The surge of interest in the hotel industry shown by private equity firms is a double-edged sword for existing hotel operators and owners.
While private equity is certainly helping to transform the industry, the reason it is able to is because of the failure of the existing players to exploit the full potential that exists in the market.
Sebastian Bazin, managing director Europe for US fund Colony Capital, made clear the opportunity the hotel sector offers. Speaking during MIPIM, the annual property industry charabanc held last week in Cannes, he said that private equity cannot compete on mature assets.
But the 'adaptive' nature of opportunity capital means it can 'exploit inefficiencies' by 'staying ahead of the curve'. Roughly this translates as where markets are too sleepy to notice and too inflexible to change, then private equity can come in and achieve a 20% plus internal rate of return on investments.
An appeal of the hotel industry has been that it is a less crowded market (until recently), meaning the field was open.
Bazin said that Colony, which has almost half of its funds invested in hospitality (29% in hotels and 19% in gaming), has achieved an average IRR to date of 28% in Asia and 27% in Europe. In the US, a more mature market, the IRR averages 20%.
The noose may be tightening in Europe too. Bazin said that in the auction for the 128 hotels sold by Accor last year, the pricing advantage was 20% to 25% in favour of the French REIT Fonciere des Murs compared to Colony.
In particular, where as Colony had to pay capital gains tax of 35%, Fonciere des Murs had only to pay 16.5% on the latent gain due to its special tax status. Plus, of course, as a SIIC, it is not taxed on the distribution to shareholders.
Almost a third of Colony's activity has had to be rethought as a result of the creation of SIICs, added Bazin.
Today (Wednesday) the details of the UK REIT legislation will be unveiled by Chancellor Gordon Brown. Provided the legislation is sensibly framed, then PE funds may soon have more to worry about.