European Hospitality Sector Outlook 2024 - Extended Version

THE QUEST FOR HIGHER YIELDS

THE QUEST

IT TAKES TWO TO TANGO

YIELD DECOMPRESSION ACROSS MOST MARKETS

Despite a considerable amount of capital waiting on the sidelines, finding a product in the market with the right price and income growth potential for sufficient returns has proven challenging. This difficulty arises from the notable yield decompression driven by the cost of financing and owners' reluctance to realise losses. Consequently, when owners need to dispose of assets in a challenging environment, for example, to deleverage their balance sheet, respond to fund redemptions, address the denominator effect, or raise capital for later acquisitions, they may opt to dispose of well-performing assets. This somewhat puts a bull's eye on hotels that, being higher-yield real estate, are less sensitive to yield increases. Moreover, hotels have been experiencing robust income growth in many markets, allowing for yield decompression without a significant reduction in value, thereby narrowing the bid-ask spread. Current trends, as indicated by the hedonic data series from RCA, suggest that hotel yields in Q3 2023 in Europe have already expanded by approximately 125 basis points relative to 2019 levels, with the UK leading the way (an increase of 178 basis points), excluding London, which continues to hold its value. Although hotel yield decompression in the UK is expected to slow down with increased activity, considering the market has nearly reached a record spread going back 15 years, the rest of Western Europe has been lagging and may witness further decompression.

While long-term convictions take precedence, the inherently "higher yield" nature of hotels as operational real estate holds significant importance. In the current high-interest rate landscape, deals must offer an appealing yield premium to justify financing costs and achieve positive leverage. This somewhat favours hotels, given their range of risk and return opportunities, spanning from fixed leases to fully variable income structures. Moreover, hotels, being operationally intensive and complex, provide ample chances to unlock value through active asset management. With increased financing costs, deals must present both a healthy initial yield and a notable upside opportunity to be financially viable. Given the limited distress sales in most sectors, investors are directing their available capital to operational real estate, particularly hotels, with a focus on value add transactions. Although such opportunities are scarce, they appear more prevalent in the hotel sector compared to others. Unsurprisingly, markets characterised by a broader array of hotel operating structures, like Spain or France, continue to maintain investment activity. In contrast, markets dominated by "dry" leases, such as Germany, remain subdued, a trend likely to persist into the next year until interest rates decline and values are rebased.

7.0%

6.7%

6.7%

6.5%

6.4%

6.3%

6.0%

6.0%

5.6%

5.5%

4.9%

5.0%

4.9%

4.7%

4.6%

4.5%

4.4%

4.0%

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q4

Q1 Q3

WESTERN EUROPE GREATER LONDON

ALL EUROPE

UNITED KINGDOM

Source: MSCI Real Capital Analytics (hedonic data series)

With increased financing costs, deals must present both a healthy initial yield and a notable upside opportunity to be financially viable. "

8 HOTELS OUTLOOK 2024

THE TIDE IS TURNING AMALGAMATED | 9