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Investors find new opportunity in the downtown hotel

How a property investor switcheroo is going to change your hotel world.

Words: David Thame

01/11/2019 6 min read

The money men and women that run the UK’s private equity, pension funds and insurers used to shun hotels. Whilst they were happy enough to lunch deliciously in Claridges or The Dorchester, the idea of seriously investing in UK hotel property gave them a nasty case of indigestion Hotels were regarded as one step away from restaurants, and restaurants are proverbially good places for investors to lose money fast. Thousands of beds, tens of thousands of bookings, the whims of tourists, the weather… the list of reasons not to get involved with hotel property was endless. So, on the whole, they left them alone. 

Today investors’ view of hotel property has undergone a complete 360 degree turn. Hotels, once regarded as the very definition of a real estate nightmare, are now welcomed as the very definition of secure, long-term income. UK hotels are a £20 billion goldmine.  As that massive re-think percolates through the real estate industry and into hotel operation and design, it is going to change hotels forever. 

So come to Birmingham, where the change in institutional attitudes is soon to be visible on hustling, bustling New Street. 

M&G Real Estate, the property arm of the mighty Prudential insurance empire, has long owned one of the shopping street’s many large and largely unused office blocks.  King Edward House, which totals 62,000 sq ft, was once the latest in office floorspace but has since become stranded on a largely retail pitch, whilst the office market has moved decisively west. Now M&G have shelved plans for offices and plan to convert it into a 259-bed boutique hotel. “We see real opportunity in repurposing this building to react to an undersupply of hotel accommodation in the city centre and to help support a thriving local economy,” M&G Real Estate Retail Development Manager Will Gerrish says 

“Advanced discussions are underway with a boutique hotel operator seeking its first Birmingham presence and we look forward to being able to share more details about them and their ambitions for Birmingham in due course.” Couched in the language of the business press release, the M&G announcement seems unspectacular. But that a fund of Prudential’s stamp is getting schmoozy with hotel operators is the stuff of revolution. 

M&G are not alone. Far from it. Some, like Aprirose, are taking their involvement far deeper than merely owning a building and finding an operator. Rather, they plan to operate the hotels themselves.  This summer the real estate investor launched its own hotel operating platform. The platform will initially be operated in conjunction with leading hotel operator, Kew Green Hotels, who will provide systems and support whilst the new service is established.  

Aprirose’s hotel assets already total 25 under a number of international brands from the major franchises, including Hilton, Marriott, Accor, plus its own QHotels brand. Aprirose’s QHotels are currently undergoing significant asset management and modernisation, with the rebrand of seven of the hotels, with the launch of 5 Doubletree by Hilton and 2 Delta by Marriott. 

Tim Shearman, Chief Executive at Aprirose Hotels, explains: “The creation of our own hotel operating platform will allow us to recruit industry leading talent and drive value for our clients. By initially working with the experienced Kew Green Hotels team it will allow us to hit the ground running and offer a seamless and best-in-class service to our customers. 

In other words, this is a long-term play which envisages national and international growth.  

Meanwhile, more traditional real estate businesses like Hammerson are re-allocating assets away from retail (a sector in turmoil) and into hotels, which in comparison seem like a remarkably safe bet. Their new “City Quarters” concept will replace their focus on shopping centres. The first plans for Birmingham and Leeds include hotel towers (14 storeys in Leeds). 

Sites like the Edinburgh Travelodge could have been residential development, and that gives us a high level of comfort. That kind of knowledge is really important to us. You have to look at the residual value of the property.

Meanwhile the hardest of hard-core private equity is also funnelling funds into hotels. UBS Asset Management, a business not known for its indulgence in fads or its casual lets-give-this-a-try approach to investment, has bought the 73-bed Edinburgh Travelodge for £9.4 million. It provides them with a yield (e.g. return on their investment) of 5.25%, appreciably more than alternative homes for their money, and forms part of a growing long-income hotel portfolio. 

Talk to UBS and the reason for the revolution in investor attitudes becomes clear. Howard Meaney is Head of UK Real Estate at UBS-AM. He explains: 

“We’re looking for long-term secure revenue streams with upward-only index-linked rent increases, and those are rare now in most sectors of the property business, but not hotels. And the beauty of hotels is that we can assess their covenant status. Because there are some very strong brands in the hotel sector like Travelodge and Premier Inn!” 

“Our fund is defensive about cash flow. It is long-dated secure income.” 

Travelodge has a lease that runs until 2042 (with the option to extend to 2047) with five-yearly uncapped RPI linked upwards only rent reviews. In property terms that makes the hotel an absolutely red-hot property. 

According to Meaney, the huge and complicated customer base of the hotel sector – precisely the factor that used to horrify property investors – is now its appeal. In short, the hotel sector stands on many legs (or sleeps on manty backs) when other types of floorspace (like an office block) depend on one or two or a handful of occupiers. More occupiers equals a safer bet, they think. 

Investors do have some anxieties. They worry that hotel operators are concealing income from hotel food and beverage operations (income that ought to be part of the rental calculations). And they worry that hotels need expensive and regular refurbishments, meaning headaches about depreciation. 

But those long hotel leases, with their upward only rent reviews, are so precious that these are problems they are prepared to overlook.  

And even if the bottom suddenly fell out of the hotel market (and they are sure it won’t), investors like UBS take comfort from the huge value of many hotels city centre sites. 

The about-turn in investor attitudes is fuelling the might brand-expansions of the leading budget and mid-price operators. 

There are clear opportunities for investors in the hotel sector nationwide at the development stage, which presents a long-term strategy providing a guaranteed stream of secure income.

The UK hotel industry saw the opening of 15,500 new hotel rooms in 2018, representing a 2.4% increase in UK hotel supply, with 2019 expected to add another 19,000 or more. So say Knight Frank, whose head of hotels Shaun Roy says that the tsunami of money now flowing into the hotel property sector is not going to ease. 

Shaun Roy, Head of Hotels at Knight Frank, says: “The hotel sector is undergoing robust levels of development activity, despite the continued uncertainty that Brexit brings. This is occurring both in London and the UK more generally and is particularly evident in those markets which have a diverse business mix, with a thriving leisure market such as Edinburgh, Birmingham and Brighton.  

“There are clear opportunities for investors in the hotel sector nationwide at the development stage, which presents a long-term strategy providing a guaranteed stream of secure income.”  

 

According to Roy, the investors see in the hotel sector the kind of gold-plated leases that they can no longer find in other sectors. 

“Investors used to think ‘oh God, hotels equal lots of customers, which will be difficult to deal with’ and now they think ‘this looks like safer income because it is diversified.’ This is a big shift in mindset and really significant.” 

Hotels offer investors a chance to buy into valuable downtown real-estate knowing that they still have the option of diversifying into city apartments, or offices, if values in those sectors make it worth their while. In short, hotels pay well today and promise liquidit5y tomorrow. What’s not to like? 

Moreover, investors eyeing up the city living market (including the burgeoning build-to-rent sector) see hotels as a way to de-risk their residential schemes. 

“Towers are expensive to build. A few years ago you might have built a tower and entirely filled it with apartments. Today, instead of 200 apartments you could do 100 apartments and a hotel. That kind of mixed use feels safer,” Roy says. 

The revolution in hotel property wrought by investors is not over yet. The dynamics which drove money into hotels is now driving it into other hospitality-linked enterprises from aparthotels to coworking. 

“They have looked at Airbnb and watched the disruption, and they have learned from it a lot more about what customers want. And what they want is their own private space but also the option to work or mix sociably if they want to. So we’re seeing a lot of boundary crossing ideas mixing coworking space, hotel space, apartment space, creative space,” says Roy. 

“For now, were hearing more noise about boundary-crossing development than reality, but it is certainly true that the hospitality industry has begun to engage with what people want. Airbnb was a wakeup call.” 

Thanks to the investors, who heard that call loud and clear and are now looking at funding the plethora of responses, the hotel revolution is far from over. 

  • See analysis of new boundary-crossing trends in hospitality our March 2020 edition, “The future of visiting.” 

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