Market Spotlight: Interview with Laura Hernando of Colliers International Spain

1. When we refer to the Spanish hotel market, are we really talking about the two big markets of Madrid and Barcelona on the one hand and the rest of Spain on the other?

The Spanish hotel market has a clear vacation bias, not only because of the attractiveness of our beaches, coasts and islands but also because of the cultural heritage of many urban destinations. A reflection of this is the record number of tourists reached in 2017 (81.8 million) which positioned Spain for the first time in history as the second tourist destination in the world (only behind France).

To assess the relative importance of the different hotel destinations in Spain we must look at the volume and evolution of total overnight stays, which reached 340 million in 2017. Taking this base as a reference, it is interesting to see how the aggregate sum of the ten main urban destinations in Spain has a level of overnight stays similar to the Balearic Islands (17% of the total for Spain) – but behind those of the Canary Islands (21% of the total for Spain).

Madrid and Barcelona are undoubtedly the two main urban destinations with a very similar number of overnight stays (19.3 million overnight stays in Madrid vs 19.7 million in Barcelona in 2017). The sum of both cities comprised 11.4% of overnight stays in Spain in 2017, considerably ahead of Seville (1.5%), Valencia (1.2%), Granada (1.0%), Malaga (0.7%) or Alicante (0.6%). 

2. Are secondary destinations gaining strength in terms of investment over prime cities? In this sense, do you currently see a location with particularly high potential in terms of investment (apart from Madrid and Barcelona)?

It's important to remember Spain's evolution as a global hotel investment destination, as the recent figures show that Spain has become a reference destination for the main international investors who have decided to focus not only on the urban segment but also increasingly on the holiday segment.

In this sense, hotel investment in Spain reached 3,907 million euros in 2017 (hotels in operation and investment in real estate for conversion to hotels), which represented an absolute historical record, well above the previous record reached in 2015, when 2,614 million euros were allocated to investment in this sector.

Geographically speaking, in 2017 the "stain" of investment spread to secondary cities and destinations that had remained relatively inactive after the crisis. During that year, Colliers registered hotel transactions in 34 cities in Spain compared to 18 cities in 2014. Malaga is one of the preferred destinations for investors, attracting 15% of total investment with 18 transactions in 2017. The Canary Islands maintained their hegemony as the favourite destination for investment, accumulating 27% of the total volume traded. Madrid retained its position as the main destination for urban investment, with 637M euros - ahead of Barcelona, which registered 422M euros.

The truth is that it is increasingly difficult to close deals in Madrid, Barcelona or Malaga, so we believe that secondary locations such as Valencia and Alicante will gain more prominence with investors in the coming months.

3. Is investment interest in under-exploited products, such as 3 star hotels, growing - to the detriment of 4 and 5 stars?

Spain is seeing a clear trend in increased interest in 3* and 4* hotels to the detriment of the 5* and 5*Gran Lujo (GL) establishments. Only five years ago 5* and 5*GL made up 60% of investment. There has been a process of gradual change since 2013 until 2017, when 5* hotels represented only 12% of the volume of investment - compared to 63% achieved by 4* hotels (vs 22% in 2013) and 25% of lower category hotels.

However, it is important to highlight that the driver of many of these transactions is the repositioning of acquired hotels. So we are witnessing a qualification or gradual improvement of a relevant part of the Spanish hotel market, transforming part of these 3*-4* hotels into 4* superior and 5* establishments. The investment priority should not focus on a specific category, but on the optimization of facilities and improvement of those hotels of any category that may have become somewhat obsolete and will need to be repositioned to maintain the level of demand reached in these last two years.

4. Do you expect the recovery of competing holiday destinations in the Mediterranean (such as Greece, Egypt, Turkey or Tunisia) to have an impact on hotel investment in Spain?

The recovery of these destinations will mean a slight adjustment to foreign tourist arrivals in Spain, however it is important to remember that in 2018 occupancy levels in Spain reached a historical high. Spain will continue to be an attractive destination to European visitors, in particular the UK and German markets, where consumers continue to see Spain as a unique product which cannot be duplicated by Turkey, Egypt or Tunisia in terms of services, facilities or complementary offerings.

Despite the recovery of these competing destinations beginning some months ago, in 2017 the holiday sector still broke all previous investment records and comprised 69% of total real estate transaction volumes. This trend continued in 2018 with important transactions such as the successful Blackstone takeover bid for Hispania, involving the acquisition of 40 holiday hotels. For many international core and institutional investors this deal signalled a green light for them to start looking seriously at holiday products in Spain.

5. What makes the Spanish hotel market so attractive to international investors? Every year we read in the media about a new record in hotel investment; will this trend continue?

Since 2015, foreign capital has been the main driver of hotel investment activity in Spain, accounting for 60%-65% of total transaction volumes thanks to capital flows coming mainly from the US and Europe.

2018 was undoubtedly a very interesting year in terms of hotel investment in Spain, with notable operations such as the Blackstone takeover of Hispania or the acquisition of NH Hoteles by Minor Hotel Group. With figures such as these we are confident that 2018 investment reports will say "new record achieved". However, our expectations for the coming years are more moderate.

6. What is the usual investor profile in this sector? Is investment coming from hotel chains, non-operating owners such as funds, family offices or even individuals?

In terms of investor profile, 2017 was the year of institutional investors. Blackstone, Portobello Capital, Benson Elliot, HIPartners, Axa or Elaia were the main investors.

The second most active investors were Spanish national chains such as Hotusa, Blue Sea or Riu with the purchase of the Building España. As for the REITs and SOCIMIs, although the volume of investment deployed stood at 467 M euros, its prominence was reduced compared to 2016, when the acquisition by Foncière des Murs of the hotel portfolio of Merlin Properties weighed particularly heavily.

Family office and private investors have always closely followed the evolution of the sector, but their more risk-averse profile and management of variable lease contracts mean that they have fewer and fewer options which suit them.

7. Where the ownership and management of a hotel is separated, is the preferred model in Spain the lease contract or the management contract? Is the hotel franchise still a rare thing in the Spanish market?

The reality is that the Spanish hotel sector continues to be dominated by independent hotels (31% of the total number of rooms) and by hotel chains that operate several owned hotels (42% according to the latest available data). Among the models for outsourcing hotel management, the lease has always been the preferred model over management or franchise contracts, a fact that has historically explained the weak penetration of major international brands in a country where tourism is so important.

However, we have been witnessing a gradual change for the past several years, partly due to the financial crisis which found many hotel owners facing lease renegotiations with lessees, and partly due to the appearance in Spain of multi-brand managers who were not afraid to embark on franchise contracts.

At present, hotels operated through rental contracts account for 16% of the hotel market, those operated through management contracts stand at 8%, and franchise contracts are close to 3%. Seven years ago, management and franchise contracts together represented only 8.8%, which leads us to conclude that there is a clear trend towards change in the hotel operating model. Although, we must recognize this change is going to be very slow at a percentage level, considering the large size of our hotel market.

8. Is variable rent the most frequent model in lease contracts? Do you see any alignment in the market between the interests of owner and lessee?

As has just been mentioned, the years of financial and real estate crisis in Spain have had a notable impact on the perception of hotel landlords and national chains, as they had a large chunk of their hotel assets linked to totally fixed rents negotiated at the most optimal market moments.

Owners have realized that rents, in addition to being high, must be sustainable throughout the contract period, and chains have learned to be more cautious and offer more conservative fixed rents that do not jeopardize their future operating profit. The combination of both effects leads us to see more and more varied lease models. The most common model is the variable rent based on hotel income (usually linked to a minimum income guaranteed by the operator). The variable rents linked to a % of the GOP are increasingly put forward by the national chains but it is still a difficult formula for owners to accept who do not intend to carry out an active asset management of the hotel.

Finally, we would like to highlight the increasingly common formulas proposed by leasing chains that want to avoid an excessively negative impact on their financial statements due to the accounting of the payment obligation assumed for a long period of time. The regulation can be very diverse but the most common dynamic is based on negotiating a maximum amount ("cap") that the chain assumes as potential loss ("shortfall") derived from exploitation. If this amount is consumed or exhausted, the chain will normally have the option to switch to an equity model or to terminate the contract early.

9. What trends do you see in hotel management contracts? In particular, do you see managers taking greater risks as a way of convincing the owner to sign?

As we saw, the increase in the prevalence of management contracts is very slow in Spain. The main reason is precisely the lack of risk-taking on the part of the operator, something totally internalised in the USA and parts of Europe, but difficult to understand in a market that cradles the main holiday hotel groups at world level.

Perhaps the most notable trend in recent years is the offer of many brands to contribute an initial amount of money ("Key Money") to support the opening or construction of the hotel. This amount is kept by the owner as long as there is no early break in the management contract.

Another less common formula for the chain is to offer the total or partial subordination of its management fees until a return figure agreed with the owner's priority is reached. It is likely that the proposal of this type of formula, or any other gesture on the part of the chain that shows their clear interest in aligning with the objectives of the owner, would help a more progressive growth of this management formula compared to other more traditional alternatives.

10. As a final diagnosis, what do you think will be the position of the sector in the next 5-6 years?

Spain will close 2018 predictably with its best historical record in terms of hotel investment and will surely consolidate as one of the main investment destinations at European level. The still significant need for investment in hotel repositioning and the potential for rapid pay-back of this type of investment will continue to attract value-added profile investors and some opportunistic funds.

Additionally, it is foreseeable that the core and institutional funds will begin to see the holiday hotel sector as an equal or more stable product than the classic urban hotel, which will undoubtedly represent a great opportunity for Spain.

The fundamentals of tourism remain and will continue to be good. There is nothing to suggest a worrying reduction in the number of tourists to Spain, but rather a slowdown in the strong year-on-year growth rates experienced in recent years, or a slight adjustment that is likely to be offset by an increase in average expenditure per tourist.

There are micro-destinations where occupancy levels are difficult to surpass and where the struggle is already centred on average price optimisation (ADR). This pressure of demand undoubtedly represents an opportunity for areas that are lagging behind in terms of hotel development, such as Murcia or Almeria, for example, and an opportunity to de-seasonalise certain destinations, but it also poses challenges to sustainable development.

That said, the diagnosis does not seem difficult: Spain should remain among the top three countries in the world in terms of both the number of tourists, the volume of income received from tourism and global competitiveness. If we improve the transparency of both operational and transaction information, the hotel sector will gain in liquidity and will increasingly approach markets such as the UK or Germany.