Hotel Values In Europe - Current Trends - By: Russell Kett - HVS International
The values of European hotels have, on average, declined in the past two years due to two principal factors - the economic downturns in major demand generating countries such as the USA, Japan and Germany, and the aftermath of the horrific events of 11 September 2001. It is sometimes not fully appreciated that hotel values in 2001 were already on the decline prior to the impact of 9/11.
By the end of 2001, HVS International's annual European Hotel Valuation Index report recorded an overall decline in hotel values among the 28 cities surveyed of 2.6%. This should be set against rises of 7.8% in 2000, 2.0% in 1999 and 7.3% in 1998. Even among the 28 cities there were "winners and losers", as shown in Table 1. Generally the decline in values in 2001 was fuelled by a decline in RevPAR (rooms revenue per available room) but this decline itself was caused mainly by a drop in occupancy rather than room rates.
Table 2 illustrates the range of values per room in each of the 28 cities surveyed as at the end of 2001:
London and Paris still head the league table with hotel values, for a typical international quality four-/five-star hotel, of more than €450,000 per room. Hotels in Milan, Zurich and Geneva had a value of more than €350,000 per room, and Rome, Amsterdam and Madrid's hotels were valued at more than €250,000. It is here that we can also put into context the strong growth in the value of Moscow's hotels (17% in 2001) - from such a small base, with values around the €130,000 mark in 2001, just ahead of the average for hotels in Athens. However, with the Olympic Games scheduled to be held there in 2004 it is likely that hotel values in Athens will show more significant growth in the short to medium term, as investors aim to capitalise on the city's worldwide exposure.
At the time we prepared our survey of European hotel values as at the end of 2001 (March 2002) we envisaged a modest growth in values for 2002 of 1.3%. However, as the months of 2002 have progressed, it has become clear that, in the case of most cities, hotel performances have failed to improve and, in some cases, have declined further. Usually a decline in RevPAR performance - especially if coupled with either an actual increase in supply or the prospects of one - will cause hotel values to fall.
So what else influences hotel values?
On the positive side, the current low interest rate environment, with rates continuing to fall in some cases, acts to reduce yields and improve values. In some cities, hotels have achieved an improvement in RevPAR and there are better prospects for the future, albeit perhaps benefiting from other cities' miseries. This can be helped further by having a strong brand and effective marketing, by an agile and experienced management who can respond quickly to changes in market and operating conditions. All these can help to achieve improvements in a hotel's net earnings and, therefore, act as a positive stimulus to its value.
However, there are also negative factors that will work to depress hotel values further. In addition to a decline in RevPAR, the current uncertainty surrounding the future prospects for the hotel sector, the reduction by some lenders in loan-to-value ratios and the increased perception of risk by some investors (thereby increasing yields) all serve to depress hotel values. Add to that a concern that significant capital investment may be required and it is not difficult to see where hotel values will have declined.
Despite the somewhat negative picture presented here, there remains considerable interest in the hotel sector from investors keen to take advantage of the underlying strength in demand for tourism generally and the belief that hotel demand will pick up in time. Major transactions have taken place to underline this point, although there have been somewhat fewer in Europe in the past year, following 9/11. There have been some notable single asset sales, such as the Hotel Arts in Barcelona for €290 million (€634,000 per room) to a consortium headed by Patron Capital and Deutsche Bank, and 47 Park Street in London for €43 million (€810,000 per room) to Orion Capital. However, most of the main transactions have involved corporate deals including several sale-and-leaseback transactions. These include Orb Estates' acquisition of 37 Thistle hotels in the UK for €950 million - 5,454 rooms at an average of €174,300 per room, and Hilton Group's sale-and-leaseback of ten hotels to the Rotch Group for roughly €250,000 per room.
There seems to be no shortage of potential buyers - and no shortage of cash available - to acquire hotels. Equally so, owners are not under sufficient pressure (yet?) to be forced into making unwelcome disposals and so the bid-ask price gap is still large: buyers are unwilling to pay the prices commanded by the owners.
So where are hotel values heading? At the time of writing (December 2002) it has never been so difficult to predict future trends. The hoped-for economic upturn in 2002 has really not materialised and prospects for 2003 are not yet sufficiently encouraging for businesses to increase their travel budgets, up their conference attendances, expand marketing plans and so forth. The imminent possibility of a second Gulf War - and the uncertainty over when it could start - adds further fuel to the fire of uncertainty. Most pundits, myself included, feel that it will be the end of 2003 or into 2004 before any noticeable improvement is achieved. The timing uncertainty is exacerbated by the likelihood that conflict in the Middle East and/or continuing terrorist outrages as recently witnessed in Bali and Mombasa will cause serious disruption to travel plans. Thereafter, growth levels ought to be restored and hotel prospects improved but it may well be several years before the record levels of 2000 will be experienced again.
It seems inevitable that hotel values at the end of 2002 will show a decline on 2001 levels, especially where RevPARs have declined. So far, most lenders have held their nerve and, whilst banking covenants may have been breeched, there has not been the spectacular flurry of receiverships and forced sales which were experienced in the aftermath of the Gulf War in 1991. In time, though, as prospects continue to look uncertain, the bid-ask price differential will start to narrow and we may even start to see some distressed hotel sales in Europe, albeit not without a fight first.
But on the brighter side, there remains lots of interest currently in the hotel sector - especially from private equity funds and Middle Eastern based sources. There are plenty of willing investors and banks have cash - interest rates remain low, yields have generally held steady, and loan-to-value ratios are typically in the range of 60%-70%.
Shares in hotel companies in the quoted sector are still trading at significant discounts to net asset values, making them an attractive target for corporate raiders. However, as their 2002 year-end valuations are confirmed, it is likely that this discount will - perhaps initially - be reduced.
These are choppy waters for the European hotel industry at present and it will be those with the strongest sea legs and experience of the sector who reach their intended port safely.