The property market and the hospitality market are closely linked. Therefore it comes as no surprise to hear that both are extremely dynamic industries, with the serviced apartment sector of the hospitality industry being the fastest growing class of temporary accommodation in Europe.
Requirements are changing for accommodation as clients are searching for more flexibility, space and a more homely experience; for business and pleasure purposes.
In theory, serviced accommodation increases risk to profitability; income is generated solely from guest rooms rather than from any offers of on-site food and drinks. However it must be noted that staffing costs are significantly reduced than in a hotel – not only due to a lack of restaurant but also in cleaning costs as it is unlikely that this service is offered more than once weekly unless a premium is paid.
This leads to an attractive combination of lower fixed costs resulting in more income becoming profit which lends itself to a business model that some might say, is more appealing than a traditional hotel.
Who is investing and why?
The most successful serviced apartments feature two main characteristics: excellent quality and prime location. In order to satisfy client demands, serviced apartments must have a wide range of transport links available in the vicinity and they must be situated close to shopping and business districts in main cities. The value stems from the clients perceived flexibility of the facilities and the ease of their ability to cater for their needs.
Capital has been injected into independent brands by a large number of enthusiastic private equity investors. This has enabled these newer and more independent brands to own and operate their own assets and leading to expansion through acquisitions in prominent cities.
The immaturity of the industry has led institutional investors to have a more cautious approach. The obstacles that have led to a deficiency of institutional investment include a lack of brand awareness and/or a proven operator track record, as well as a lack of understanding on the part of the investor of the sector as a whole. Some operators have even commented that investors been unsure as to whether the assets are classed as residential or commercial perhaps since, in the UK, sites acquired for development as serviced apartments were often apartment blocks authorised for planning purposes for residential use, although serviced apartments are now recognised as hotels.
This in turn has led to many institutional investors creating more risk adverse transactions, which have involved sale and leaseback arrangements which are proving popular.
Sale and leaseback structures
Through a sale and leaseback structure the investor will acquire the freehold/long leasehold title to the asset, and will then grant a fixed term lease (eg 25/30 years) back to the operator. Subject of course to the terms of the lease, the operator may opt to charge its lease to a third party lender for the provision of additional operating finance.
This provides the investor with reliable security as legal title to the asset is acquired at the outset, and a regular stable income over a fixed period with no exposure to the risk of an operating loss. If the operator is unable to meet the rent payments, the investor can terminate the lease and take back the asset.
For the operator, working under the remit of a lease rather than a management or franchise agreement allows it to have full control over the day to day operation of the asset. However it will also assume full risk for any operating losses and at the same time will remain liable for the rent payments throughout the term irrespective of the success of the business. That said, if the business proves to be successful the operator will retain the whole of any surplus.
Who are the operators?
Despite being a relatively new concept within the UK, the serviced accommodation market has been a well-established, thriving market in areas such as the US and Australia and have been so for many years.
The market features a variety of operators, from ‘big brands’ to smaller independent brands who are looking to offer something new to clients.
Although it may seem that the larger companies prefer to remain asset light as they tend to adopt the management or franchise agreement model. Whereas smaller independent brands who don’t have the large level of financial support and identifiable covenant strength may have to consider alternate options depending on investor requirements.
Serviced accommodation remains a developing sector of the market and due to the infancy of the industry, it is reasonable to assume that institutions will continue to remain interested, but cautious and any investment involvement will be carried out accordingly. However, as the market grows and an increasing number of success stories are reported, there is a chance that institutions will move away from sale and leaseback structuring towards management and/or franchising agreements which has been the case in recent years for more traditional hotel operating models.