The Knight Frank Hotels team’s fifth annual hotel round table, in partnership with CoStar News, saw eight industry leaders discuss the important issues and challenges facing the industry today.
This is part one of a discussion explored how hotels face operational challenges linked to energy and staffing, the lending and development market, the attractiveness of hotels as an asset class compared to broader commercial property, the rise of "bleisure", environmental, social and coporate governance and predictions for the sector next year.
Attendees:
- Marcus Boret, managing director, Marick Real Estate
- Karen Callahan, head of hotel valuations, Knight Frank
- Sandeep Cheema, commercial director, London Town Group
- Meenal Devani, president and chief investment officer, Aprirose
- Rebecca Hollants Van Loocke, chief operating officer, Frasers Hospitality EMEA
- Andy Lancaster, director of retail, hotels and leisure, Natwest Group
- Shaun Roy, head of hotels and specialist property investment, Knight Frank
- Wan Yau, partner, Studio Moren
Chair:
Paul Norman, Managing Editor, Europe, CoStar News
Paul Norman: It’s great to see you all and it’s been a very busy time since our last roundtable, where so much has changed. So I think there’s a good scene-setting question for everyone which is if you were the new prime minister, what would be your top initiatives to help the real estate hotel sector at the moment?
Karen Callahan: I think one of the easiest ones that that could actually be implemented would be to look at business rates relief again. I think that would have an immediate impact, and could be proportional to size of businesses etc, and whether or not that is full relief for the sector or whether it's partial relief, business rate relief over the next six months or so would be very beneficial to the market. Other initiatives could be around the opportunity to play with VAT, which is a topic that's been very much at the forefront of the industry over the last two years, a lot of people lobbying for that. And my third one, which I think this is more of a longer term play, is to see more efforts being made in regards to staffing.
One of the challenges that we've got in this sector as we have for the country as a whole is that very low unemployment rate which is now at its lowest level since 1974. So, whilst we all bemoan the lack of staff, it's a structural issue, within the UK economy – there simply aren't enough people to go around. I know there's supposed to be a new T-Level [vocational qualification for 16-19-year-olds] starting next September to encourage those post-16 to go into catering.
This is a step in the right direction but I think that we need to see more initiatives like that rather than this constant push to get everybody into university, when the sector doesn't need everybody to come in with a degree to their name. We need to see people coming into the sector more and seeing it as a career but I don't think that's something that we have achieved at the moment.
Rebecca Hollants Van Loocke: I definitely think VAT is one of the big points. Being able to reduce VAT, being able to encourage people back into the UK would give a huge boost to the hospitality industry and I would love to see that happen. I know it’s been campaigned for many years and sadly we haven't seemed to make too much progress but I do think that would be a huge boost. I'm also a huge fan of trying to encourage people into the industry, something we take great pride in here at Frasers Hospitality. We've been working with lots of diversity and inclusion organisations to try and encourage younger, more underprivileged people to come into the industry to understand what a future career in hospitality can actually deliver. There is a huge amount of talk about sending everybody to university and I think we really are missing a trick. I certainly joined the hospitality industry having not gone to university at all, and would consider I've had a very enjoyable, fulfilling career.
And that said, I also think it's not really what the government is going to do, I do think we need to be cleverer with what we do in terms of automation and technology and use that to help support and encourage people into the industry. It's quite a traditional industry and I think young people today like to be in an environment with a lot of new technology, they're very savvy and it's trying to get that blend of technology to support us and younger people who don't have a university career ahead of them to come into the industry. And if there's anything the government can do to continue to support with their apprenticeships, which I know they've done a lot of, I think that would be a huge boost for the industry as well.
Paul Norman: Yes, it's already appearing the new prime minister has got quite a lot to contend with.
Wan Yau: From my perspective as an architect working in the building side of the hospitality business, we'd like to see the prime minister transform and streamline the planning process. The planning system is a huge block to development. In London there are many local authorities that have issues about where hotels can be located; resistance to the reuse of redundant shopping centres and offices into hotels.
It is a deterrent to potential investors, owners, developers and hoteliers to risk and invest in sites which require planning permission. In the UK the planning process takes approximately a year-and-a-half to arrive at determination. There is no guarantee at the end of this process that consent will be granted. This is a huge amount of risk and that puts off a lot of investors.
Andy Lancaster: I know this question is not directly about the pandemic, but if I think about the approach through that period, a key objective was supporting viable businesses with the aim of them getting back to where the revenue line was in 2019, pre-pandemic. That was the basis on which the majority of emergency loan support was underwritten in the sector. In many cases that pre-pandemic revenue level has now returned, or indeed been exceeded, but right now it's all about what's going on between top-line revenue and bottom-line profit. The cost of doing business has increased through a combination of factors including, but not limited to, VAT returning to its previous rate, food price inflation, business rates relief phased down, and costs associated with attracting and retaining staff.
This is putting pressure on profitability and cash flow, so as a banker you would not be surprised that we spend a lot of our time looking at the sustainability of earnings for businesses who are looking to raise finance. When speaking with operators, anything that can help ease the cost of doing business right now is welcome. For some businesses, coming out of the pandemic, their balance sheet is carrying significant additional debt that they had to take on to get through the pandemic. In most cases that has served its purpose, but there isn't a lot more capacity to take too many more hits right now. So, when I talk to operators in the sector a common theme is the call for government to pull levers around some of the aforementioned areas and release some of the cost pressure they are currently facing into. That would be my priority.
Paul Norman: Okay, thanks, Andy. There's a lot more questions going forward on the cost of living and cost of business crisis to come back to there. Maybe we will come to Meenal next.
Meenal Devani: Top-line revenue growth has clearly been a beneficiary of current inflation. However, our biggest challenges in hotels are ones that others have alluded to: energy costs challenging labour market conditions and higher interest rates. With energy costs for some businesses increasing by five to seven times as they come off fixed price contracts, the intention to help businesses with energy costs is right – although with the political rollercoaster we have been on, there is still a lot more clarity required. It has the potential to help break the cost push spiral but the scale and length it is being offered for still seem too light relative to what is needed and to the macroeconomic benefits.
The other challenge is labour markets where we simply don’t have enough people to fill roles – not just in hospitality but also care, farming and a host of other industries. This needs urgent attention terms of looking at immigration and allowing workers to come into the country to work across all industries. It is unrealistic in an economy with full employment, as we have, to talk about protecting British jobs, which is what Brexit was about to a large degree. With the level of vacancy that exists, this is not a policy shift that can wait.
On the investment and macroeconomic front, low interest rates and growth without inflation over the last 20 years have in large part been driven by globalisation, free trade and free movement of people. Those factors have kept costs relatively low, inflation low, and interest rates low. What we're seeing now is a wide scale reversal of that on a global scale which has concertinaed with geopolitics and supply chain issues to tremendously impact all sectors and investment confidence. The longer term thinking has to be around how we go back to globalisation in a way that works with the politics of the country.
Paul Norman: Well, obviously, we're hearing a lot on that topic, and that's natural in this sector. Marcus, from a construction side of things, what would you'd like to see?
Marcus Boret: The quality and availability of hospitality staff is struggling at the moment and I think anything that we can do to promote the sector and start to consider a better strategy for employment structures of training and bringing people on through industry rather than necessarily going through further education or university. We've got cost of living challenges which the prime minister is looking to address and on a wider scale, what would be good for the development and delivery in our side of the industry would be to promote growth of manufacture in the UK. There’s a heavy reliance upon importing, so the more we can produce in this country, the better we're going to be. Planning is another area, as we continue to deliver increasingly complex mixed-use developments we are forever getting caught in authority expectations that challenge viability analysis. This is only going to become more and more pronounced over the next period as cost of living and energy crisis hits, and as all these indices start to affect us.
Sandeep Cheema: Our focus is more on the energy side, the government is making the right noises but it’s not expanding out to businesses. VAT is an area they could look at in utilities, which they could start now and continue for those that require a high energy usage to operate. But on the energy side, the government is making the right noises it's unfortunately not expanding out to businesses. We're not really seeing what support is available for high energy operating businesses. VAT is an area the government could review, if there's an option of reducing VAT for energies and utilities, that's something that could start now and continue, not just for 6 months. But then, there's also sustainability.
What can we do to implement more sustainable measures in our hotels? How can we make ourselves a little bit more efficient in how we run and operate? The government could look at grants for hotels that are coming aboard, give incentive-driven timelines. Fortunately, our business does not have a staffing issues, yes, we've managed to get our staffing levels to a controllable and manageable level, but the quality of staff is another problem, due to the lack of time given to train and induct, we have sadly rushed through our on on-boarding, just to reach the operating levels we needed in a very short space of time. I think what the new PM could look at is apprenticeship schemes and bring the buzz back into working in hospitality.
Entry-level roles could be attractive to students who can do that alongside their education. Combining a job and study could allow hotels to develop their workforce better. Develop a motivated, skilled workforce with knowledge of the business. Review the apprenticeship support package and placement support package which was in place at the start of the year.
Shaun Roy: As well as what everyone else has touched on I’d add that whilst it's not necessarily in the prime minister’s wheelhouse to be able to influence on the cost of debt, the base rate would be the most influential part of getting the transactional market moving and enabling many hoteliers to be able to invest in their estates. So, I would see that as pretty important. I doubt it’s going to happen and certainly not in the immediate future and it's being done for very responsible and realistic reasons, but that would the biggest thing I would say. And probably freer movement of staff as everyone else has said.
Paul Norman: Okay, well there's some really key themes that we're all coming back to there, so it's great to set the scene. I thought I'd come to one here for Shaun first off in that it's a chance to look at your investment market with changing conditions and how they're performing against other sectors in real estate. The last couple of years has seen a poor reduced trading across most hotel sectors, but the capital value side of things has generally held up quite well. With the wider property sector now taking a severe capital reduction, maybe some of them would argue against that but certainly it has been seen over the last 3 months. How much will positive trading conditions insulate hotels from this wider property market downturn? And indeed, are you seeing interest from investors already because of this, Shaun?
Shaun Roy: The wider market has definitely seen capital reductions depending on product, sector, lease lengths, geography, etc, but that's undeniable to a lesser upgraded degree. I think we've been fortunate in the trading properties arena, so it would be that sort of operational properties in student accommodation or hotels or healthcare, the increased trade has insulated it to a degree so far from drops in value. And that has cushioned, but hasn't completely dissipated what is happening in the wider market. That has happened for very understandable reasons, which is much higher inflation, but also cost of debt.
I think property’s biggest attraction and certainly in the more mainstream institutional categories has been its positive arbitrage against corporate debt and gilt specifically. And when you look at that arbitrage, it has been very significant. Certainly over the COVID period where everyone felt the property would have a bit of a rougher ride, but when you're getting 0.1% in the bank and property could give you a very significant arbitrage above that, there was a compelling reason. That compelling reason has dissipated. So, what do investors have to do? They have to either accept a lower arbitrage between the risk-free rate and property and be compensated less for its illiquidity and inherent risk or prices have to move out, and my expectation is that we will see a bit of both. I think investors will feel that the risk profile isn't quite as dramatic as perhaps it has been and accept lower rates of return, but property values have already fallen and will have to fall a little bit more.
Paul Norman: Were you seeing evidence people taking advantage of these changing dynamics to really invest in particular areas or central London?
Shaun Roy: We've seen a little bit of it. My expectation is that it’s going to be and is beginning to be driven more by a currency as much as anything else. I would anticipate a 15% reduction in our home currency in sterling compared to what the majority of international investors are denominated in or linked to, be it the Hong Kong dollar linked to the dollar, or Middle Eastern investors, North American investors all being generally dollar-denominated which has got to make us more attractive. And where does that money usually flow into? It usually flows into the most recognised jurisdictions that is definitely number one. You know top of the hit parade would be London, and then it will filter out into Edinburgh, Cambridge, Manchester, and places like that. It has been a relatively quiet summer from that type of profile of money, but we're certainly getting more and more questions being asked.
Paul Norman: Thanks, and Andy from your point of view looking at this sector in particular has there been a shift where it feels more positive for hotels against other asset classes in commercial property?
Andy Lancaster: My team focus on hospitality, so I don’t have interaction across the broader commercial real estate market, but from the investors that I do speak with regularly the hotel sector as an asset class is still attractive to them. Investor focus will be varied when looking at the sector, depending on risk appetite and areas of expertise. High-level headlines are often written regarding performance, but really we need to be more granular, it’s about geographic location, specific assets and the drivers underpinning the business model of any given hotel.
In the transactions we are seeing, those businesses that remain attractive to a range of investors are those that have bounced back well from the pandemic, are taking appropriate actions to manage cost, and are now driving rate growth as business and leisure travellers return. We have also seen a number of investors where the focus is on potential turnaround situations, although there has been limited availability in market to date. As a lender we are still looking to support good quality transactions in the hotel sector, and we are certainly not alone. Liquidity in the debt markets is strong currently.
Paul Norman: This has set quite a positive environment for hotels, but another question I’d like to explore is will recession, which I think we can safely say we're heading towards, put an end to investment and growth in the hotel sector?
Andy Lancaster: From my perspective, I would say not. We still have a growth agenda and appetite towards the hotel sector. However, as is always the case, whenever we're looking at a proposition we have to fully understand the profit and loss of the business that's in front of us and take into account the sustainability of earnings. So, all the topics that we've been talking about this morning so far are areas that we would explore through our underwriting. We always would, but we are having to probe a bit more than ordinarily because there's some headwinds impacting the sector currently, and there is a high degree of uncertainty at the moment.
To date, hotels have been able to pass through some of the cost inflation and consumers, coming out of pandemic, have largely been prepared to absorb that because they missed the experience and they're hungry to do stuff again. I guess the challenge is looking forward into the next three to six months and understanding if consumer behaviour is going to change. Will people pull back when their discretionary spending power is squeezed? Where we have funding conversations underway we are trying to work through those scenarios, to understand the potential impact on the sustainability of future cash flow because that's clearly very important for servicing any debt obligation.
Karen Callahan: I think my take on it is we're almost in a similar position to where we were, say 12 months ago but with different factors at play. Twelve months ago we were coming off the back of a strong staycation market and there were concerns about what the return to work would look like, the corporate market and how that business-led demand would return to the hotel sector. And I think we felt that the final months of 2021 would then as we went into 2022 give confidence to the investment market.
Then the corporate market had come back and obviously the staycation demand had fallen away but that strength of recovery was coming through. Then obviously we were hit by Omicron and that put us all back, you know, from a time frame perspective in terms of that recovery. Now as we sit here with the cost-of-living crisis coming through, that's affecting not just personal, domestic spending but businesses as well.
They are looking at their own operating expenses and their own travel requirements and obviously there's a desire to meet in person but with the cost of that now much higher than it was they're rethinking and going back some of them on to more of a Teams-based meeting platform. The next three months will be very interesting as to how the average room rate growth that we've seen in the sector and the recovery that we've seen in the sector on a headline basis can continue at that level. Is it going to plateau? Is it going to continue to increase? Will we see a little bit of a falling back in either ADR or occupancy? I think as we start 2023 hopefully we will have seen a positive few months for both corporate and leisure demand that give the investors, the confidence that they need, that the revenue, at least the top line isn't being hurt by any economic challenges in terms of recessionary led growth and retraction. Certainly what we're seeing is the momentum is still there.
Sandeep Cheema: Similar to Karen, what you've just said succinctly is actually where business is. What we've seen is a big push from the corporate market which may have not come back in the individual levels. There is still a worldwide 16% homeworking policy in place. Of 16% of companies worldwide and I know from the US markets I think they said it's 53%. However, what we've seen is there is a lot of pull from corporates wanting to have group stays in hotels especially in London.
In our provincial markets we've seen there is still a lot of business coming in and if it's led with a group stay or a meeting because that's still happening, companies still need to collaborate and hotels are best suited for that. From a transient or a leisure perspective what we are seeing is all that pent-up demand from the last three years. Events that should have happened that haven't happened are happening in later parts of the year. There are many high-end events that are happening in London. As a result, there is a healthy base of secure group business until the end of the year. What my concern is really when we come into the first quarter of next year given we had Omicron at that time last year, we don’t have any sensible comparatives. In the first quarter of next year, I think the cost of living is going to have a huge impact.
There is going to be people wanting to wait and see as we don't know how cold winter's really going to be for us. There is going to be a quiet period but there is still a buzz about the UK so I'm still confident. This year has been a strong year and it will continue to be a strong year for us. We're seeing numbers of note of close to 2019 so from our perspective we've seen a recovery already. I think next year, the first quarter will be a challenge but I think businesses will start seeing the need to come in and collaborate and they will collaborate in hotels with meeting space as opposed to going in to offices.
Paul Norman: There's a lot to pick through there. We've gone into a mix of performance of hotels as well as the investment market which are always tied together. Rebecca what would you say?
Rebecca Hollants Van Loocke: I just want to support very much what Sandeep is saying because it's very much the pattern we see as well. Although we are not pure hotels, the majority of Frasers brands are serviced apartments, therefore you would tend to see a slightly different client. In Frasers Hospitality’s boutique hotel brands, Malmaison and Hotel du Vin, they have well exceeded 2019 levels this year already. It's been an absolutely tremendous year. Across the Frasers brands we've seen massive rate increases. I don't expect them to go down nor do I expect them to continue to rise.
I think there have been quite substantial rises in terms of price per room per night and I do think that will begin to plateau. I think demand is changing as the normal day to day corporate hasn't yet fully returned. We don't see that demand on a Tuesday, Wednesday that we used to see but we do see that people are staying longer which is a huge plus for us. People are travelling on business, instead of one or two nights going away and maybe coming back again I think from a business perspective, from sustainability perspective businesses are asking their travellers to travel and maybe to stay that little bit longer.
And when I say that I don't mean months, I mean instead of one or two days we're seeing quite a lot of extended travel in terms of five days, seven days, 10 days is becoming a lot more normal. I do think moving forward again in the first quarter of next year, it's uncertain. Business on the books between now and Christmas is strong, it's healthy, it's looking good.
But, as Sandeep rightly says, we don't know quite how the winter is going to pan out and what the support is going to be on energy. I think it will be difficult however on the plus side we may see some relaxing in terms of staff, I think there might be more staff available because I do think that some businesses are really going to struggle with these increases in costs and perhaps that will be a slight re-balancing in the employment market that perhaps sadly, some people may be made redundant because some businesses fail and there may be other opportunities in the market, staffing wise. It would be good to see that lovely corporate business return as it used to. I don't think we'll ever see that.
Paul Norman: The cost of operating in the industry is obviously facing huge costs with energy bills, huge increases in the cost of food. How is this shortfall going to be made up? And in the cost of living, you know, you've asked are you passing these increased costs at a time when customers are dealing with a cost-of-living crisis themselves and looking to make savings? But can you afford not to? What's the light at the end of the tunnel? I think that's a critical issue, those two things together and how the hotel industry is dealing with it.
Rebecca Hollants Van Loocke: Obviously, we've seen a massive increase in terms of the price per room per night. I don't think any of us anticipated that energy would rise as dramatically as it has and sustained that level of height. We don't focus on going out there and saying okay, our customer needs to pay more because we've got to pay more, I don't think it works quite like that because the dynamic of supply and demand, not withstanding, will have an impact on that ADR. The ADR has risen because demand has risen which has helped, I suppose, buffer these early costs. I think what we are very seriously looking at now is how we can reduce our consumption, not that we weren't before, but that has become very much at the forefront.
We don't want to, let's say levy an additional charge to customers because we've got to pay that additional heating bill or something like that. It's something that we have discussed, but it's not something that we're comfortable to do. I think the price point in the market, again, will be dictated to a degree by supply and demand, and what other operators do within the market. So, to try and mitigate costs, we do hedge a lot of our energy, so we have already forward bought a fair amount a while back with our purchasing team, so we look at that on an on-going basis as normal anyway.
Clearly, with the increases, we're not in as good a position as we might have been in the past, but we have got at least a fair amount hedged which means that the exposure is slightly less than it might be for an individual. So that's very much part of it. Do I think we're going to pass on costs directly to customers? No, I don't. I think it will be all about being efficient, making efficient savings, working on energy reduction, and really trying to manage that cost as best we possibly can while keeping our ADRs at the level they are now.
Perhaps edging up if demand is there to support it, but I don't see them going down, and I think we have, I hope we have enough buffer in that at the moment to see us through if there is also some government support over the next six months for us to get into calmer waters next year when I hope with all the efforts in Europe as well, that we can see energy prices coming down a bit.
Paul Norman: Meenal, how are you feeling about this? How are you dealing with this cost increase, do you need to pass it on to people who are really struggling? Can you afford to? What are you seeing here?
Meena Devani: We are in a very high inflation environment where households are paying more for milk, bread, and everything else, so it isn’t a shock to consumers when menu prices or room rates go up. The challenge, as both Sandeep and Rebecca alluded to, is that the mix of business is changing, and so that does mean that corporate demand is a bit lower, the types of meetings and events are quite different from historic meetings and events , eg, here is a greater focus on short term, team building activities.
Leisure demand is also much more last minute. So the approach to sales and marketing needs to adjust to work with those changes. At the same time, we are very conscious that we would much rather not simply pass cost pressures on to consumers and instead should use the current environment as an opportunity to reduce inefficiency in our businesses. As a result, one of the areas we are spending a lot of time on now – which is good for business and good for the planet – is energy efficiency with a granularity and urgency that it hasn't had before.
We are now asking questions that were easily overlooked in a cheaper energy environment like how efficient is the lighting, do the saunas need to be on all day, should we have a thermal pool cover and what’s the payback on solar panels. On the labour side, we are starting to think about various programmes to bring in our own staff from abroad to alleviate the pressures on the current workforce who have been fully stretched by the lack of availability of additional staff. We haven't yet, but we know some hotel groups have done it very successfully.
Paul Norman: Marcus, where do you think construction procurement will head in the next twelve months? What are the pressures there?
Marcus Boret: I think what's quite interesting is that post pandemic, the construction industry had a massive rebound. The contractors that we talk to are the larger main contractors. All of them have secured all of their 2022 order books, and most of them are 60-80% covered for 2023, so it's an interesting position out there. We know there are supply bottlenecks out there and as I mentioned earlier, we are reliant upon importing. For example, if you look at China, they're still struggling with COVID, they've got lockdowns, there are factory shutdowns, and we're heavily reliant upon them. The conflict between Russia and Ukraine is causing further pressures. Brexit, we've talked about. I think the problems there still prevail.
Paul Norman: It's never going to go away, is it?
Marcus: It's not going to go away, no, it will ease. I read recently that construction material prices over the last 12 months have risen by up 26%. If you look at government inflation figures, June saw 9.6%. So there are pressures out there and I think some of the contractors with the workload that they've already secured are going to start to limit their appetite to bidding. I think contractors are going to look more to readdress their attitude towards risk and complexity, and I think they're going to look to try and negotiate more than work on a competitive tendering process. It may be that delayed or shelved development projects affect this, but I certainly see them being more selective. This will all put pressures on delivering new stock. As a developer who has been through a few cycles in the past I think what we need to do is develop the schemes that are more attractive in design terms for function, efficiency and buildability. I also think we need to consider modern methods of construction, and we need to try and make things more attractive to the construction industry to promote these products.
Paul Norman: How are you going about doing that, Marcus? Or how do you suggest doing that?
Marcus: I don’t think there is one answer that fits all, but I think we've got to look at optimising the design, and materials that we are using. The marketplace is ever-changing in terms of the products that are becoming short in supply chain bottlenecks, so being flexible is important. I think the earlier you engage with contractors, the more assistance you can get on buildability and supply fluctuations.