Global hotel operators have identified Europe as a target for franchise-driven expansion, with operators such as Marriott International looking to the region for growth. That growth may be slow in coming as institutional interest in the sector grows and lease-favoring Germany continues to be a safe haven for investors; however, third-party management companies are increasingly offering a route that works for both owners and operators.
Marriott International has announced plans to become the leading hotel company across the scale segments in Europe by 2020, following the 2016 acquisition of Starwood Hotels & Resorts Worldwide. The group planned to pursue franchise-based growth, with brands like Moxy and Courtyard by Marriott leading the drive.
In the UK, franchising plays second-fiddle to leases. According to CBRE Hotels, in London, approximately 26 percent of room supply is operated under an operational lease agreement, with around 17 percent operated under a franchise agreement. In comparison, in the UK regions, about 21 percent of room supply is operated under an operational lease agreement, with around 13 percent operated under a franchise agreement.
Joe Stather, associate director, CBRE Hotels, said the large proportion of operational leases in the UK is due to market share by Premier Inn and Travelodge. “However, many other relatively new operators are expanding through operational leases, fueled by investor demand for long-term fixed income, including Dalata, Motel One, Roomzzz and Staycity, etc.,” he added. “Some of the larger global operators will still sign some lease-style agreements, if the assets are strategic, such as InterContinental Hotels Group on the Principal hotels.”
Earlier this year IHG announced it was to rebrand 12 hotels in the Principal portfolio acquired by Foncière des Régions, with flags to include Kimpton. The deal with FdR will see IHG take hotels onto its balance sheet through managed leases. The structure will see IHG retain a royalty fee, before rent payments, of an amount equivalent to franchise fees from existing hotels; pay rental amounts which are forecast to stabilize at £48 million per year in 2021, with inflationary increases thereafter; fund any shortfalls in rent payments up to an annual and cumulative cap on losses of around £16 million and £48 million, respectively, at stabilization; and retain a share of profits after rent payments.
Looking at the wider European market, Stather said institutional-style capital, such as annuity funds and insurance funds, are seeking opportunities across Europe. “Many have, or are starting, European funds and are looking for hotel stock to diversify their portfolios,” he said. “Most are looking at the obvious lease markets including Germany and Benelux, although a shortage of investible stock on the market has been driving down yields in these locations.
“One response to this is a relatively high number of forward-funding deals, as a way for investors to increase their exposure to the sector. There are some operators in other European locations that will enter operational lease agreements, such as Melia and NH Hotels; however, the number of operators is [slimmer].”
Recent months have seen the number of operators looking again to leases expanding, with Radisson Hospitality announcing a return to leases for strategically important locations. As part of the group’s five-year plan, it plans to take on up to €400 million of lease risk as it looks to expand in Europe. The group said the decision was taken in part because of the increased demand for leases from institutional investors targeting the hotel sector.
The company has been exiting leases in secondary and tertiary locations, with plans to replace them with leases in stronger sites. Twenty percent of Radisson Hospitality’s hotels were leased and the five-year plan sees that remain around 20 percent.
“In markets, such as Spain and Italy, where investor demand is generally low for leases (partly due to lack of strong covenanted tenants), the yield differential between vacant possession and operational lease is narrow,” said Stather. “With a lease yield, you are capitalizing circa-60 percent of EBITDA and therefore, while the yield differential is low, it doesn’t make sense for sale-and-leasebacks or putting in an operator on a lease because it is value-eroding. So, we don’t see any material increase in stock under an operational lease.”
The changing profile
Just as Europe looked to be viewing franchises more favorably, a changing investor profile has driven many back to leases. For those for whom only a franchise will do, the rise of that other U.S.-based model—the third-party manager—can give both parties what they need.
“Some institutions, given the shortage of stock under an operational lease, are looking at franchises with third-party managers, predominantly in the UK,” Stather said. “They have always had trouble with taking on the hotel staff; however, many are starting to find ways around this with the help of operators or by setting up special vehicles. It is possible that this could fuel a surge in the supply of stock with franchise agreements, particularly in the UK.”
This year saw Interstate Hotels & Resorts add 12 new hotels to its international portfolio, including the company’s first hotel in France, after signing a deal with Borealis Hotel Group. Interstate will manage the hotels under long-term agreements for owner, development and lease partner Borealis Hotel Group. The pair were considering further growth in the Netherlands, Belgium, Germany, France and additional Western European countries. In addition, Interstate said it would continue to pursue the UK and Russia.
Included in the deal were the 314-room Ibis Budget Amsterdam City South and the 63-room Hotel Indigo The Hague-Palace Noordeinde, with other properties under construction and due to be delivered by late 2019 or early 2020. Franchisors include IHG, AccorHotels, Marriott International and Hilton.
Other options for franchises
Increasingly, there are signs the operators will look to be more flexible within contracts, potentially flipping from managed to franchised over the course of an agreement. Driving this are more-demanding owners being presented with more choice and a faster-evolving trading environment, where 25-year contracts are viewed by many as too long. Those wishing to maintain their pipelines will need to be flexible.
Katherine Doggrell is an editor at Hotel Analyst, the U.K.-based news analysis service for hotel investors.