New lending to hotels in the UK has stalled – and despite hopes of a rapid recovery once Covid-19 restrictions ease, there is likely to be more pain ahead for the market.
The pressure on hotels and their investors is intensifying, with pre-pandemic revenues not expected to return for some years. More distress is likely to appear from Q3 onwards, according to Nicole Lux, senior research fellow at the Business School and lead author of a new report into the lending market.
“Owners and operators are very aware that cash flows might not last for another 12 months of lockdown,” Lux says. “Quite a few of them are pessimistic – many predict [those] won’t come back until 2023 or 2024.”
The Business School’s inaugural report on the market, produced with Berkeley Capital Group in aid of non-profit community Women in Hotels, deems that over the long term, hotel lending will retain a “strong” place in real estate loan books. Lenders surveyed for the report identified value in major city centres such as London and Birmingham and said that the pandemic will “not affect their long-term view”.
For months the hotels market has been braced for a wave of distressed deals. But Lux tells EG that lenders appear to be “in no hurry” to enforce loans. “We’re not really seeing ‘for sale’ signs yet, simply that operators are trying every avenue they can – renegotiating terms, putting waivers in place, seeking loan extensions,” she says.
The report notes that lenders have grown their loan exposure to hotels substantially since the global financial crisis. The total value of debt secured against hotels in the UK stood at £15.1bn in June 2020 and accounted for 9% of total outstanding CRE loans on lenders’ balance sheets at year-end 2019. The hotel investment sector amounted to 12% (£135bn) of the UK’s total £1.1tn institutional real estate market at the end of 2019, according to figures from STR and Savills.
UK banks historically dominated the hotel loan market, their market share amounting to 62% in 2004. They have since reduced their exposure to just under a third as of the first half of 2020, while non-bank lenders and insurance companies accounted for 38% of the total market.
This trend looks set to continue. New origination for 2021 is likely to be concentrated in debt funds, although the larger transactions are expected to be carried out by traditional banks and insurers.
Lender targets on interest coverage ratios, which measure a company’s ability to meet its financial obligations, reached an average of 2.2x in H1 2020.
For context, 1.8x is broadly viewed as low, while 2.5x is generally considered as the desired minimum mark. However, some lenders were found to require up to 4x, particularly for managed hotels without a strong affiliation with an established brand.
Lending margins rose to 305 basis points, from 270 in the previous six months, reaching a 58% loan-to-value average. These are expected to increase to 300 to 400bp at the end of 2020.
With banks focusing on existing clients, it has become tougher for hoteliers to obtain new financing without a relationship bank or lender, the report says. Although specialist debt funds can deploy money into senior and junior hotel lending, Lux notes that many borrowers seem unaware of new market entrants.
“A lot of lenders are generally indicating they are full in terms of their current exposure and cannot look at new financings,” says Lux. “It is a difficult climate for refinancing and for borrowers to move from one lender to another, as lenders’ books are already full. It will be hard to find an alternative lender at this point in the market – we will definitely see more distress from Q3 onwards.”
The greatest liquidity lies in loans of between £50m and £100m, while lender diversification and availability for smaller sizes is “much more limited”.
Notably, the report found that most hotel businesses are unable to qualify for the government’s Coronavirus Business Interruption Loan Scheme – other than the furlough scheme, access to other support initiatives was “limited”.
Given the difficulties in obtaining new financing, hotels have had to devise new strategies to improve cash flows. The report suggests that independent hotels have found it easier to stave off distress and raise financing by joining larger brands during the pandemic.
More than three-quarters (78%) of UK lenders outlined their preference for financing hotels with a franchise or renowned brand image. Those hotel operators, such as Marriott and Hilton, have in turn fielded fresh requests from independent hoteliers seeking to join them, expanding their networks to generate more income.
Brands are still pursuing new developments slated for launch in the coming two to three years, with continued access to cash for projects. In some cases, schemes have shifted towards converting space into serviced apartments, reducing hotel space allocation.
The most popular method for hoteliers to generate alternative revenue has been hosting key workers. This is followed by offering “home-office” rooms. However, room rates for these uses can be up to half that for standard occupation.
In this minimal cash flow environment, financial pain seems set to worsen for hoteliers in the months ahead. But Lux is confident there will be a sharp and “immediate” rebound for the sector after a full vaccine roll-out and a relaxation of travel restrictions.
“Because of the vaccine, lenders in general are confident there will be a comeback,” she says. “It will pick up straightaway when we can all travel and stay in other places again. There will be an immediate turning point – we as customers are willing to travel if we are allowed to.”