A Bleak Landscape
The headlines do, to an extent, say it all. It’s a challenging time – but does the mood music match reality or only selected elements of it? We explore current issues facing the sector here.
News bulletins and posts focus on the relatively weak economic environment.
This presents nothing but negatives: consumers are tightening their belts, interest rates are rising, funding costs have increased dramatically, staff shortages abound, and businesses are closing. Not to mention the war, inflation and recession. The following articles all tell the story:
- Hospitality firms face ‘perfect storm’ this winter (see link here)
- Why it’s last orders for local pubs as hospitality struggles (see link here)
- Prezzo puts restructuring plan to creditors (see link here)
- The hospitality industry needs “full surgery” rather than a “sticking plaster” of temporary tax cuts (see link here)
- Food inflation hits another record high (see link here)
- Hospitality sector loses 4,600 venues in 12 months (see link here)
Based solely on the above, delegates to this year’s International Hotel Investment Forum held in Berlin could well conclude that our sector is at a complete standstill. (see link here ‘IHIF’) .
Is it time to shut up shop, draw the curtains and go home?
Three Hurdles to Jump
A combination of three challenging trends is impacting sector dynamics and current activity:
(i) Operating/trading margins being squeezed
(ii) Construction costs increasing
(iii) Higher costs of funding
These factors are affecting hospitality businesses big and small and a wide range of planned projects.
The fight for survival is being felt most at the smaller owner operator end of the market where volume and efficiencies are harder to drive.
Hurdle 1: Squeezed Trading Margins
Owners and managers in the sector have seen their business models challenged through:
- Substantial increases in operating costs of food, beverages and other supplies
- Utility costs doubling or even tripling in some cases
- Higher Payroll cost influenced by a rising National Living Wage and competition form other sectors
- Withdrawal of government subsidies that shielded various cost effects
- Consumer demand becoming less predictable and more erratic
Where demand has allowed, price increases have helped, although in some cases they have counteracted costs more than adding to profit margins. Evidence is all around:
- Pub closures continue at an alarming rate.
- Bar and restaurant prices have rocketed and operating hours have been cut back.
- Smaller properties with limited marketing presence and in weaker locations are finding the ability to service rising costs of debt harder.
- Difficulty in refinancing existing businesses is leading to a slowdown in some growth plans.
Hurdle 2: Why Build?
Shortages of materials and rapidly rising construction costs (in excess of 30%+ over previous 2019 levels) led to:
- A development pipeline slowdown.
- A value gap between costs of construction and day 1 values.
- Investors changing focus to income producing assets over new development.
- Prioritising projects in major city centres over (perceived) ‘secondary’ locations.
Hurdle 3: The Investment Backdrop
Despite inflation at 10%+ and lending rates 4%-5% higher than a year ago there is still investment appetite to own hotel stock.
- However, values remain high.
- Buyer sentiment is hesitant unless valuations/pricing is adjusted to reflect the new economic reality.
- Lending criteria has tightened. The yield gap has narrowed even for long term budget hotel lease deals.
- Banks are ‘open for business’, but in reality caution prevails.
- Branded hotel projects in prime city centres are seen as safer bets – leaving some less high profile opportunities out in the cold.
- Debt heavy financial structures is leading to distress in some businesses.
How the Sector Has Responded
A natural reset has occurred.
This recognises some fundamentals simply can’t be ignored.
- Lower volumes of trade and higher costs have led to the harsh reality that many smaller businesses are less viable.
- The rationalisation of the pub sector has continued.
- Aspirational concepts in less well located, smaller markets have not taken off.
- Loans have become due.
- Projects that lack the basics of location, quality, market presence, finance and/or marketing and management expertise have gone aground.
Business stakeholders have responded:
Operators have been inventive and implemented changes to reflect the new reality:
- Opening hours are being tailored to times of peak demand
- Menus are being reengineered, purchasing agreements renegotiated
- Utility costs controlled and contracts extended
- Pricing and revenue strategies amended,
- Technology enabled to provide efficiencies
- Concepts changed and marketing enhanced
- Rents renegotiated
Alongside these challenges, brand owners continue to want to expand their presence and seek representation in new locations so the ‘hunger to grow’ remains active.
Construction is stalled, but not forgotten:
- Construction costs are evidenced as starting to stabilise.
- Developers are becoming keener in pricing terms.
- Despite the current value/construction cost ‘gap’, projects of all kinds continue to be considered.
- Stakeholders are looking to longer term strategies taking a view that interest rates and inflationary pressures will improve over time.
- Destinations continue to be created with accommodation and hospitality provision as a core element that also helps attract other occupiers.
Investors remain focused on opportunities:
- Despite the many challenges presented to real estate investors… for hotels, the mood music may be improving
- Although not considered a mainstream asset class, hotels represent an option to investors broadening their search for a less volatile asset class
- Consumers continue to travel and corporate events are now returning close to pre-pandemic levels
- Hotel values are holding fast in contrast with other real estate options…specialists HVS report that values across Europe rose overall (by an average 3% in 2022) underpinned by a strong performance through 2022.
Market drivers ensure continued activity
These are countering some of the constraints identified previously.
Tourism is on the rebound. Leisure is still on the menu:
- Many sectors of society have survived the pandemic well
- There is an increasing expectation of eating out and seeking new experiences.
- Innovation is attracting new market segments such as Millennials and breathing life back into staycations with ‘wow’ factor experiences.
- New concepts are breaking the traditional mould e.g. deconstructed hotels (see link here), focused leisure offerings (see link here)
- Diversification has opened up the sector with a mix of alternative offerings including lodges, pods, motor homes and treehouses providing a mix of serviced and non serviced accommodation and widening choice Examples include (link 1) (link2)
- Pubs have increasingly added bedrooms to diversify their business model and consumer offer (see link here)
Working with Lynn Thomason of destination development specialists Hotel Solutions, we have seen projects consider a wider range of accommodation types (not just hotels of all standards) to attract new markets.
Regeneration is driving development in some areas
- Councils faced with limited resources, declining high street retail and empty properties are seeking to regenerate areas with hotels or conference facilities. Why? Because they have identified economic, profile and employment benefits to create a more attractive destination. In some cases they see the provision of these facilities as a stimulant to help attract other broader commercial activity in a location and are willing to help unlock development.
Investors continue to seek opportunity
- The need to deploy cash is identified by Henry Jackson of Knight Frank who believe activity will increase provided debt can be secured and values re-estabilished. After all what are the alternatives in real estate that currently scream ‘opportunity’?
- Working with Rob Gray of asset management specialists Wallgate Group its clear that many current opportunities are challenged by high asset pricing, but investors are continuing to examine where value can be added. Scenarios include repositioning, rebranding, financial re-engineering and/or differentiating through new concept development. Portfolios offer the opportunity to create new platforms and added value through asset selection and ongoing asset management.
Major venues want to broaden their appeal
This includes a range of underutilised assets such as sports clubs. These venues increasingly seek to broaden their business model by including accommodation and related hospitality offerings to help create true year-round destinations.
The headlines are catching up
As businesses adapt and change to the new environment a more favourable set of messages are finally hitting the airwaves after the sweeping doom laden headlines of yesteryear
- Number of UK hospitality businesses on the rise (see link here)
- Cost-of-living crisis: Hospitality firms adapt to survive (see link here)
- Hospitality drives city centre’s growth as Edinburgh takes top slot (see link here)
- People still ‘happy to spend’ on holidays, says PPHE Hotel Group (see link here)
- Hospitality developments aid to growth of city’s night-time economy (see link here)
- Premier Inn owner reports revenues 27% ahead of pre-pandemic (see link here)
- Manchester City submits plans for 400-room stadium hotel (see link here).
We are a long way from writing off hospitality as an option either from a business, investment, or consumer proposition point of view.
More Good News Ahead
Whilst current market conditions may lead to some fall out in which major players may cease to trade, new owners enter the market, and different business models be adopted, the sector continues to see considerable activity.
The key point is that the hospitality sector remains a dynamic sector that will spot opportunity and respond to rising consumer expectations, which in turn drive the need for facilities and services which the sector is best placed to offer.
The range of live projects and creative situations being considered by clients with whom we have been engaged recently are evidence that investors recognise the challenges but are looking longer term to a sector with growth fundamentals.
This presents an active and aspirational sector picture for the road ahead.
Headlines identify themes but for every negative trend there is an investor or operator eyeing an opportunity.
We look forward to contributing and exploring their assessment and implementation.
Thanks to Lynn Thomason of Hotel Solutions and Rob Gray of Wallgate Group for their contribution to the above article. We have worked together on a range of sector projects from early concept, development through to post opening operational and asset management stages . Clients have been as diverse as Regional Councils, Universities, Investment Funds, Private Owners and Local Community organisations on sites across diverse locations including city centres, coastal and rural locations in regional UK ( Essex, Lancashire, Yorkshire, Somerset and the South Coast) and Northern Ireland.
Images reproduced from Unsplash with thanks and credit to absolutvision-Wyd_PkCa1BY,; sophie-grieve-williams-yft5oP073_s-unsplash;interactive-sports-VYTQNnaboUA-unsplash;raquel-baires-8kbehseBQtE-unsplash;fons-heijnsbroek-JJpWirD-qDU-unsplash;towfiqu-barbhuiya-joqWSI9u_XM-unsplash;brett-jordan-fswQZLlHC3Y-unsplash;Photo by Krzysztof Hepner on Unsplash; shlomo-shalev-GoPYSBvZ-QQ-unsplash;annie-spratt-IT6aov1ScW0-unsplash;jon-tyson-XmMsdtiGSfo-unsplash