director, 11 square metres. CitizenM, with it’s owners to yield more per square by way of forward funding agreements. strong demand, we have seen
Investment Properties UK Hotel operators standardised 14+ sq m room, was one of foot out of their real estate. With this lack of supply and strong demand, some instances where the forward
the first innovators labelled as affordable we have seen some instances where the funding risk does not appear to
Historically, the leased hotel market was luxury. In the right locations, this efficient forward funding risk does not appear to impact pricing.
dominated by the budget operators Premier use of space allows owners to yield more with a strong covenant with full repairing impact pricing. This is usually where it’s
Inn and Travelodge; however, the appetite per square foot out of their real estate. obligations is still limited. A risk for investing a prime location with a strong underlying
to lease in prime locations has increased Another significant change has been in the in new hotel concepts is the ability to re- vacant possession value, subject to a good
dramatically. These new entrants are food and beverage offerings. Generally, let and the underlying vacant possession covenant lease and a credible developer.
predominately in the budget, mid-market or this is one of the hardest areas of a hotel value, but as further new operators enter
serviced apartment sectors and have been to generate profit. Some operators have the market, this risk is reducing. We have
willing to pre-let on a long-term basis. This reduced or removed food and beverage, seen a trend of institutional investors
has been one of the key drivers in attracting such as Nadler Hotels; others have brought starting to look at management agreements
hotel investors and developers. In 2019 the in external specialists, for example Hoxton where they can benefit from the upside and
new IFR16 accounting rules are coming Hotels. attain higher yielding returns. I expect this
into effect requiring tenants to bring most to be a growing trend going forward.
leases on to their balance sheets.
Travelodge Hoxton Hotels Hub by Premier Inn CitizenM
6 FIXED -INCOME HOTEL INVESTMENT | 2018 7
IS IT REALLY PRIME? FIXED -INCOME TRACK RECORD
The current strong demand for Coupled with a hotel’s configuration (room Croydon Park Hotel
long dated index linked hotel count and size, layout, other facilities), the
Location Greater London, UK
investments is compressing potential reasonable trade will be assessed
yields and narrowing the gap and provide both a market value with Rooms 211
between prime and secondary vacant possession and sustainable rental
hotel investment opportunities. value. Client Evans Randall
With prime yields going sub 4% Yield Confidential
it is important to understand and Assuming that all Premier Inns are
compare the key hotel valuation prime is either a pure covenant play Price In excess of guide price of £25.0m
metrics. or an example of what I call “brand
seduction”.
South Place Hotel
Mark Woolfitt, If we look beyond the covenant, what
Director, creates value in a hotel? The answer lies Where rent is agreed at a level such Location London, UK
Valuation Services UK in the ability to sell bedrooms and thereby as 75% of likely, or actual profitability,
Rooms 80
create a profitable business. That said, not probably means that during the life of
all hotels with the same brand name have the lease the operator’s margins may Client Frogmore Developments Ltd
equal trading potential over time because well come under pressure to service that
Yield 4.27%
of their location and/or their configuration. rent and this could lead to a reduction in
Assuming, for instance, that all Premier maintenance spend. The best located and Price £67.0m
Inns are prime is either a pure covenant designed hotels will perform better during
play (so property characteristics become the life of the lease and ensure a strong,
largely irrelevant) or an example of what stable investment. Rent cover of 1.5 to 2 x
Travelodge Liverpool Street
I call “brand seduction”. If you can’t would suggest a more serviceable long – Location London, UK
buy the “best” hotel then the competitive term position for the lessee. We have seen
nature drives the price on the next examples of high rental offers in lieu of a Rooms 142
best to the point where it can become capital payment up front and such offers
Client Goldman Sachs
indistinguishable from the price paid for need to be viewed with care, considering
the best; the brand potentially masking key both the underlying vacant possession value Yield 4.80%
value differentiators. This is of course yield and rental prospects upon reletting.
Price £42.0m
compression, which is fine if the underlying
real estate risk is understood and the hold The flight to quality continues; but we must
time horizon can accommodate a future not overlook the key hotel metrics and the Grove London Travelodge Portfolio
yield shift outward. differences between prime and secondary.
Location Various, Greater London
I believe hotels are good investments but
Location is as important for a hotel as want to ensure that our clients do not Rooms 4 Hotels
any other property and demand drivers, filter out “bad news” to buy secondary
infrastructure and existing and proposed investments at prime prices, or if they do, Client Goldman Sachs, Avenue Capital & Golden Tree
supply (competition) are all key factors. they do so with full knowledge. Yield 4.88%
Price £72.5m
8 FIXED -INCOME HOTEL INVESTMENT | 2018 9
FIXED -INCOME TRACK RECORD
Staycity Hayes
Location Hayes, UK
Rooms 269
Client Ballymore Group
Yield 5.40%
Price £32.7m (Forward Commitment)
Travelodge Southwark
Location London, UK
Rooms 202
Client Glebe
Yield 3.28%
Price £56.3m
Maldron Newcastle
Location Newcastle, UK
Rooms 265
Client McAleer & Rushe
Yield 4.99%
Price £32.7m (Forward Fund)
Holiday Inn York
Location York, UK
Rooms 161
Client Coloney Northstar
Yield Confidential
Price £15.3m
10 FIXED -INCOME
HOTELS
HOTELFIXED
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- INCOME| 2018
11 11
KEY CONTACTS For more information regarding this report or how we can assist you to realise your hotel ownership ambitions, please contact: Lewis Corby Marc Nelson Director Director Investment Properties UK Investment Properties UK t: +44 20 7182 3976 t: +44 20 7182 3610 e: lewis.corby@cbrehotels.com e: marc.nelson@cbrehotels.com Joe Stather Mark Woolfitt Associate Director Director Advisory Services EMEA Valuation Services UK t: +44 20 7182 2523 t: +44 20 7182 2598 e: joe.stather@cbrehotels.com e: mark.woolfitt@cbrehotels.com To learn more about CBRE Research, or to access additional research reports, please visit the Global Research Gateway at www.cbre.com/research-and-reports. CBRE Disclaimer 2018 CBRE Limited confirms that information contained herein, including projections, has been obtained from sources believed to be reliable. While we do not doubt their accuracy, we have not verified them and make no guarantee, warranty or representation about them. It is your responsibility to confirm independently their accuracy and completeness. This information is presented exclusively for use by CBRE clients and professionals and all rights to the material are reserved and cannot be reproduced without prior written permission of CBRE.
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