Hotels: restructuring for recovery

The level of uncertainty across the European hotel market is probably greater right now than it has ever been. Levels of interest across the opportunistic investor community are very high, but this is on the expectation of distress creating opportunities to acquire assets or businesses at a significant discount to pre-pandemic pricing.

Hospitality consulting firm HVS published figures in September showing a decline in value of between 5% and 30% for the European hotel market, with this wide margin of difference depending on the trajectory of the recovery. Since these figures were published, many countries have experienced second waves of the pandemic and resulting lockdowns - while, more recently, encouraging news on vaccines and treatments has impacted on share pricings.

While there are some similarities across the different European hotel markets the impact of different legal responses, government support packages and restructuring regimes means that each market has responded differently. UK business loans, employee furlough schemes and moratoriums on evictions mean that many hotel businesses have been able to continue to trade in circumstances that would in normal times have triggered distress.

UK performance during the pandemic

PwC's recent UK Hotel Forecast estimated an 81% collapse in 'revenue per available room' (RevPAR) for the London market by the end of 2020, down to £28.72 from £153.54 in 2019. The regional UK figure experienced a similar dramatic drop, down to £23.11 from £53.98. In PwC's view it will be 2024 before we see a 'real terms' RevPAR recovery to 2019 in London; and 2023 for the UK regions.

Even more worryingly, PwC's figures were released before the UK government announced a second England-wide lockdown of four weeks, from 5 November until 2 December. The short-term impact of this second lockdown could be significant.

Kate Nicholls of trade body UKHospitality says that the sector is facing a "tough winter", with businesses needing "enhanced grant support to keep venues alive and a solution to the ongoing rent debt problem that continues to linger over the sector".

Of course, the impact is not even across all parts of the market. While London is heavily reliant on business travel, events and international tourism, hotels with leisure-oriented businesses and subsectors more attractive to UK 'staycationers', such as aparthotels, are expected to recover more quickly. Market expectation is that consumers will feel safer in aparthotel accommodation for the foreseeable future, which is likely to assist even those aparthotels in major cities and currently closed markets in their recovery.

This expectation is backed up by performance in the first part of the recovery. The Knight Frank Hotel Dashboard report for October 2020 showed that the UK's extended stay and aparthotel sector had outperformed the hotel sector as a whole, achieving 34.0% gross operating profit (GOP) as a percentage of total revenue in the year to September 2020.

The outlook looks potentially better in the longer term given recent positive news on vaccines. PwC's figures were based on assuming a positive vaccine announcement in the second quarter of 2021.

Investment trends

Investment levels are currently very subdued. There are clearly hotel businesses in distress, particularly those that were less profitable or already highly leveraged. However, this distress is not yet triggering transactions due to unprecedented levels of government support.

In the UK, this support has consisted of financial support through business loans and the employee furlough scheme – which has now been extended until March 2021 – as well as regulatory support. Moratoriums on enforcement action by landlords, currently extended until the end of 2020, give hotel tenants the ability to delay payment of rents; and adjustments to the insolvency laws, again extended until the end of 2020, are providing businesses with the ability to trade on in circumstances which in normal times would have triggered distress.

The result of this is the accumulation of substantial additional liabilities for these businesses. UKHospitality estimates that the hospitality sector will be nearly £3 billion behind in rent payments by the end of 2020, and additional trading disruption due to the second English lockdown and similar restrictions elsewhere in the UK will have pushed this even higher. So far, lenders have generally seen forbearance on loans to be the most sensible option and have agreed to suspend covenants and amortisation payments - but with new capital waiting on the sidelines, lenders may now push borrowers to seek third party investment to meet new cash flow requirements.

Although the furlough scheme has been extended, this will ultimately end. Similarly, government loans will be required to be repaid. The expectation is that repayments will be structured at low costs and over a long period to avoid blunting a recovery, but the debt will burden balance sheets. Many hotel businesses will not be well positions for a recovery in the short or medium term without additional investment or restructuring. This will create opportunities for well-capitalised owners and opportunistic investors to reorient such businesses or repurpose them entirely to a new use.

More clarity on the trajectory of the pandemic now seems likely given progress on vaccines, and with it more certainty over future performance - just look at the share prices of hotel groups following the recent announcements by Pfizer and BioNTech. However, this clarity will also bring closer the moment that government support will be withdrawn and restructurings will be required.