The return of the hotel market

The hotel sector has faced one of its most challenging years in history due to Covid 19. Premier Inn is a prime example, reporting a £1bn annual loss for the year to 25th February 2021 with sales falling by almost three-quarters. Year to date February 2021 saw actual reported occupancy for open hotels in the UK at 26% (down 61%)*.

How has the hotel market faired compared to other sectors?

It can be argued that offices and retail will never fully recover as people are adept to shopping online and working from home however hotels will certainly bounce back from the short-term impact of forced closure. There is a large choice of tenants from a variety of sectors for developers, so we always analyse the most suitable occupier from a value and reliability point of view. Hotel occupiers tend to compete against student, residential, offices and care for the most prime sites and all of these sectors have been impacted by Covid. Our view is that if hoteliers approach the market correctly then they can become a desired tenant for landlords again.

How to be desired by developers?

Ironically during times of uncertainty, the main thing landlords and developers look for in occupiers is certainty. From a wider market point of view, certainty means a strong performing tenant with minimal risk of them failing to pay rents or becoming insolvent. On a deal basis, certainty means that landlords want to see secure leases being signed for a substantial period to reduce the risk of their holding. So, for hoteliers looking to snap up best sites as we move away from the pandemic, the ones offering attractive lease arrangements to developers will be warmly received. Pre-Covid, the hotel market was moving towards hoteliers signing more Hotel Management Agreements (HMA) as they were in a strong position and HMA’s are more favourable to the hotelier rather than developer. This dynamic has now changed, and we are seeing a lot of hoteliers prepared to sign leases again.

What is an HMA?

Hotels often have an owner and operator relationship which is facilitated either through a lease or Hotel Management Agreement. The former involves a company signing a lease directly with a landlord for a fixed term with the hotel company responsible for all operations and therefore financially exposed to its performance. On the other hand, in a Hotel Management agreement the landlord/developer owns the building but also the hotel business and is therefore exposed to whether the hotel if profitable or loss making.

Hotel Management Agreements certainly became a favourite of the industry pre-Covid as hoteliers were in a strong negotiating position with landlords. HMA’s are a much-preferred agreement for hoteliers for the following reasons:

1. They do not have to commit to a hefty, fixed rent every year which under a lease would be payable regardless of performance.
2. The hoteliers receive their management fee regardless of the performance of the hotel.
3. If an unforeseen event happens (such as a pandemic) they will not be financially exposed and responsible for sizeable outgoings.

Historically, lease deals have been the predominant arrangement in the hotel market, landlord to operator relationship. In 2018/2019 we were starting to see the sector move more towards HMA deals as the market was in favour of hoteliers. The majority of landlords prefer leases for the following reasons:

1. They provide certainty of income.
2. Landlords are not exposed to the performance of the hotel on a day-to-day basis.
3. Leases are easier for landlords to value, and should they wish to sell the building it is a far more viable sale if a lease is in place rather than an HMA.

What will the hotel market look like post Covid-19?

Hotel operators are no longer in the strong position they were before the pandemic and at Jansons we are already seeing a variety of hoteliers prepared to take leases. Before Covid leases were few and far between but the savvy hoteliers realise that they will have to offer developer friendly deals in order to snap up the best positioned real estate. The pandemic has proved that property developers should stick to what they know which is the real estate world.

With an HMA developers are taking the risk on the performance of a hotel which is outside most of their experience and understanding. It is tough to value a building based off an HMA for landlords as there is no certainty of income. Potential purchasers of the building looking at the agreement will not be bullish on their values as it would be viewed as a high risk buy. Leases on the other hand are relatively low risk. In a market which will be in recovery mode for the foreseeable future, certainty is key, and this points to leases. Therefore, for hoteliers to secure the most competitive sites, they will need to reconsider their model and offer leases to developers and landlords. They might feel like this is a step back in time and that they are creating value for another company but it will be essential for them in order to occupy the most prominent sites.

*https://www.savills.com/research_articles/255800/312546-0