Jochen Schaefer-Suren, founder and co-chairman of IREMIS, a real estate investment management company, spoke at the Hospitality Asset Forum to present the proper development of an investment strategy in these very difficult times and his three viable investment strategies for success.
We are in a changing world. What is happening? What is important are the cyclical changes, the short-term ones as well as the other changes. I'm going to focus on the ones that are most important because they are the structural changes that last. And any investment that will last seven or eight years minimum, unless you are a trader/trade-up, will have to live with these changes that will last.
What are the drivers of these changes?
- The Covid is a one-off, it may happen again but it is not something we have to live with on a regular basis;
- The new world order, with the war in Ukraine, tensions with China and other tensions, all of this will have a lasting impact;
- Ecological behaviour, saving energy, all these new behaviours;
- The impacts on food production, droughts, fires and other unrest, the economy as a whole and the cost of all of this will have an impact on capital markets and financing.
What is interesting, and I think really structuring, is that a lot of companies are thinking about onshoring. This is the opposite of globalisation and this morning Nicolas Baverez spoke of "deglobalisation". Because this has an inflationary effect which will last and we must already think about inflation in two or three years' time.
Other changes that have taken place include long-term inflations, impacts on interest rates, households, companies, government budgets, cyclical inflations and QE or QT (the opposite of monetary policy). Everyone hears about inflation. In October, it passed the 10% mark in the UK and Europe. Interest rates went up 300 basis points, minus 25/ minus 30 basis points, they went to 260/270, they were at 3% in the US, mortgage rates were at 6/6.5% and that's going to continue to be the case.
The other thing is the central banks. Balance sheets are shrinking, there is less liquidity in the markets. The Bank of England has started, the ECB has restricted lending to banks, and not having enough liquidity will reduce balance sheets. All of this is going to have a big impact on funding and refinancing.
Let's talk about the changes in the hospitality industry. Here we have both short-term and longer-term things, including travel. Full-service and limited-service properties and budget hotels are the best performing hospital assets. I think you have to have very thin, very narrow concepts to be able to manage the risks. Here are the changes that have taken place:
- average prices are rising;
- energy prices have gone up three to four times and that affects margins.
So we have a very uncertain outlook for the hotel industry. And the other point, it was said by the people representing the budget hotels. In general, these properties perform better when there is a recession. On the other hand, luxury hotels do well because they are less affected by the crisis.
Now, what is very interesting is the perennial investments. These need to be addressed, including the costs and challenges of refinancing. My last fund was about 650 million, the average debt costs were fixed over five years. Now, if you go to the banks, as we all know, it's 4, 5, 6% depending on the banks' conditions.
How do you develop an investment strategy on the capital market and on the tourism market? You have to look at who the investors are. We deal with institutional investors but if you are an operator or owner, you have a different strategy, a different approach compared to institutional investors.
I have invested mainly for institutional investors and equity. But you have to establish the criteria to match the needs of these investors with a return on investment and a good strategy. And you have to estimate the drivers of happiness to achieve these objectives. They need to exist to ensure quality of income and sustainability and value. And if you create them, how do you create them? How much does it cost?
We have 50 cities and we make sure that these cities are attractive destinations before we look at hotel industry assets. If they have resilience or growth potential, if they are declining in their life cycle. In terms of values, you have to distinguish between the hospitality industry and real estate. For each of these, we need to look and ensure that the drivers, which are critical, are in place. For each, we have identified measures that we have put in place, and that is how you create value.
At the field level, we enhance value with ownership and distribution operations. Now that we have identified the most important features, we need to look at how we can achieve our investment objectives. So we have three alternative strategies that we have developed. Previously, we were talking about budget hotels which are much more resilient to domestic travel. The hotels that are more exposed to international travel are the ones that have suffered the most compared to the hotels that were active and benefited from local or domestic demand. And so there we have the limited services, that is, those with lower profitability but higher margins.
If you sign a lease at the bottom of the cycle, as a 5-year investor, it's not the best investment. You should invest in something hybrid, as long as it doesn't go against the investor, it can be in your interest and can create partnerships. On the 4/5* and luxury hotels, we can do a lot more to create value in these hotels while reducing debt. We can convert and redevelop the hotels. We believe that the result of the current situation is that there will be many hotels that will exit the market, especially the weaker independent hotels, without much investment, that do not have the support of a big brand. Of the three alternative strategies we have developed, two are for city hotels, one is for core plus and the last one is for value added and opportunities.
We focus on everything in the value chain, everything that is needed and we have a clear strategy on how to succeed. When you look at the added value and the opportunities, if you have investments, and by definition if you look at 4/5* hotels for added value concepts, you are not going to buy a hotel that has been renovated, you are going to sell it to somebody.
The hotel has just been renovated two years ago, it's doing well but you don't want to create value that doesn't need renovation. You need a good partner who is going to convert that hotel so you need to add that to your capabilities. You need the capacity of a partner who is going to manage all the risks associated with that.
The other point we have is the resorts. Stations are really a very difficult thing. As an institutional investor, in the last few years and because of the rebound in leisure travel, there are a lot more of them than there are for business travel, so they are more attractive. The issue with resorts is that for some resorts the value decomposition is focused on the operational side and on the real estate. When we think about the resort, when we take away the hotel, what do we have? If we have a beach on a remote island, we have no access. So the value is limited. You always have to be aware of that and you have to remember that reliable cash flows, reliable gross margins are access factors.
Is the length of the season in this particular destination and the demand for leisure resilient or not? Because of the cost of living, there is a real question about demand in the leisure sector in the future. Not in the luxury sector and not in the economy either, but in the mid-range because people will find it hard to pay for all this. We have identified different types of resorts, we have to think about what type of resorts we are looking at and where we want to invest. In general, we don't have lease agreements for these stations. If someone wants to sell a lease and the developer has a lease, you have an asset in depreciation. In the resorts, you have franchises and that's a bigger risk for investors, so you have to be very careful.
A lot of hotels are following our strategy, which is to get out of real estate and develop in high-end cities where you can sell flats. So we have more liquidity with this real estate. It reduces your risk and you can recoup your investment.
I've been working for Aman as a strategic reviewer for five or six years. They build villas and sell them for 5 or 10 million. Once they sell these villas, they get their investment back and the hotel is just a shell. When there is a renovation, when there is the construction of a residence or a villa, that is to say a real estate development, one must be careful to have the right partners on the construction side. And that's where the value lies.
To conclude, the future is beautiful but today you have to be patient to see the best strategy. There are strategies that are viable, that work as you have seen but you really have to remember that you either need market corrections to reduce uncertainty, for example inflation, economic outlook, inflation rates etc., or you will see that prices will fall to compensate investors for the price risk. It's either one or the other.
Three years ago I saw what was happening to my portfolio, there was a 3% cap right. It was incredible! That's why I sold. Now the market is over, it's gone and it's no longer sustainable given the current environment. It will take time, there will also be hotels that will leave the market, that is, there will be less supply. Some hotels will be converted too. This will be triggered either by operating leases or by refinancing. However, there are refinancing problems, especially with capital management problems or major renovations. There are several scenarios that can be triggers. At IREMIS, we are in the process of raising funds precisely to seize these opportunities.
More than ever, real expertise is based on years. This expertise is essential to implement good investment strategies that work and to deploy them effectively.
Already signed up? Already signed up? Already signed up? Already registered? Login here!