Covid-19 and the Hospitality Sector: Has Debt Become the Elephant in the Room?
As hotel owners and operators grapple with hygiene challenges and re-booting businesses due to the Covid-19 pandemic, the issue of debt is looming large as hotel owners and operators face major problems in meeting loan and lease commitments despite having little, if any, revenue currently.
John Wagner, co-founder of Cycas Hospitality, which owns two hotels and manages another twenty or so extended-stay and full-service hotels in Europe, said that its bank has, so far, been "most cooperative", but he acknowledged that "there's still a big negotiation to come because what they've done is, they've given us a debt repayment holiday."
Covenants have been waived, he said, but repayments have not been forgiven. "It's just been pushed down the road. And the question is, when's it going to be due?"
"The first conversation (with the bank) is, ‘well, all the debt payments for the months you've missed, we'll add them on at the end of the year.' That was the starting position. We still need to negotiate but fortunately they're reasonable people….at least they have been to this point."
Wagner was sharing his experiences during the latest HoCoSo Connect online forum, moderated by HoCoSo chairman Jonathan Humphries, who steered the discussion towards the health of assets. "It is extremely important that companies look at the overall health of their assets to ensure longer term sustainability," he said. "Companies which have developed a higher level of immunity prior to Covid-19 may be better positioned to weather the storms ahead. If they haven't, they need to start building their immunity systems now."
Wagner said that currently about half of his group's hotels that are still open are doing "reasonably well" given that many of our competitors are closed. Compared to normal times, occupancy rates were ranging from 40 to 65 percent, he said. "We're nowhere close to break-even. We're paying wages and the light bill but we're not paying lease costs and we're not paying property debt.
The hotels are positive in terms of gross operating profit, "but nobody's making any money at the moment. Nobody. Not us, not the owners. Nobody." That said, he said his group is doing better than some others, "so I'm counting my blessings. I have a strong faith that the collective strength of mankind will find a way through this and we will, eventually, prosper again. I just do not know what it will look like yet. As if to prove that point, our development team remain fully engaged and if anything, are busier now than before the pandemic hit."
A strategist with a major real estate investment group in Europe stated in another forum in recent days that the worst thing that can happen is if an investor suddenly goes silent and no longer answers phone calls or emails. His team, he said, was seeing two groups of investment managers: those that go ‘blank' and disappear; and those that are trying to deal with the situation and are not in denial.
- Debt and a lack of visibility
Bořivoj Vokřínek, Strategic Advisory & Head of Hospitality Research EMEA with Cushman & Wakefield, told the HoCoSo session that debt and the lack of visibility "on the curve to recovery" are among the most pressing issues for hoteliers.
"Banks are basically kicking the can down the road by extending mortgages and payments, giving breaks and dealing with the current situation rather than calling in loans and covenants," he said. Consequently, issues are not being resolved and, instead, are "just being postponed."
This is due to a "huge amount of requests" that banks and lenders have received, as loan books have grown significantly in recent years, due to a peak in active transaction activity. As for the lack of visibility and uncertainty regarding the recovery, lenders are "waiting to get more clarity before they decide whether to call-in loans, postpone or renegotiate."
Unlike the 2008 financial crisis, Vokřínek said, when banks were more exposed by giving loans to overleveraged businesses, "the financial system is much healthier now," so that allows for greater room to negotiate. "The trickier situation probably will be with the hotel leases, especially in Europe where this business model is more common and some hotel operators had signed very aggressive property rental terms in recent years" he said, adding that there are likely to be "huge differences between different markets in terms of recovery."
"Even if you look at the last financial crisis, some markets recovered within a year, while others took ten years to recover. Once bankers and landlords start realizing that tenants will not be able to pay rents in some markets for five or more years, how's it going to be resolved? It's fine for everybody to say there will be some haircuts (rent payment reductions) for the next few months until the recovery starts. But nobody is just going to accept a haircut for the next five years."
- On the need for operators to maintain relationships with owners and landlords
The forum also heard how a hotel group's ‘decent' relationship with one particular landlord had become somewhat strained over a ‘troubling' lease, with the landlord refusing to give any relaxation of payments. "Even though two hotels involved are closed, he's still demanding rental payments."
Maintaining relationships with banks, lenders and landlords is key, HoCoSo chairman Humphries said. "When the banks, owners and operators fall out, it's a recipe for disaster. Humphries stresses the need for greater collaboration between all the stakeholders, combined with authenticity and open communication. The approach must be, ‘we're all in this together' rather than an ‘us and them' approach."
- Buyers are already seeking bargains, but sellers are not offloading distressed assets - yet
As for potential M&A activity, Chris Mumford, founder of Cervus Leadership Consulting, said "there are still a lot of people out there, interested in investing in our sector, whether it's now or down the road." For example, he is currently working with a family office which wants to take a stake in a luxury-end business. "They're very bullish on the space so that's positive."
Hotel advisor Alphy Johnson said that, in the US, "nobody is taking any action whatsoever" as they are waiting to see which way things will go. "Is there going to be a second wave or recovery? So, there's a lot of hesitation."
Major financial players such as sovereign wealth funds are still looking to buy assets and hotels remain a target for investors, Johnson said, but sovereign wealth funds are also looking to repatriate funds at present "because, whether it's the price of oil or Covid-19, they need their cash."
"So where is the cash? That's the big issue. Are we looking at brands going from ‘asset light' to ‘asset maybe-not-so-light' and getting back into the equity in their hotels?"
As for Europe, acquisition activity is picking up generally, said Vokřínek of property consultancy Cushman & Wakefield. Investors are starting to come back and there are strategic sellers but "we're not talking about distressed sales yet."
"The strategic sellers are either trying to strengthen their liquidity positions because they think that, six to twelve months from now, there will be opportunities to buy distressed assets. So, they're filling their war chests to go on a buying spree later on."
"Deals that were put on hold across Europe before Covid are now coming back to the table, so that's all good."
The impact of distressed debt could have systemic consequences across the whole financial system, from the asset holders, operators, banks, to institutional investors. The message from this forum is: let's make sure debt doesn't become the elephant in the room, by having open, honest, constructive and collaborative dialogue to find solutions with all the stakeholders involved.
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A message from the HoCoSo leadership team:
Like many of you, we have worked through numerous seismic events during our careers and we are total believers in the power of collective thinking in navigating uncertainty. At the start of this year, HoCoSo labelled 2020 as our Year of Community. We didn't realise then how important this ethos would be. As we watched from Europe as much of China's hotel market was shut down in a matter of weeks, we reflected on the Chinese character for crisis 危机, the literal translation of which is danger + opportunity. So we launched HoCoSo CONNECT, to focus on opportunity; to work on solutions; and to support each other. Our Weekly Forum series brings together a focused group of industry leaders to debate what is happening and to find solutions. We are motivated by a sense of community, responsibility and urgency.
Our huge appreciation to our roundtable of experts: Alphy Johnson, President, International Hospitality Advisor; Chris Mumford, founder of Cervus Leadership Consulting; John Wagner, Co-Founder, Cycas Hospitality and Borivoj Vokrinek, Partner, Cushman & Wakefield.
To the hospitality industry, we offer freely our time to be a sounding-board to support your internal discussions, planning and communications; and to work on practical solutions together. If you are interested, we'd be very happy to get around a virtual table so please do get in touch. Jonathan Humphries, Katharine Le Quesne, Irene Zijlmans.
About the Author - Stuart Pallister
After working as a television journalist in Asia and Europe for nearly 20 years for mainly CNBC and Asia Business News, BBC Radio and TV, European Business News, and McKinsey, Stuart switched to digital content development at INSEAD business school and the National University of Singapore. He then headed the Academic Editorial Content at Ecole hôtelière de Lausanne and launched its knowledge platform Hospitality Insights by EHL.