Reimagining Real Estate: Hotels: the current landscape: a U.S. / UK comparison

What are the trends and market conditions we are seeing in the hotels sector at the moment? How may these impact investors?

In terms of market conditions, the hotels sector has recovered well from Covid. There was initially a strong rebound which has now moderated. In the UK, hotels are currently enjoying very high occupancy rates – in fact, the UK leads the world here. Hotels have also seen strong growth in average daily rates. The UK also has a large development pipeline with around 91,000 rooms - this is the fourth largest in the world. The improved investment volumes we are seeing in the sector are expected to continue.

In terms of the political arena, in the UK we are waiting to see how the policies of the new Labour government will impact the sector. The good news is that the new government clearly views hospitality as a key sector, but they are also likely to introduce new regulations that will have an impact, especially in relation to labour laws (as we have seen) and also around ESG.

In terms of trends, we are seeing more hotel conversions taking place rather than ground up development – this is because building a new hotel is both hard and time-consuming. This, coupled with higher build costs, and higher lending costs, are not giving the desired returns. So, we are seeing that conversions are fuelling expansion in the hotel sector, supported by finance from alternative providers who are prepared to lend at higher loan to value ratios.

A trend is also emerging of new hotels being built around stadiums and events venues. UK sports venues are looking to develop U.S. style entertainment districts.

The luxury sector has been particularly strong with a significant number of new openings. The other emerging trend is branded residences – in recent years, branded residences have seen significant evolution, and are set to enjoy enormous growth as consumer demand continues to swell. Supporting this expansion is the continued growth of high-net-worth and ultra-high-net-worth individuals. Customers of branded residences are demanding bigger spaces with concierge services, integrated with hotel services giving access to gyms, spas, and fine dining options. But at the same time, privacy, security, and independence are also key in this area.

And, finally, any discussion about trends would not be complete without talking about AI, and what this means for the hotel sector. The feeling is that a customer-centric industry like hospitality is not going to get strategically disrupted by AI, but there is likely to be tactical disruption with a significant number of jobs in the back office potentially being disrupted. AI is proving useful for the industry because hotels are finding it difficult to hire staff, and the industry could enjoy greater levels of productivity and profitability thanks to AI tools. Clever use of AI will give staff more time to focus on taking care of customers, and also assist with providing a seamless guest experience.

What are the planning issues to be aware of when repurposing to a hotel?

Although there is an established history of repurposing buildings to hotels in the UK, the planning position regarding this particular change of use is not particularly sophisticated or helpful. Hotels are in use class C1, alongside boarding and guest houses. As they are in this quite narrow use class, it means that there is not automatically the flexibility to switch to or from this use to another as there is for, say, retail units or offices, falling within use class E. So the starting point is that planning permission of some kind is required for the change.

In recent years there's been somewhat of an explosion in permitted development rights, which grant blanket planning permission for certain changes of use, subject to certain, often local, exclusions. This means, for example, that in many cases you can change from office use to residential use without the need to secure planning permission. Hotel use, though, has been noticeably absent from these changes, and it remains the case that in order to change to or from a hotel use, you need to secure planning permission, save for the very limited case where a hotel is being changed to a state school.

Given the growing number of vacant buildings, often in central locations, which would seem potentially a good fit for hotels, it seems surprising that the planning regime has not caught on to the potential for repurposing buildings in this way, especially, as local authorities are often keen to see active uses, such as bars and restaurants, which are often included within a hotel use.

Perhaps, though, it is the very breadth of types of hotels, and associated uses, which has left it out in the cold in terms of planning relaxations. Many planning permissions for hotels have detailed conditions controlling the hours of operation of different ancillary facilities, such as bars or gyms, and in particular when, and to what extent, they can be used by guests versus non‑residents. These issues remain a very real concern for many local planning authorities, as well as concerns around security and servicing, and it is often only through planning restrictions that these issues can really be controlled.

If you are considering repurposing a building to hotel, the need for planning permission need not be a significant obstacle. With increasing focus on embodied carbon and LPAs keen to bring activity back to their areas, there is often a real appetite for these projects. Early engagement with the LPA can be key to ensuring that a robust, operationally appropriate consent can be secured.

One particular feature which is perhaps more relevant to the repurposing of buildings to hotels than to other uses is the tendency to bring back historic buildings into a new use, for example, banks or former civic buildings. Where you are repurposing historic buildings, there are extra considerations from a planning perspective. If the building is listed as a building of special architectural or historic interest, then listed building consent will be required, and this will relate to both internal and external works. Even if the building is not formally listed, it may have a local listing, or form an important part of a conservation area. In both of these cases, although no separate consent will be required, there will be extra hoops to jump through in order to secure the planning permission for works to the building.

What are the main issues regarding financing in the hotels sector? How is the funding gap impacting the sector?

Looking at the wider global context, we are seeing a backdrop of increased geopolitical risk and uncertainty, with elections bringing political instability or inaction during election campaigns and stubborn inflation and high interest costs – or the unpredictability of where rates will go next. In the context of commercial real estate and real estate finance, these factors have led to lower property valuations and a substantial increase in the cost of financing. These factors together have served to slow down transaction activity and depress financing activity too. The fact that interest rates have stabilised and are starting to reduce is positive for the sector.

Certain asset classes face greater challenges than others and while many of the European real estate lenders have pulled back from real estate lending during these challenging times, hotels as an asset class has remained attractive and continues to flourish.

Looking at the picture in terms of loans, we are seeing that loans are coming up for refinancing in different economic times to when they were signed. This is resulting in tighter terms and higher costs, more restrictive covenants and less flexible LTV ratios. The practical result is that borrowers could face funding gaps in what they can raise against what needs to be repaid and on less advantageous terms.

There have also been changes in the providers of finance – with traditional lenders stepping back and being less active, in the face of tightened lending criteria, tougher credit standards and regulatory concerns such as higher capital requirements. This trend has meant opportunities for private capital to step in, albeit with the higher pricing typical for private capital deals; high net worth individuals and family offices.

So there is a large need for capital now and in the near future – and the funding gap needs to be closed – and that leads to opportunities and challenges for parties in the hotel market to meet that need or for opportunistic investments, divestments and so on. For owners and borrowers facing up to refinancing or needing to raise new finance, it is particularly important to plan ahead, get organised, plan for a potentially longer process from start to finish than we have perhaps seen over previous years as deals can take a little longer to come together.

Although the economic landscape remains complex, the outlook for the remainder of 2024 and into 2025 gives reason for cautious optimism for the hotel sector and therefore financing of hotels. Interest rates are stabilising and potentially being reduced and this is likely to encourage investor confidence and drive further activity in the market.  There is more pressure for market participants to be realistic about asset pricing and to close the pricing gap between seller and buyer – this is crucial for facilitating transactions and driving market activity, and in turn at prices which provide comfort.

How is the current financial picture affecting repurposing?

Upfront costs for repurposing buildings can be substantial and we are seeing the same challenges and opportunities for raising debt for repurposing as elsewhere in the real estate finance market. But there are ways to stand out and increase interest in financing a repurposing project. Hotels can be particularly attractive here as they provide reliable investment potential; and when well managed and operated, they provide both regular income streams and are attractive assets for resale. All of these factors mean that hotels are attractive as an asset class for repurposing. Engaging with a competent hotel operator with the right strategy means that completed developments will promptly achieve stabilised occupancy.

What about capex?

When we are looking at the funding of capex through new loans or existing loans, the same challenges may arise in terms of raising debt. There will be restrictions around spending the capex and related reporting then additionally some lenders will not allow distributions during capex work that they are funding.

During the pandemic, some hotel owners shifted funding away from capex to help shore up their positions and survive the pandemic. This has in some cases meant capex is now under-funded but the work is due or overdue, either to keep competitive, to meet brand and operator requirements or at the point where the owner had been planning to exit, meaning dampened valuations.

Being aware of existing financing arrangements and requirements is a must before carrying out a new project. Existing financing conditions and requirements are also very likely to require lender consent for any renovations or construction work.

What trends are we seeing in terms of ESG?

Looking at ESG, and opportunities for green loans and sustainability linked loans, the hotels industry is building a track record now of having a real and meaningful focus on ESG. It is an asset class which is ripe for advances in this area and leading the way within the real estate industry by incorporating good practice from energy efficiency to managing food waste to opportunities to operate with socially responsible business practices. The hotel industry is already well on its journey in relation to sustainability as that is what customers now expect.  There is more work to be done, but many brands have brought sustainable principles into their supply chain. Whilst hotels are not generally that efficient when it comes to energy consumption we are seeing that ways of incorporating smart building tech into new builds or refurbishment would be a positive way forward. Repurposing might well provide that opportunity.

Looking at the European picture, while many of the European real estate lenders have pulled back from real estate lending during these challenging times, hotels as an asset class has remained attractive and another potential hook has been the ability to make green or sustainability linked loans, which are increasingly popular.

Hotel investment

The UK hotel investment market is reported to have seen a very significant resurgence in the first half of 2024, with investment volumes reported to have reached around £3 billion in the period between January and the end of June 2024. This marks a substantial increase from 2023, which reportedly had total investment for the whole of the year of £2 billion. Hotel assets are increasingly becoming a must-have asset for any balanced investor or fund. As such, competition for the quality products is likely to remain strong. Brands continue to develop new offerings to catch customers' imagination and we see this trend continuing.

Looking at the European hotel market, investments in the first half of 2024 are reported as being in the region of EUR11.6 billion, with luxury and upper upscale hotels accounting for nearly 50% of the total first-half volume. This very positive growth story can be attributed to several key portfolio transactions and the continued interest of international investors, particularly from the United States. Perhaps we’ll see more smaller or individual asset deals next year in the UK, and potentially larger or portfolio deals in the European hotspots and gateway cities.

Hotel outlook in the United States

The outlook in the US shares many similarities to that in the UK. Market conditions remain strong with more service economy and extended stay hotels and luxury hotels leading the charge, but the resort hotel market may be showing signs of softening. Many hotel lenders refuse to finance boutique hotels, new hotel construction has slowed and refinancings are slow to realize unless necessary and even then, the sale of the hotel may be preferable.

Nonetheless there seem to be improved investment volumes in the sector which is very encouraging and as mortgage rates are expected to decline, we expect investment volumes to continue to improve and lower borrowing costs may also increase opportunities for repurposing.

The U.S. continues to see measured increases in hotel performance although it is often two steps forward, one step back. Growth is still often driven by geographic location, with the sunbelt again showing particular strength this year. The first part of the year continued a strong hotel development trend, with Q1 setting an all-time record (1,144 projects comprising 141,336 rooms under construction). This comes at a time when sales of established hotels are relatively thin. Solid performance is still not enough to bridge the continuing gap between seller and buyer pricing expectations. The average occupancy rate for hotels recently was at a respectable 70.1%, showing a 1% increase measured against the same period last year. The average daily rate for the same period rose by 2.5%, hitting U.S. $169.85, and Revenue Per Available Room rose by 4.2% to U.S. $119.01.  Unfortunately, inflationary pressures take a bite out of many of these gains. Many owners are choosing to instead invest in improving their existing properties with significant capex projects. Interest rates remain stubbornly higher than anticipated despite the Federal Reserve’s rate cutting and $25 Billion in CMBS loans are due or about to become due. Owners will have to be creative and come up with cash to sort these loans out. It is neither the best of times nor the worst of times. But there is guarded optimism in the market.

The recently conducted U.S. elections for the Presidency, one-third of the Senate and the entire House of Representatives could bring good news to the hotel industry and its profitability, with some differences that should come immediately. The National Labor Relations Board’s (NLRB) recent new rules for determining joint employer status, which went beyond any similar rules established during the Administrations of previous Democrat presidents, will likely be repealed very quickly on in the Trump Administration. Rules proposed or pending at the Federal Trade Commission (FTC) impacting the industry, such as those addressing resort fees, will likely be repealed, perhaps before they even come into effect.  And the Biden Justice Department’s impact on hotel companies with what some see as overly wide interpretations of antitrust laws will also be a thing of the past.

The generally more favorable positions of Republican Administrations to the hotel industry on matters including tax policy, labor policy and the regulatory environment could unlock significant growth opportunities for the industry. A potential concern for the industry is whether the President-elect’s immigration policies go beyond the least restrictive means necessary to achieve their goals and whether that has the effect of reducing foreign travel and tourism to the U.S.

Next steps

Although the economic and political landscape remains complex and difficult to predict, the outlook for the remainder of 2024 and into 2025 gives reason for cautious and guarded optimism for the hotel sector on both sides of the pond, an optimism which we hope will continue and result in a strong performance and plenty of opportunities for growth next year.

Authored by Jackie Newstead, Hannah Quarterman, Ana Tenzer, Michael Kosmas, Katie Gill, Janan Kanagaratnam, Stella Bliss and Ingrid Stables.