Sustainability and ESG
Sustainability has been the key word at many Expo Real shows in the past, highlighting a growing commitment to green property development. Developers, investors and governments showcased projects that not only minimised their environmental footprint, but also prioritised energy efficiency and green building practices. Technologies such as solar panels, smart grids and green roofs were presented as integral components of sustainable real estate projects. Although most of the ESG measures to be taken are cost-intensive, especially for existing buildings, shareholders are focusing on these measures to optimise their portfolios for the post-crisis market. In addition, new bank financing is only available for ESG-compliant products, as banks are under regulatory pressure to build "greener" portfolios.
The COVID-19 pandemic highlighted the importance of supply chain resilience, and logistics facilities appear to be one of the winners in the current crisis. Companies are reassessing their supply chain strategies and looking for real estate logistics solutions that can mitigate future risks. Despite the current crisis, investors continue to view the real estate logistics sector as a stable and attractive investment option due to the steady demand for warehousing and distribution space. In addition, a general adjustment seems to have already taken place in the market. Developers are focusing on flexible space solutions, such as shared warehouses and on-demand storage, to accommodate seasonal fluctuations and changing business needs. This goes hand in hand with the increasing integration of advanced technologies such as automation, robotics, Internet of Things (IoT) and artificial intelligence (AI) to enhance warehouse operations, optimise inventory management and improve supply chain efficiency.
Residential as an asset call is not really a winner, but it is still doing well due to the shortage of housing, especially in Germany. It can be observed that classical office investors are also becoming active on this sector. Residential property in Germany has always been perceived as a stable and safe investment during economic downturns and real estate crises. The development to more home office also leads to more need for living space and even more private square metres for each individual. A damper on the market is the high level of regulation, especially for renovations and ESG requirements, although this should also be seen as an opportunity. It is also true that the environment for residential developers remains challenging, with high interest rates across the board, high construction costs and sales to private consumers no longer a given.
Sale and leaseback
With interest rates for traditional bank loans significantly higher and uncertain as to when or if they will fall, sale and leaseback transactions are back in the spotlight for both buyers and sellers. Sale and leaseback transactions can provide property owners with immediate cash flow, which can be particularly valuable during a crisis when access to capital may be restricted. This influx of capital can help companies meet operating expenses, reduce debt or invest in other critical areas of their business. Sale and leaseback transactions typically involve long-term leases, which can provide investors with a stable and predictable income stream. This can be particularly attractive in times of crisis, when other investment opportunities may be more uncertain. In addition, investors can diversify their property portfolios by acquiring properties with established tenants and reliable rental income, reducing the risks associated with vacancies, particularly in relation to the weakening office sector.
Transactions and financing
The difficult market situation is first reflected on the investment side. According to a recent study by JLL (Global Capital Flows Database, as of 31 July 2023), the transaction market in the hotel and hospitality sector has reached a new low compared to previous years. According to the study, EMEA hotel and hospitality transaction volumes fell by 22% in H1 2023 compared to H1 2022. Hotel transaction volumes in Germany fell from EUR 19 million to EUR 13 million in this comparative period, compared to EUR 34 million in 2019 (source: JLL Hotels & Hospitality). The few transactions that did take place in the comparative period focused on smaller individual transactions rather than portfolio deals, as financing for such smaller transactions was still the most readily available in the current market environment.
On the funding side, the crisis sentiment is particularly evident in the fact that existing liquidity is increasingly being held back, especially by institutional investors, due to the volatile interest rate environment and inflationary pressures. Instead, compared to 2022, hotel operators and project developers in particular have been active as investors in the market. The investment focus remains on the value-add segment, where there is strong investment potential due to expiring financings, fund maturities and short to medium-term CapEx requirements.
The current market situation is also having an impact on the brokerage industry, which is feeling the effects of the collapse in the transaction market for hotel real estate, particularly in the business areas that specialise in this sector. Colliers was the first of the major brokerages to withdraw from the hotel business in Germany as of 1 October 2023. In the future, Colliers will withdraw completely from hotel real estate consulting. Time will show whether other brokerage firms will reduce or abandon their hotel business as a result of the current market conditions.
Hotel Project development and Conversions
New development in all asset classes has come to a near-standstill, including the hotel sector, due to increased construction costs and high interest rates. Developers have to massively pre-finance the construction costs until the sale of the property, usually 12 months before completion, which is no longer possible for all developers in the current market environment.
The major theme in project development continues to be the conversion of existing buildings that were originally used as office or retail space but are no longer attractive for various reasons (location-related demand trends, structural sustainability needs, etc.). The increasing vacancy of office space away from prime locations, as well as empty inner-city shopping centres, offer attractive conversion opportunities for the hotel industry within the existing permitted commercial use. At the forefront of these conversions are mixed-use concepts that are individually adapted to each existing building. However, even conversions of buildings into hotels – in particular in connection with ESG related renovations – sometimes became too cost intensive in proportion to the current market rents.
Therefore, on the operator side, the focus is more on acquisitions and rebranding as well as takeovers of existing hotel operations than on new construction and complex conversion. Nevertheless, some players, especially in the serviced apartment sector, have now specialised in the conversion of existing buildings and aim to offer attractive solutions with tailor-made, mostly digitalised concepts.
Operators have recovered since the last lockdown ended in April 2022, with facilities serving business travellers recovering from COVID 19 pandemic much slower than those in holiday destinations. The overall recovery seen in the industry has been merely driven by the catch-up effect of holiday travel, which is now free from any restrictions again. In addition, it can be seen that the recovery in the top four German cities compared to the previous year is mainly based on ADR (Average Daily Rate) increases, while occupancy has only risen moderately in each case. In the German hotel market, the most significant recovery is taking place in Berlin, while Frankfurt and Munich still have some catching up to do.
Operators expect a further upturn in 2023/24 due to major international events such as UEFA EURO 2024, with venues in 10 German cities, as well as tourism spillovers from major events in neighbouring countries. In addition, the industry expects a delayed recovery in international business tourism due to the opening of China in March 2023.
In spite of the cautious optimism on the part of the operators, the framework conditions represent the following major challenges:
- The outbreak of war in Ukraine in February 2022 led to supply chain disruptions and dramatic increases in personnel, goods and services, and energy costs. The cost side remains unpredictable for operators.
- Inflation leads to a significant increase in rents and leases through the frequently agreed index rents. At the same time, inflation has a negative impact on the consumer behaviour of the guests and thus on the travel and turnover of the hotels.
- A significant shortage of skilled workers is slowing down operators and preventing the industry from returning to pre-crisis levels.
Overall, further consolidation is expected in the operator segment, driven by strong expansion of individual operators in the white label/serviced apartment segment. The serviced apartment segment, with its digital operating concepts, low staffing requirements and stable occupancy compared to traditional hotels, proved particularly crisis-resistant during the pandemic, and can also be popular with owners and investors in the area of conversions with innovative use concepts.
Transaction scenario in 2024
There will be movement in the market as the pressure to sell increases for some players in 2024 and opportunistic investors see their opportunities in distressed assets coming to market. 2024 will be the first year that 10-year low interest rate loans expire. This will create a risk that property owners may not be able to refinance their properties as they once financed at 1% and now have to refinance at 4% or more.
Authored by Ulrike Janssen and Tobias Strohmeier.