What next for UK hotel financing?

There are early signs that confidence in the credit markets is beginning to strengthen for hotels. London has for some time been open for hotel borrowers, but provincial markets have been highly selective for a number years, with only those with high-profile sponsors or low-leverage transactions being able to access debt through relationship lending or club deals.

To set the context, it is worth noting that there is approximately €932b (£770m) of non-performing loans (NPLs) estimated to be still sitting in European banks. Most of these banks have material exposures to real estate and have been selectively selling down these positions for some time. It is therefore unsurprising that banks, which have come under pressure from government to lend, are focusing on “safe havens” when looking to put their balance sheets to work. The risk assessment, asset quality and stress tests announced by the European Central Bank in November 2013 demonstrate that we are far from the finishing line and that this is a topic that will remain front and center in the financial and political environment in the near term.

2 |  What next for UK hotel financing?

Confidence is returningThe hotel transaction market has been improving for the last 12 to 18 months with a mixture of private equity and sovereign wealth funds together with private institutions having a significant amount of equity to deploy in the coming years. This was certainly the mood at the International Hotel Investment Forum in Berlin. Many see the current entry point near the bottom of the cycle as an attractive window of opportunity.

At the recent EY Real Estate and Hotels workshop — Capitalizing on recovery: building a leading business — in January 2014, 67% of the audience believed that they would “definitely” be undertaking a hotel transaction in the next 12 months with another 26% “probably” undertaking one. Confidence with hotel equity investors has also been mirrored with mezzanine investors but has not transpired fully to senior lenders.

Three recent hotel transactions suggest that the provincial UK market is increasingly attractive. Topland’s acquisition of Menzies Hotels in November 2013 and Hallmark Hotels in August 2014, Starwood Capital’s acquisition of Four Pillars in January 2014 were all-cash transactions. The ability of Topland and Starwood Capital to pay all cash was an advantage in their respective auction processes in terms of timetable and reduced an element of execution risk for the vendor. Additionally, in both cases it also demonstrated that the buyers had strong confidence that the acquisition could be financed at a later date.

ADIA’s acquisition of the 42-strong “Blackheath” Marriott portfolio in January 2013 and Starwood Capital’s acquisition of Principal Hayley in February 2013 was seen by many as heralding a renaissance in UK provincial hotel transactional activity. Although the anticipated “flood gate” of deals did not open, these deals certainly offered the market a level of transparency that was lacking for some time. Citi provided the financing on Principal Hayley, trumping a staple package offered by Goldman Sachs.

The recent announcement of Starwood Capital’s acquisition of De Vere Venues earlier this month will perhaps set another trend for the industry. On this occasion, RBS and Barclays provided £140m of senior debt (61% LTV), replacing Lloyds Banking Group, the incumbent lender and joint venture equity investor. Both RBS and Barclays have been selling down their exposures to the hotel sector for some time, but does this deal signal a renewed appetite to look at material portfolio deals in the provinces?

A new breed?We have also witnessed the entry of new lenders coming into the senior hotel market. Most notably, perhaps, LRG’s £430m refinancing of its 61-strong hotel portfolio in 2013 saw the banking syndicate made up of AXA, Deutsche Bank, GE, HSBC and LaSalle, supported by an additional £155m junior loan from GIC. With demand apparently strong, the final make-up was a mixture of domestic and international demand, and pension and insurance capital. Notably, the absentees from the syndicate were the traditional UK lenders: Lloyds, RBS and Barclays.

In December 2013, Radisson Edwardian announced a £450m refinancing across four bilateral loans. Metlife, the US insurance lender, provided a £200m 20-year fixed-rate facility secured on the Radisson Blu Edwardian hotels in Bloomsbury Street, Heathrow and Manchester. Additionally, Aareal Bank provided £175m secured on five hotels and Santander has lent £28m secured on one property, all on a seven-year fixed-rate basis.

Another notable transaction completed in Q4 2013 was Aareal Bank’s provision of £167.7m and €153.2m five-year senior loans to Park Plaza to refinance four London and five Dutch hotels, respectively. Aareal remains one of the more active lenders in the market, particularly for established hotels in European gateway cities.

The presence of pension and insurance funds, such as Metlife, is also providing long-dated options for long-term borrowers keen to take advantage of historically low interest rates. The impact of recent UK government changes to pensions and the potential knock-on effect on the annuity markets is yet unknown, and this may have a bearing on the appetite of UK providers offering this type of funding.

3What next for UK hotel financing? |

Market terms likely to improveWith renewed confidence in the market, borrowers can expect to have improved terms. London leverage has for some time been strong, with LTV rates above 70% at quite aggressive margins for prime assets, and more choice around potential lenders. The regions have proved more difficult, but confidence is returning however is more choice with regard to lenders.

Interestingly, two-thirds of the audience at the EY Real Estate and Hotels workshop expected the financing markets to improve in 2014. Forty-four percent believed that it would slightly improve, with 23% expecting significant improvement. Two percent believed the financing market would worsen.

On the whole, borrowers can expect terms to be extended to five if not seven years, margins to decrease from crisis highs and LTVs to increase to historic norms. In the commercial real estate market, we are starting to see 85% LTVs being quoted for prime assets, which raises concerns that the markets may be heating up too quickly.

Development remains the most difficult area of funding, again particularly outside of London. Naturally, as the market moves from distressed to performing, and as the economy starts to improve (UK economic output is already back to pre-peak levels), then the question of development will be asked increasingly often. No doubt this will be the next challenge for borrowers and lenders alike.

Where next?It is clear that those with relationship banks, low leverage and realistic expectations about fees and margin have been able to tap the banking market. Traditional lenders have not always been open for business, but other lending groups (international, pension, insurance) have stepped in to fill the void. The combination of these new entrants, coupled with the return of the incumbent UK clearing banks, is likely to bode well for the industry. Cautious optimism is spreading up the capital stack from equity to mezzanine investors and now to the banks. However, as the banks are still in the process of resolving issues from the financial crisis, it is unlikely that we will see the same levels of aggressive lending that we witnessed during the previous peak.

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ContactsCameron Cartmell Ernst & Young LLP Head of Hospitality & Leisure, UK&I

T: + 44 20 7951 5942 E: ccartmell@uk.ey.com

Matt Maltz Ernst & Young LLP Partner, Real Estate Tax

T: + 44 20 7951 1886 E: mmaltz@uk.ey.com

Christian Mole Ernst & Young LLP Executive Director, Transaction Support

T: + 44 20 7951 3034 E: cmole@uk.ey.com

Nam Quach Ernst & Young LLP Head of Leisure, Lead Advisory

T: + 44 20 7760 9264 E: nquach@uk.ey.com