‘The crisis has cast a long shadow," said Sir Mervyn King, governor of the Bank of England, in the first peace-time radio broadcast of any central bank chief since March 1939. By the end of 2011, there were reasonable hopes that the European crisis would find a resolution, but as 2013 approaches, those hopes remain speculative.

Quarterly GDP growth across Europe has been disappointing, to say the least – Spain remains in recession with negative growth of -0.3% and youth unemployment of 56%, while France and Germany both languish at 0.2%. Almost every economic forecast released over the last 12 months has been revised downwards. Other countries outside the common currency have fared just as badly. After repeated warnings from economists and opposition leaders, the UK entered a double-dip recession in the first quarter of 2012.

Background fundamentals

Behind the malaise lies a combination of wider macroeconomic factors. Uncertainty across the eurozone and civil unrest in the Middle East are chiefly responsible. But policy decisions aren’t helping. In a report for the International Monetary Fund, economists Oliver Blanchard and Daniel Leight estimated the fiscal multiplier of spending cuts to be as large as 1.7% for every 1% reduction. Those figures help explain why transaction numbers for 2012 have been so disappointing in the European hotel market. Current estimates suggest volumes for the period lie around 10-15% lower than this time last year. What investors face is not just a class of risk, but an almost endless well of Knightian uncertainty.

" Hotels that are known to be in financial difficulty are risky for conference organisers, wedding planners and holiday goers."

"The world has become increasingly hard to predict," says Arthur de Haast, chairman of Jones Lang LaSalle Hotels. "Medium and long-term planning is virtually impossible. The eurozone crisis hasn’t been resolved; it just teeters from one deadline to another without getting substantially better. At the beginning of the year, we expected transaction volumes to mirror this period in 2011, but the latest figures suggest we will fall short by over £1 billion." Some investors have only themselves to blame. Like so many other sectors, too many in the hotel market found themselves over-leveraged and overconfident when the crisis came. The result – repossession and refinancing – has been one of this year’s standout features.

"Assets that were bought at the peak of the market with huge leverage have been most impacted from an ownership perspective," says de Haast. "They are the ones under the greatest pressure, often in the hands of the banks. Those hotels that were bought by investors with financial strength, who weren’t overly aggressive with their debt structuring, have continued to do well." For those tied down to a bad capital structure, the story has been grimly selffulfilling.

Reluctance to book

Hotels that are known to be in financial difficulty are risky for conference organisers, wedding planners and holiday goers. The reluctance to book compounds the original problem in a classic vicious cycle.

High debt costs also mean some investors have lacked the cash flow they need to invest in their product. In a hugely competitive market where demand is already poor, any backlog of capital expenditure can be fatal.

For all the owners that have defaulted on their loans, surprisingly few properties have made it back onto the market over the past year. Many of the assets that have been repossessed are yet to be released. Whether that’s selfdenial or financial acumen is hard to say. Selling at today’s prices would, in many cases, require the recognition of loss at a time when banks are under intense pressure to demonstrate profit. It is, according to Timothy Lloyd- Hughes, head of European hotel, leisure and gaming at Deutsche Bank, something of a Mexican stand-off.

"The real reason why deals haven’t been closing this year is that sellers are looking at the 2007 prices while buyers are looking at today’s," he says. "There’s a mismatch. What I hope they’ve now realised is that this is the new normal."

Capital attraction

For major gateway cities, operating performance has been considerably better than transaction volumes. London and Paris have shown year-to date revPAR growth with demand holding up well, despite an aggregate macroeconomic drop. In Germany and other Central and Eastern European cities like Budapest, Moscow, Prague and Warsaw, hotel performance has been almost as impressive.

London’s growth owes surprisingly little to its ‘bumper summer’. Neither the Olympic Games nor the Diamond Jubilee made particularly significant contributions to the hotel market. But then again, mega-events rarely do. "It’s a well-known fact that largescale events deter other markets from coming to the city," de Haast says.

" Brands have been chasing opportunities where they can throw out the competition or show flexibility on existing management contracts."

"Big conference organisers, business travellers and even leisure travellers tend to stay away. That was the case with London, but fortunately it didn’t experience an unsustainable surge in supply or the kind of investment we saw in Beijing or Athens."

For all the signs of promise across the gateway cities, areas in the southern Mediterranean belt have struggled. revPAR in Athens is down by 20%. In Lisbon, Madrid and most major Italian cities, the numbers are equally poor. That’s created something of a two-tier market. Almost all of the prime assets have been clustered around the liquid areas, with pricing and interest back, more or less, to 2007 levels. But outwith that relatively small core of cities, the situation looks increasingly bleak. Only deals with very specific foundations have occurred in the tertiary cities.

"There are people out there who, for specific assets and highly specific reasons, will want to buy," de Haast says. "The Belfry and Hyatt in Birmingham are good examples of that. But those assets that don’t meet the requirements of those exacting buyers have been incredibly hard to shift."

Investing to consolidate

In the Hyatt’s case, it was the operator itself that made the investment. After high-net-worth-individuals, hotel operating companies have actually been the second-largest investors in the European hotel market this year. The reasons are simple. With debt finance largely unavailable and investment activity still low, operators are being forced to defend their businesses autonomously. Brands have been buying hotels to establish new areas, consolidate their distribution in key markets or protect their position when a management contract is at risk.

None of this is supposed to be for the long term. The need for bricks and mortar over the past few years doesn’t mean the asset-light business model is changing in any fundamental way.

"These guys aren’t trying to rebuild large real estate portfolios," says de Haast. "What they’re doing is selectively buying key assets in important markets that are crucial to their distribution. Most will only hold these assets for a few years until they’re comfortable either that the product and brand is established or that they can put a new long-term management contract in place."

Constraints on liquidity

The constraints on liquidity and debt financing have also aided cash-rich buyers, predominantly from the Middle- East. Their preference for long-term assets, international prestige and deals that demand capital, has brought them straight to the fore.

"For all the signs of promise across the gateway cities, areas in the southern Mediterranean belt have struggled."

Institutional investors have also been visible. The legacy of leased hotels in mainland Europe has interested a variety of players: insurance companies, German open-ended funds and specialist real-estate funds have all played a significant part on the market over the previous year.

"A lot more players and pools of money have come into the sector over the last three to four years," says Lloyd- Hughes. "There’s been a lot of interest from sovereign wealth funds and high net-worth individuals. On the loan side, you’re seeing more insurance companies, too – across the board, we’re dealing with a broader geography.

"We’re also handling a change in the way deals are structured. During the boom years, loan-to-value ratios were at 80, sometimes even 90%. We’re now down to 65% as the maximum. The knock-on effect is that there’s a lot more mezzanine and junior debt spinning around. Everyone is looking for yield. With cash and zero and other asset classes performing badly, you can achieve around 10-12% with mezzanine. It’s a change that’s unlikely to go away any time soon."

All down to politics

A change in focus is something hotel operators and owners will hope to look forward to in 2013. With constraints on development finance, and headwinds from Europe and the Middle East, neither has been able to focus on expanding their portfolios over the past year.

Conversions have been popular in that context. Brands have been chasing opportunities where they can throw out the competition or show flexibility on existing management contracts. "The ability to grow businesses has been more limited over 2012," de Haast says. "In order to keep the pipelines moving, brands are having to be much more flexible, putting money behind deals and showing elasticity on the terms."

"There’s an increasing realisation from the banks and owners that the market isn’t going to bounce back quickly."

How will 2013 fare? It depends who you ask. For Lloyd-Hughes, the outlook is positive. Markets swing between periods of obsessive bad news and periods of resilience.

"I think we’ve moved into the latter category psychologically," he says. "Since September, when everyone got back from the summer and Bernanke [chairman of the US Federal Reserve] said he’d do whatever it takes, I think people have started to calm down. We’re in for a long grind, with zigs and zags, but to paraphrase Jack Nicholson, I think that’s about ‘as good as it gets’."

Continuing uncertainty

At Jones Lang LaSalle, de Haast is less optimistic. "I don’t see a big change from 2012," he says. "From an investor perspective, Europe remains patchy with continuing uncertainty. Managing cash flow and doing what you can to maintain your product is going to be a priority for owners. There’s an increasing realisation from the banks and owners that the market isn’t going to bounce back quickly – to increase liquidity on transactions they’ll have to be realistic about pricing."

If the eurozone crisis lies at the heart of the hotel market’s transactional torpor, then politics lies at the core of its solution. The lack of political willpower across the region illustrates an extraordinary loss of self-belief within the technocratic elite. The result – a lost year for vast swathes of people, businesses and hotel deals.