• Deep in debt, hotels face challenges

Debt providers are set to share the pain of the hotel sector’s hiatus, as it moves to recovery.
But despite fundamentally high levels of debt in the space, it appears unlikely there will be a move to foreclose, as in the aftermath of the financial crisis.
Inevitably the sector is already seeing casualties, as smaller and largely unbranded hotels declare they will not reopen. Across the UK, there is a steady trickle of properties, usually privately owned, laying off staff permanently, after viewing the length of the road ahead towards recovery.
More recently, midmarket group Macdonald Hotels has moved to put all staff into a consultation process, which in the UK is a necessary first stage ahead of redundancies. “With no realistic prospects of a return to anything like normal trading for the foreseeable future, we were simply left with no choice,” said Macdonald group deputy chairman Gordon Fraser. “Potentially, we are looking at around 1,800 roles at risk, in all areas and at all levels of the business.”
And accounting group Boodle Hatfield has warned of the high level of debt currently carried by the hotel industry. It has calculated the UK’s top 30 hotel groups have a total debt of GBP6bn, 44% higher than the GBP4.2bn they were carrying during the credit crunch in 2009. The total represents 106% of shareholder funds.
The practice notes that hotels have continued to add to debts during the last year, notably in London, as they invest in improving their assets to attract higher margin business. Partner Adam Chamberlain said hotel owners need to get their action plan together. “It’s clear that, in flagging the tapering down of the furlough scheme, the chancellor will start to focus minds on restructuring. Adapt for now and take what income you can now – but realistically, any income is going to be, at best, patchy.” He warned there is no point waiting for the new normal to arrive: “Those who are proactive will be in the vanguard.”
Chamberlain sees three broad groups of hotel situations. The top category are those where there is inherent strength, and an accommodation can be made by the parties involved, notably something that applies to development projects. Boodle Hatfield is working on conversion of India Buildings in Edinburgh, to create a Virgin hotel, which is being funded by third party debt. “That was signed off after lockdown,” he noted, with little fundamentally changed aside, perhaps from some modest delays in construction.
At the other extreme, he sees companies or individual hotels that were already under pressure. “There were lots that were kicking the can down the road – some will just go to the wall,” though he does not expect to see a rush from lenders to foreclose.
Between those two extremes sit a large number of surviving businesses. “The most interesting part will be in the middle – that’s where we’re going to see the opportunities. Because there’s a lot of leverage in the sector, what it needs is more equity investment. There is plenty of scope for mutually beneficial opportunities out of this.” He expects lenders are less likely to enforce on borrowers, with the market for the next year or more focused on moving towards a more normal trading environment.
And it may be some quarters ahead, before the real cashflow crunch comes. Speaking at an industry conference, PwC industry leader for hospitality and tourism in EMEA, Nicolas Mayer, referred to the “valley of death” that hospitality operators now face, as they incur the costs of reopening, while revenues will take some time to ramp up. “That gap can be 150 days,” he warned.
At Aareal, Bettina Graef-Parker, managing director of special property finance says the group has been sharing the challenges – but remains as keen as ever on the hotel sector.
“We’ve never dealt with anything like this,” she told Hotel Analyst, “despite having been through the financial crisis with hotels.” The lender has advanced around EUR8.5bn of commercial mortgages against hotels, the majority of which are located in Europe and North America.
She notes that the closure of a hotel requires contractual adaptations, as the lending agreement will require the asset to continue trading.
“We have borrowers that are very experienced and have been with us for a long time. This should be a team effort shared between the borrower, the lender and the operator.” At Aareal, the approach has been to look at the cash burn of a property, to understand what level of joint support will be needed to ensure the business retains its long-term health.
Emerging from the crisis, Graef said there will be changes. “Generally, one can say that pricing has increased, but our appetite remains. Financing costs have obviously increased, and LTVs have gone down.” She cautioned that existing fundamentals, such as new supply into specific markets, will still be the key determinants of performance.

HA Perspective [by Chris Bown]: Right now, only the seriously adventurous want a hotel on their hands. Move forward a few months, with guests travelling again, that mood may change. But there’s certainly a feeling that the banks are not in a mood to foreclose on any scale – at least in Europe. The US, with more complex and more highly leveraged deals, are already seeing a few instances where keys are being handed back.
But there are still plenty of things to unravel, not least those complex instruments of the recent past, ground rents. And some have warned that, with rents and tax bills only being deferred, the real pain could be seen in mid-2021.

Additional comment [by Andrew Sangster]: Just as in the period following the GFC in 2008, you can group hotel companies into three camps: the good, the bad and the ugly.
The good are sustainable businesses that may in the short-term breach some covenants and may need to refinance but are otherwise sound. As we write above, this may include a number of development projects (although I would argue that many of these are more vulnerable than is currently understood).
The bad are those businesses that had been profitable before the pandemic but now find themselves in a position where they cannot service debt or meet lease obligations. These companies will need recapitalising but the day of reckoning may be many months off yet.
The final category is the ugly, a group which encompasses those hotel groups that were already in trouble before the crisis, like Macdonald Hotels. It is hard to see how such companies will last for long: as we are seeing in other operational real estate sectors, such as restaurants, administration, CVAs and maybe even closures seem probable.
The majority of action will ultimately be in the bad category. These have unsustainable capital structures that need fixing. Private equity is an obvious source for this cash but hefty discounts will be expected.
Timing is going to be hugely important. And the pandemic has bolted on a whole new area of uncertainty around when the businesses can start generating a positive cashflow again. Some operators are claiming that this can be achieved with occupancies as low as 30% to 40%. Maybe.
The challenge is that consumers will not want to pay for the poor experience they are going to receive when staying at hotels. If service levels are cut back, access to facilities like gyms and pools reduced or stopped, rates will have to reflect the new reality. A five-star hotel will now offer little more than a Travelodge, perhaps just a slightly bigger room. Consumers will want room rates to reflect this.
Historic trends showing break even at a certain occupancy only have relevance if rates hold. For luxury and boutique properties this is not going to be easy. Any restructuring of the capital structures of such businesses will need to reflect the ongoing losses being made on re-opening. While well-located urban assets will have significant alternative use value, this is less likely with suburban and country properties.
Alongside the trading challenges on re-opening is the weak macroeconomic picture. There remains a big divergence of views. Some are still holding fast to a V-shaped recovery. This may well look right in that switching from a situation of no trade to some trade is clearly going to show a strong growth. But what matters is how close we get to returning to business at 2019 levels. This doesn’t look good.
This month (10 June) the OECD group of big economies published economic forecasts. These showed the UK suffering a 11.5% drop in GDP in 2020 followed by a 9.0% rise in 2021. The Euro areas was down 9.1% in 2020 and up 6.5% in 2021.
So by the end of 2021, economies are still significantly below where they were at the end of 2019 (remember that the percentage rise on rebound needs to be bigger than the drop to fully compensate).
But it is possibly much worse if we get what the OECD economists describe as a “double hit”. Then the UK will go down 14.0% in 2020 with a meagre 5.0% bounce in 2021. The Euro area goes down 11.5% in 2020 and has a feeble 3.5% bounce in 2021.
The OECD also produced stats on the debt-to-equity ratio in different industry sectors. For accommodation and food services the numbers, based on 2018 figures where available, were grim with French and German industries averaging around 1.75 and Italian about 1.5. Of the major Euro economies, just Spain was below 1.0.
There remains so much uncertainty about the depth of the economic downturn and how profitable hotels can be as they reopen. It seems unlikely that people will be rushing to strike deals this year but there is much anticipation about 2021.
Optimists will point to the wall of money waiting to be deployed and the palpable FOMO (fear of missing out) that abounds. Pessimists will argue that the depth of the likely recession, possibly the worst in hundreds of years, will lead to a grindingly slow recovery with hotels and many other sectors of operational real estate, the slowest to get back to profitability.

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