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European hotel owners to weigh business models as COVID-19 shakes up sector

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European hotel owners to weigh business models as COVID-19 shakes up sector

SNL ImageNow is not a good time to own a hotel however it operates. Whether privately owned, leased, managed, or franchised, the COVID-19 pandemic has had such a devastating impact on the sector that few are making money.

Still, the crisis is beginning to raise questions about certain ownership structures, with a number of hotel property owners already finding their model unsustainable.

U.K.-based value hotel operator Travelodge Hotels Ltd., which is owned by Goldman Sachs Group Inc., Avenue Capital Group LLC, and GoldenTree Asset Management LP, told its landlords in March that it was suspending rent payments after it failed to pay its second-quarter bill. The company launched an insolvency process known as a Company Voluntary Arrangement on June 3, which proposes payment of half its rent for 2020 and 2021. Secure Income REIT PLC, which owns 123 of the 564 properties operated by the brand, is among the landlords opposed to the plans.

Christian Mole, head of hospitality and leisure at EY, said in an interview that the current crisis means hotel operators using such fixed lease models are increasingly likely to look for alternatives, including more turnover-based leases. "The lessee is left totally exposed by a fixed lease in a shutdown situation, and you frequently end up in a big bun fight between the landlord and tenant," he said.

The issue is particularly pressing in Europe, where the hospitality sector's recovery from the crisis is lagging that of other major global markets. Average occupancy in open hotels in Europe had recovered to just 15% by the end of May, compared to 47% in China and 38% in the U.S, according to hotel data provider STR.

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A long, slow recovery toward pre-crisis occupancy levels is predicted, with STR warning that it is unlikely to happen before 2024. The time it takes to control the virus, and demand and capacity for air travel will feed into recovery, Robin Rossman, managing director at the data provider, said during a June 4 webinar.

The longer the current crisis persists, the more likely hotel owners are to consider alternatives to long-term fixed leases, according to Mole. "It really depends on how long it takes to ramp up to more typical levels of occupancy," he said.

The Travelodge Owners Action Group, which represents the owners of around 470 Travelodge hotels, began considering alternatives shortly after it threatened to pursue the CVA. Options included a move to fixed-price longer-term leases, EBITDA-adjusted leases, which would comply with REIT requirements, and pure-play management agreements.

Matthew Pohlman, who acts on behalf of a number of multinational hotel operators, investors, developers and private equity firms in the Europe, the Middle East and Africa region as a partner in global law firm Goodwin's real estate group, said hotel operators operating under leases with a significant fixed-rent component would welcome a shift to turnover-based leases in the current environment. "It gives the tenant or the operator a bit more breathing room when the operating environment is down because the rent levels would reduce in a commensurate way," he said. "You're going to see a fair bit of focus and scrutiny on rebalancing the interest between landlords and operators in that way."

Turnover-based leases also have the advantage of keeping lease obligations largely off-balance sheet for hotel operators with substantial lease liabilities, said Mole. This is a consideration for some multinational hoteliers, particularly since the introduction of International Financial Reporting Standard 16 in 2019, he said. A number of global brands that have divested much of their hotel property portfolios in recent years to become more asset-light already find the model attractive, he added.

The prevalence of lease-based hotel business models varies throughout Europe's major hospitality markets. Among chain hotels, which comprise 12.7% of total hotel properties and almost 40% of total rooms in the region, the lease model is most common in Germany where it used by 38.5%, according to a 2019 report by Horwath Hotel, Tourism and Leisure Consulting. The lease model is also widespread in other major European markets including Italy (36%) and Spain (26.9%), Horwath's data showed.

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A shift to turnover-based agreements in these markets offers the least disruptive change to the ownership model, Mole said. "If you look at countries such as Germany, in particular, where the lease model is so ingrained, it may be quite radical to shift from a lease to a management contract, whereas switching a lease to a turnover-based model is going to be a lot easier from a legal, administrative, and operational perspective," he said.

Newly developed hotels could be one area where turnover-based leases see substantial growth, Mole added. The pipeline of hotel projects in Europe is still fairly significant, he said. "You may well see over the next year a swathe of lease renegotiations in respect of existing portfolios, but I think as new hotels are built and open up, these owners will find themselves under pressure to enter into turnover-based deals with occupiers."

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