Hospitality has faced an unprecedented crisis. Although the industry was at the peak of its cycle, the capabilities of many market participants are now at a low. Hoteliers and operators that had problems before the pandemic are going through a difficult situation. Now they can only count on potential help from the state.
Local demand generated by domestic tourism and business travel will be the most active driver during the rebound of the hotel industry. As large MICE events are cancelled this year, business travel is only likely to pick up in full in the long term. Both issues need to be taken into account when buying a property.
Most affected will be the cities with the largest proportion of international tourists and MICE guests, such as Vienna, Prague, and Venice.
During the recovery period, Germany will largely benefit from strong demand in the domestic market. Hence, we recommend focusing on this country when buying a property.
Germans are likely to spend major holidays this year in their home country, Germany, Austria, Switzerland, abstaining from far-off travel, thus bringing more local tourists to Berlin and other cities of Germany. This is how Frank Hoerl from DEHOGA, a German HORECA association, sees the situation.
The disposable income of tourists has gone down. This will affect room rates. To illustrate, “If earlier we could sell a double room with breakfast at a rate of €129–149 per night, now the rate per same room may fall down to €99–119,” Frank Hoerl explains.
As expected, corporate hotel guests whose earnings have decreased will also be negotiating new terms of stay at the end of summer and they will be getting discounts.
Many large businesses will manage to benefit from this crisis. After the migration to remote work and the tightening of budgets, companies now see that this model can perfectly handle corporate demands while materially reducing transaction costs. Business tourism might not be needed quite as much in the long run.
Frank Hoerl believes that recovery of rates in the A locations will be faster than in the C locations.
The fastest to recover will be 3–4 star branded hotels because they can guarantee compliance with quality standards, including sanitary norms, according to Frank Hoerl when asked about future developments.
Although the scale of this crisis surpasses all the previous ones, the industry is still considered to be growing. China, leader of the post-pandemic renewal, now sees revival in the tourist sector and gradual recovery of hotel occupancy.
The short-term risks to consider are the following:
- Labour market disruption
- Existing contracts revisited with operators as revenue expectations drop
- Fewer projects in the pipeline
- Difficulties obtaining financing
Travel restrictions and drop in the number of flights
As people significantly cut down on travel these last months, the hospitality industry has literally been cleansed. This is clearly shown by the current dynamics of hotel occupancy rates.
Everyone is suffering from a sharp dip in revenue figures: large companies like Booking.com and Expedia, cruise operators and airline carriers are selling their shares.
Changes in the structure of demand
Amid this backdrop, the structure of tourism demand in each location is a key factor that shapes property performance. Domestic demand will be the basis for the post-pandemic recovery of hotels. International travel restrictions and cancellation of many MICE events will negatively impact countries and cities where those industries are dominant.
Demand in Germany is the most well-balanced and diversified with 50% demand in the six largest destinations generated by local tourism. We expect that the German market will be well-positioned for recovery as appropriate occupancy rates can be ensured by local demand.
The tourism industry accounts for 11% of total EU GDP and governments are willing to support the industry:
- Austria, Germany and the UK are loosening taxes. These countries have deferred income, company and sales taxes until the end of 2020.
- Spain has established a €400 million fund to support the liquidity of companies and private entrepreneurs in the tourism sector.
- France has permitted tourist companies to issue credit to clients for future services instead of reimbursing cancellations. This will help sustain continuous cash flow for these companies.
European governments will provide additional support for domestic travel. For example, Italy is preparing an incentive programme for domestic travel: a resident tourist will get compensation for some expenses incurred when they spend a holiday inside the country (the approximate amount will be €350–500 per person). Such measures are expected to be taken soon in other European countries.
To support the gradual return to “normal” crossborder travel, the EU is preparing an initiative of internal “green corridors” between the countries with the most successful programmes in halting the spread of coronavirus. These countries include Germany, Austria, Switzerland, and the Netherlands. Croatia was one of the first countries to enter into bilateral agreements with Slovenia, Austria, Hungary, and the Czech Republic to ensure inbound tourism during the summer season. Greece is ready for such initiatives too: the Greek healthcare minister proposed the introduction of “health passports” for safer tourist travel along these “corridors”.
Governments are also trying to prevent the decline in disposable income of their populations, which is why several have provided compensation payouts on salaries and unemployment benefits. Across Europe, Christie & Co report that compensations cover 60–80% of employee salaries in Germany, 70% in France and Spain, and 80–90% in Austria according to the locally established thresholds.
Recovery of the hotel industry
As to the speed of hotel occupancy recovery, note the current dynamics in China that occurred once the pandemic was under control. At the beginning of February, the year-on-year occupancy rates plunged by 90%, down to 7–8%. Yet by the end of March, the average occupancy managed to exceed 20%. The entire cycle from the dramatic occupancy decline to the start of recovery took about two months. We expect similar occupancy recovery dynamics and acceleration in other regions.
The EU and the USA are gradually easing the quarantine measures and publishing plans to reopen their borders:
- In mid to late April, Norway and Denmark reopened kindergartens, primary and middle schools.
- Austria has reopened trade companies, irrespective of their size, while hotels and restaurants are expected to reopen mid-May.
- Businesses in Germany have returned to work as usual, and schools, museums, and zoos have reopened.
- The hardest hit, Italy and Spain, are also lifting restrictions. Since 4 May, Italians may travel to neighbouring regions, and restaurants and bars are reopening. Spain started the first stage of lifting the lockdown on 11 May with shops, fairs, social services, cultural facilities, and hotels permitted to reopen.
- Residents of Greece are once again allowed out without restrictions, and may visit public places. The authorities plan to allow hotels to reopen from June.
- The UK PM announced gradual removal of quarantine measures.
- The USA has partially loosened its quarantine in Georgia, Oklahoma, Alaska, and South Carolina. The other states plan to gradually reopen restaurants, hair salons, and the other businesses and service providers.
- The Czech Republic became the first country to allow its residents to cross the border from 24 April. Gyms, restaurants, and hotels have already reopened.
Hotels in Berlin
We expect that, in the worst-case scenario, the average hotel occupancy in Berlin, as one of the promising EU destinations, will not drop below 50%. The year-on-year occupancy from March to May is expected to be 5–10%.
If this trend persists, we expect the year-on-year occupancy to be 50% in June and 80% in July 2020. We expect occupancy to achieve the rate of 2019 in August at the earliest. Taking into consideration potential delivery of new projects in the pipeline, we expect the average occupancy across the market to recover up to 78-80% over the period to 2023.
Contracts and banks
We expect that all last year’s optimistic forecasts by operators and hoteliers now lag behind by two years. This might impact specific contracts and opinions of the banks concerning project financing.
We have not seen many management agreements in Germany in the past decade. There have been mostly lease agreements. “They say about 85–95% hotel agreements are leases,” comments Dr. Clemens Engelhardt, a qualified lawyer, industry author, and Bar associate specialised in hotel acquisitions and sales.
Contemporary lease agreements have various components and mechanisms for risk allocation. This is why further on we will see more hybrid contracts based on lease agreements in the markets.
Changes to framework approaches in banks and new forms of agreements for the hotel industry are not to be expected, “Banks look primarily at positive cash flows, and active development will start when hotels show the ability to pay rent and achieve the 2019 performance,” comments Peter Ebertz, head of the investment and development company Hotels Art-Invest Real Estate Management.
Therefore, businesses will have to focus even more on the selection of a good operator that will satisfy the bank and efficiently manage the property in such challenging times. Dr. Clemens Engelhardt believes that operations are now a key factor in such decisions,
“Uncertainty has always two aspects — risk and opportunity. The operations of a property will now be key for an investor, as never before. We should keep in mind a hotelier that should get revenue for the investor.”
Hotel investment potential and risk factors
Now that the short-term implications are clear, further analysis of the investment potential should include the possibility of structural changes:
- Increase in remote work and more focus on health, wellness, and performance
- Deglobalisation of supply chains in order to mitigate risks
- Changing perception of travel and focus on sustainable consumption
- Stronger technology integration, in particular in PropTech and MedTech, that wil impact private and corporate life
Taking into consideration these factors, investors are expected to increasingly turn to protective assets and sectors that focus on domestic demand and longer stays.
There is no exhaustive information about the impact of COVID-19 on key indicators. So we recommend that investors consider some fundamental points at the level of short-term assets when it comes to risk:
Revenue stability: the fewer changes in contractual revenue, the lower the risk. This favours proliferation of residential housing and office properties with credit agreements and strong remaining terms.
Critical nature of operations: the more critical the property and rent are for revenue and business operations, the lower the risk. This brings benefits to data processing hubs and critical logistics assets.
Density of use: higher density means higher operational risk of contamination.
These short-term risks apply to hotels, retail, certain housing properties, and flex-office operators. The projects that are already underway or are to be launched should think and reason from a mid- and long-term perspective. “That is why it is now important for the lessor and tenant to remain “in sync” — all in the same boat”, explains Peter Ebertz.
lAccording to Martin Bonnet, a broker at Berlin Finance, “Upon acquisition, investors should take into consideration the uncertainty and potential risks of the future. They should reassure that in case of further quarantine they would have the funds to cover any potential losses incurred by the property maintenance costs, payroll, and other issues that would have to be sustained. In this sense, I would recommend establishing provisions for at least two years.”
Market prospects and window of opportunity
Dr. Engelhardt believes that several risk factors cannot yet be accurately evaluated. “The property prices and, consequently, rentals were too high. Personally I believe that the actual market price for the nearest months is factor number 15–17 for business hotels in city centres. There is a market move in the making, caused by a number of factors that cannot be estimated so far:
а) the banks and financiers willing to exit the current projects,
- b) insolvency of certain market participants (hoteliers, developers, investors, financiers),
- c) entry of the so-called “smart money” into the market.”
There are still many unknowns but several things are expected. “In a mid-term perspective, some projects would change their profiles, some investors would exist and sell the assets. The project pipeline is certain to be smaller, which would cause faster recovery of the existing enterprises,” comments Peter Ebertz.
If the coronavirus spread is stymied in the short term, global property investments are expected to revive in the second half of 2020. There is a record level of “dry powder” ($330 billion) and pressure on capital placement. This will raise investor appetite. We expect investors to have more clarity as the situation stabilises, and for pent-up demand to be unleashed in the second half of the year.
Although property investments have been fluctuating for many years due to various declines, the general trend suggested that capital injections into real estate were on the rise. We do not see any reasons why this trend should reverse. Property still generates good relative returns compared to other asset classes. Alongside with that, we have witnessed a spike in the securities and goods markets. The difference between returns generated by property and government bonds remains at a historic high or about that.
We expect to see continuing flows and potentially more capital placement into property in the mid- and long-term. Thus, the impact of COVID-19 on returns might even be considered favourable as excellent assets can be acquired at a better price.
Notwithstanding the current state of things in the hospitality industry, there is large pent-up demand that will first be unleashed as domestic demand rises and then be supported by international interest. People will not stop traveling, and with the current mobility we expect a dynamic recovery and consider the entire industry to be promising in terms of investment potential.