European Hospitality Sector Outlook 2024

THE QUEST FOR HIGHER YIELDS

Pricing is likely to remain under pressure at least until interest rates begin to decline, expected in the second half of 2024. During this period, smaller deals below EUR 20 million are more likely occur due to lower dependence on debt, decision-making flexibility, and less IRR-driven investment strategies. Conversely, larger portfolio M&A opportunities are also gaining interest, with lenders and investors willing to invest substantial amounts in single transactions. However, the outcomes of such deals initiated earlier in the year remain uncertain. As a significant amount of hotel debt matures in 2024, some activity will result from refinancings, where lenders evaluate loan-to-value ratios (LTVs) and debt service coverage ratios (DSCRs) amid ongoing market repricing and income volatility. Distress is expected to be sporadic rather than widespread, surfacing on a case-by-case basis as loans mature.

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 favors 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.

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, as owners are reluctant to realise losses. In challenging situations, such as a need to deleverage, respond to fund redemptions, address the denominator effect, or raise capital for future acquisitions, owners may choose to sell well-performing assets that 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 Europe have already expanded by approximately 125 basis points, 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.

YIELD DECOMPRESSION ACROSS MOST MARKETS

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%

WESTERN EUROPE GREATER LONDON

ALL EUROPE

UNITED KINGDOM

Source: MSCI Real Capital Analytics

PRICE PER ROOM INDEX

HEDONIC SERIES, INDEX VS 10YR AVERAGE

130%

120%

90% 100% 110%

80%

70%

60%

50%

Q1 Q3 ‘08

Q1 Q3 ‘09

Q1 Q3 ‘10

Q1 Q3 ‘11

Q1 Q3 ‘12

Q1 Q3 ‘13

Q1 Q3 ‘14

Q1 Q3 ‘15

Q1 Q3 ‘16

Q1 Q3 ‘17

Q1 Q3 ‘18

Q1 Q3 ‘19

Q1 Q3 ‘20

Q1 Q3 ‘21

Q1 Q3 ‘22

Q1 Q3 ‘23

ALL EUROPE

WESTERN EUROPE

UNITED KINGDOM GREATER LONDON

Source: MSCI Real Capital Analytics

6 HOTELS OUTLOOK 2024

THE TIDE IS TURNING AMALGAMATED | 7