There was a time, early last year, when the outlook for Europe and its vibrant hotel industry started to look rather less rosy. A series of bellwether elections in key countries like France and the Netherlands had put leading continental populists on the cusp of power – and a longestablished era of globalisation under threat.

The elections came in the wake of a string of terrorist atrocities in gateway European cities including London, Paris and Barcelona, revealing a world far more hostile and far less welcoming than it perhaps once was. Forecasts of long-term growth in tourism and travel could no longer be taken for granted. But despite the economic and political uncertainty, in 2017 Europe enjoyed the highest levels of occupancy, ADR and RevPAR ever recorded by STR, the hotel benchmarking company. Terrorism, it seemed, would not stop tourists from travelling – and neither would the steady rise of nationalist, protectionist politics.

It is a mood that has, by and large, continued through 2018, with the market enjoying steady (albeit slower) growth than before. According to STR’s latest figures for September, ADR and RevPAR are both up on the year before, with occupancy only slightly down. European hotel transaction volumes, meanwhile, have grown by 5.8% in the 12 months to Q2, according to research from Deloitte and CBRE.

“2017 obviously was a very strong year, but 2018 has been similarly strong,” says Peter Szabo, associate at HVS Hodges Ward Elliott. “Overall, Europe is still a very positive picture.”

Strong transaction market

As fears surrounding terrorism become more muted, French hotels have witnessed a resurgence, particularly in Paris, where strong growth has been reported in RevPAR and occupancy. Russia did not win the 2018 World Cup but enjoyed record-breaking ADR and RevPAR performance, while strong performance has also been recorded in southern Europe due to temporary shifts in market dynamics.

“Mediterranean countries have obviously benefited from fallout in other markets, be that the turmoil in Turkey, or in Egypt and Tunisia,” says Andreas Scriven, lead partner, hospitality and leisure at Deloitte.

Despite recurring fears that the era of cheap credit is coming to a close, interest rates have remained low, with debt easy to find and available from a number of different sources.

“I have not worked on a deal where anybody has raised the issue of securing appropriate levels of debt finance as an issue in completing that deal,” says Scriven. “It simply doesn't come up at the moment. But we are seeing slightly different approaches to lending into the market. In the run up to the past recession it was with more traditional banks. Now I would argue that has been diversified. You've got new entrances, one example being the book that Metro Bank created.”

The availability of debt has helped fuel a strong transaction market in Europe through 2018. Notable deals include: Vivion Capital’s £742 million acquisition of Project Ribbon, a pan-UK portfolio of mainly Holiday Inn hotels; Starwood Capital Group’s sale of a portfolio of 14 UK hotels to Foncière des Régions; and Lone Star’s £600-million disposal of its remaining Amaris hospitality portfolio and operating platform to LRC Europe.

“Investors still feel very bullish about Europe,” says Szabo.

When the pound lost its value compared to other currencies, Asian investors saw a chance to get a discount buying hotels in the UK.
– Peter Szabo

The rapid rise of institutional investors

But while there are many reasons to be cheerful, analysts say there are also causes for caution. According to a recent HVS report, European banks are now lending less for new developments and average loan sizes have decreased.

Interest in hotels as an asset class remains significant, but transaction volumes are not growing at quite the same rate as in previous years, suggesting that while the market is not in decline it is beginning to slow down.

“If you look at Europe as a whole in the first half of 2018 and on a rolling 12 month basis, we saw just under 6% growth in terms of transactional volumes,” notes Scriven. “That is materially down from full-year 2017 over 2016, which was about 22% growth.”

The profile of investors has also changed, indicating again that the market is nearing its peak. Coming out of the downturn, the industry was dominated first by opportunity funds and hedge funds, then by traditional private equity.

Now analysts say institutional money is expected to become the dominant source of equity in the hotel market.

“The type of capital, the cost of that capital and the risk that capital is willing to take has shifted a little bit,” says Scriven. “And so have the return requirements and the hold periods that they are looking at. It all feeds into the narrative that we are close to, if not at the top of, the cycle.”

The skilled labour shortage

Ten years on from the collapse of Lehman Brothers, a few of the deals being done are also raising “red and amber warning signs”, according to Scriven.

“From an investment standpoint, some of financial engineering that is going on makes me a bit nervous,” he says. “In certain deals, there are some who are trying to extract additional value which may or may not be [there]. That certainly brings back hints of memories of 2007 where we saw this exact same thing. It would suggest there is going to be a realignment in terms of where we see deals and also the performance of those assets.”

Despite a relatively strong year for transactions, London, which sets the tone for the wider market, has seen a slowdown in performance this year. In Deloitte’s 2018 European Hotel Investment Survey, more than half of respondents expressed belief that the UK has now hit the peak of the market, with 25% saying it is already entering a downturn. Unsurprisingly, respondents ranked Brexit as the biggest risk to the market over the next five years.

“The closer we get to key deadlines without any resolution, the more uncertainty there will be,” says Scriven. “People defer their spend and UK residents may potentially start cutting back a little bit.”

Respondents to the Deloitte Survey listed their second biggest concern as absence of skilled labour. Last year, the number of EU citizens coming to the UK dropped by 12%, according to the Office of National Statistics, with the EU referendum cited as a key driver. According to KPMG’s Labour Migration in the Hospitality Sector study, the UK’s hotel industry could face a recruitment shortfall of more than 60,000 workers per annum from 2019.

Cost pressures and oversupply

The acute shortage of labour comes amid a “perfect storm of cost pressures”, according to Scriven, who cites the national living wage, apprenticeship levy, rising business rates and the cost of labour as major challenges facing UK hotels moving forward.

“The cost pressures are going to make it difficult for some players,” he says.

Barcelona, one of Europe’s great success stories over the last decade, has also struggled in 2018 following a moratorium over hotel development and last year’s Catalan independence referendum.

Early signs of recovery in Turkey, Egypt and elsewhere may also have a negative impact on leisure segments in Spain as well as Italy and Greece going forward, adds Scriven.

“People are going back to Turkey and part of that is price-driven,” he says. “It is obviously cheap to go there and the same is true for a number of other markets, assuming there are no additional shocks.”

Some markets are also facing oversupply issues that are likely to become more of a problem going forward into 2019.

“There is some significant supply going into markets like Copenhagen and if you look at the pipeline for Edinburgh there is a huge number going in there too,” states Scriven. “But it remains very market-specific.”

Of course, as always it is hard to generalise in such a diverse market. Investors have different risk profiles and some see opportunities where others get cold feet. Brexit, for example, may look like an unmitigated disaster as things currently stand but Szabo says it has actually worked to the advantage of some investors.

“Asian investors in particular see a buying opportunity,” he says. “A couple of transactions in the past year have shown that when the pound lost its value compared to other currencies, Asian investors saw a chance to get a discount buying hotels in the UK.”

Market forecasts

Which markets perform well in 2019 is likely to depend on where they are at in the economic cycle. While the UK is clearly at a more advanced stage, other European markets still have some way to go before they reach the peak.

“These are some of the markets that saw more significant stress in the last downturn,” says Scriven. “Certain places are actually now only just starting to unravel some of those issues. The first hotel non-performing loans have been brought to market in Greece, for example.”

Even in more mature markets like the UK there are still plenty of opportunities to be found, Szabo adds, so long as investors have the right mentality and correct expectations.

“Many investors are not trying to find the perfect time in the cycle but are looking at individual investments on a deal-by-deal basis,” he says. “If the deal and their underwriting makes sense, they will go for it.”