• PE stress over lack of distress

The lack of distressed sales in the hotel market may be good news for the stability of the sector in general, but has been a disappointment to vulture funds seeking to turn a profit in the downturn.

Last week's Euromoney conference, the 10th Annual European Hotel Finance & Investment Summit held in London, highlighted the contrast between cash-rich funds unable to find acquisitions which met their return requirements and a cautious lending environment which has seen competition for limited resources keeping all but the strongest contenders on the sidelines.

Marty Kandrac, a managing director at The Blackstone Group, bemoaned the lack of acquisition opportunities, but was hopeful that 2011 and 2012 "should be floodgates" as lenders brought the current period of "amend and extend" to a close.

The comments were echoed by Ramsey Mankarious, CEO, Cedar Capital Partners, who said: "It's the right time in the cycle to invest. It might not be the absolute bottom, but you're buying for a five to 10-year hold. The biggest challenge is finding assets to buy. Often the seller's idea of a price is too high, but the gap is narrowing.

"I think we've been through the worse. We've made more offers in the last couple of months than we have in the last couple of years."

Kandrac added: "It's a high risk asset class, but if done right over a long period of time it's very rewarding. The reason very few deals have been done is because there has to be lower value to get some growth."

The funds have in turn found themselves priced out of the market by high net worth buyers for trophy assets, who are happy to acquire them for a lower return. Josh Wyatt, director, hospitality and leisure, Patron Capital Partners, said: "You can't compete with that if you want to own it for three years with IRR at 20%. The higher up the scale you go, the more likely it is that we are not going to be buying that asset."

One of the issues facing current and future sales of assets, Wyatt added, was that, with a fall in volumes of readily-available cash, properties were being neglected. "There's a lack of sponsor equity", he said, "which has created a capex bomb".

An asset owner who has failed to provide a flood of distress, Peter Anscomb, senior corporate director and head of hotel finance at The Royal Bank of Scotland, said: "Banks must decide how much loss they want to crystalise. If one believes in the product, selling it at a loss is merely giving the profit to the next purchaser."

He added: "The one thing that seems immovable is the expectation of return on equity."

Offering a glimpse at an upside was Russell Kett, managing director at HVS, who presented a method of valuation which took the future debt which could be raised on a property and wove it into the current value.

Kett's example showed a hotel purchased with all equity, or 50% LTV, which was then refinanced in 2013 with 70% LTV and sold in 2019. Using this method, which assumed an improvement in lending conditions, values could be raised by up to 30%, narrowing the bid-ask gap. This method, Kett suggested, would more accurately "reflect current and medium term lending conditions".

But the debt financiers in the room were sceptical and lined up to criticise the approach.

With private equity representing a wall of money with nowhere profitable to go, the other end of the spectrum saw lending further limited by the estimated Eu40bn of European hotel debt which must be refinanced between 2011 and 2014, according to David Rowe, partner at Talbot Hughes McKillop.

Rowe warned that the hotel sector "may get squeezed in the fight for refinancing", with owners "perceived as bearing an ever-increasing share of the operations risk and hotels operationally complex compared to other real estate investments" .

Like Kandrac, Rowe thought that there would be some movement away from "amend and extend" to more extensive restructurings, which would be driven by improvements in market confidence, combined with an inability to refinance on current or remotely similar terms and ongoing cashflow concerns.

Jon Hubbard, managing director, Jones Lang LaSalle Hotels, agreed with Rowe's assessment of perceived risk in the sector, with developments in particular low down in the "debt pecking order". He was, however, convinced that there was "institutional funding for prime leased assets…from the very limited group of banks open for business".

With the focus back on the banks to relieve the lack of the funding in the sector, the comments from the lenders' panel were indicative of the increased demands banks have of their clients now that supply of funding is at a premium. All concerned were interested in increased transparency between parties, in addition to greater risk sharing.

Bettina Graef, head of hotel properties, Aareal Bank, said: "There are problems with brands not willing to share operational performance. We need more transparency, because at the end of the day it's an operational financing."

Tim Helliwell, head of hotel finance, hospitality and leisure team, Barclays Corporate, said: "Lenders are increasingly attempting to be clear about what needs to go into a deal to make it work. It's all about deliverability and for deliverability you need clarity.

"We are seeing risk share in terms of constructors putting in money, or local government coming in where they see that there is an upside. There is a degree of greater risk share coming in."

Tim Lloyd-Hughes, vice-chairman of real estate, gaming and lodging, EMEA, Deutsche Bank, added: "How can the brand be helpful? Put some equity in."

The debt financiers stressed that lending in today's market was all about cash flow, not loan to value.

Bill Waite, head of hotel financing, AIB Capital Markets Britain, said: "We don't treat hotel lending as property lending, we treat them as an operating business. Look at the business providing the cash flow that is going to service the debt.

"It's back to Banking 101", said Lloyd-Hughes, "it's all about cashflow. For the last 10 years we were not lending on real estate or hotels. The banking industry has been through the shits just as much as the hotel industry, if not worse. Now that the world has corrected itself, we are in there refinancing, taking over from other lenders, doing more loans. The question is, does it all stack up to make a decent return?"

The consensus from the panel was that they would lend six to seven times Ebitda, possibly higher for refinancing/restructuring, with an eye on existing relationships and with the more transparent management contract favoured.

 

HA Perspective: There is no question that there is an enormous volume of distressed hotel lending still being sat on by debt financiers. In the first two to three years of this down cycle (depending on whether you date from the summer of 2007 when lending stopped or from the autumn of 2008 when the economy collapsed), very little has been traded.

This has annoyed the vulture funds set up in expectation of picking over the bones of distressed assets and plucking some bargains.

Such funds argue that the banks are merely putting off the inevitable. Blackstone's Marty Kandrac suggested that in effect banks were making today's customers pay for the previous lending mistakes via higher margins.

The lenders retort that it is more a case of returning to normal after the aberration of the three years or so leading up to the summer of 2007 when lending was exceptionally loose and done at uneconomic margins.

What seems clear, however, is that the lenders are in no mood to take a massive write-down on their books and leave massive profit opportunities available to equity investors with enough cash.

It was argued that this attitude will change when borrowers are faced with a repayment date. While this is certainly more serious than say a loan to value covenant breach, such problems can still be amended and extended if all parties play ball. It is hard to see the crunch that some are predicting.

Rather, it seems likely that a range of factors will lead to deals falling apart and assets coming to market. Principals falling out with their borrower, or simply walking away, is a strong candidate. It is hard to see why this will suddenly be a flood – a steady trickle seems most likely.

The "capex bomb" is another candidate for precipitating an asset coming to market. Properties will spiral into decline without some investment. But the banks have a legion of wily asset managers to advise them through this and the capex bomb is unlikely to provide the sudden explosion some are hoping for. A muted fizzle seems most likely.

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