The UK hotel sector

A tale of two markets

KPMG's analysis of the recovering UK hotel sector reveals a picture of mixed fortunes for hotel owners and operators. In London, and for the larger hotel chains in particular, there has been a steady return to healthier average room rates (ARR) and occupancy leading to an overall improvement in revenues per available room (RevPAR) of over £100 on average compared to a provincial equivalent of less than £50. Occupancy rates are now topping 80% in London, but failing to reach 70% elsewhere. For many, this next period will be a case of survival of the fittest, with currently successful businesses continuing to grow and prosper whilst weaker performers go to the wall.

Introduction

As the economy lumbers back into growth, but with the prospect of another dip into recession still looming, the UK hotel sector is making a gradual recovery in terms of ARR and occupancy levels. As a rule it can take up to six months for the underlying trends in an economy to be reflected in hotel sector performance so this squares with the general upswing in other markets. However, this overall picture of recovery masks a more complicated composition of markets and trends. The market is divided into London and regional segments. Within those segments are further sub-divisions into branded (currently 25% of the market and rising) and non-branded operations and through distinct value offerings eg budget vs. boutique. Each offering is tailored to different levels of price and customer offering and broadly falls into four main segments:

There will also be distinctions between brands appealing more to leisure travellers than the business community and vice versa. In terms of branded offerings the picture is clear – the stronger the brand proposition, the stronger the performance. Franchising an established brand can therefore be an attractive proposition for a property owner. Under this type of arrangement, the property owner retains the risks associated with running the hotel and is required to live up to the standards set by the brand owner. Owners who do not want to run the hotel directly may prefer to use an operator and enter into a management or lease agreement. In most management arrangements, the owner of the property again retains the majority of the risk associated with performance, with the operator paid a fee for the day-to-day running of the hotel. In lease arrangements, the risk and rewards rest with the operator, who is responsible for all aspects of operating the hotel, including capex. In these situations, the operator retains all the profits after paying rent to the property owner.

The differences in ownership and operating structures play a significant role when it comes to the provision and renegotiation of finance. This is a particularly key issue in the current climate, with lenders looking at hotel recovery plans and projections with ever increasing scrutiny. In an insolvency situation, lenders will find some ownership and operational structures more challenging than others in terms of the degree of control they can exert administratively and in the realisation of assets.

Back to top

Factors in play

Performance within these markets and segments is influenced by a number of factors:

Tourism and business travel activity is continuing to increase. In the three months to March 2011, there were 4% more visits to the UK by overseas residents than in the equivalent three months a year ago. Also in the three months to March there was a 6% increase, in nominal terms, in the amount that overseas visitors spent in the UK compared with the same period last year. Early indications are that Q2 will post further increases in tourist trade, although year-on-year comparisons are less relevant for this period because of the effect of the Icelandic ash cloud on air traffic during 2010, the relative weakness of the pound against the dollar and the euro continuing to favour incoming travellers (this position is despite the current debt crises in Greece and Portugal).

In 2009, there was a shift in customer base from business travel to leisure travel. Although this position hasn't yet completely reversed, we are certainly seeing a re-balancing in favour of occupancy by business travellers. Fuelled further by modest rises in GDP, we don't expect it to be too long before the position returns to where it was. The increased proportion of business travellers will help to improve the achievable level of room rates. As elsewhere, the relative spending power and disposable income of UK citizens is likely to fall when the combination of public sector spending cuts and tax rises take full effect in the latter half of 2011 and beyond.

In anticipation of the London 2012 Olympic Games, there has been a marked planned increase in the volume of new hotel capacity in and around London, either through building or renovation activity. This increase in room supply would normally be expected to result in RevPAR reductions, but this has not been the case to date. The Olympic bounce will have a knock-on effect to the wider M25 area and locations hosting specialist events within the Games programme elsewhere in the country. In other major conurbations, the pattern of new building is less consistent. There is recent concern by hoteliers in Liverpool, for example, that new developments may lead to surplus capacity and reduced rates, but that picture is far from clear and could equally represent a shift toward higher quality facilities and the rates those facilities can attract.

On the financial side, each situation will tell a different story. Without doubt, the continued level of low interest rates has protected many businesses from collapsing over the past two years. Despite this favourable backdrop, many hotels and chains have been subject to pressure and demands from lenders. Central to most financial problems is the issue of property. For borrowings secured on property values, the falling market has triggered breaches of loan-to-value covenants and consequent refinancing terms needing to be agreed. The prolonged downturn has also revealed underlying tensions in many owner/lender relationships that will continue to put strain on financial arrangements for some time to come.

For those with access to capital funds, such as the major budget chain operators, including Travelodge and Premier Inns, the picture is somewhat different. Chain operators are continuing to build capacity at a significant pace in a race to grow volume and whilst this may lead to surplus supply in five years or so the battle for immediate market share takes precedence. Smaller operators with access to capital funds should invest in refurbishing facilities in anticipation of an upswing in business as the global economy recovers. But for many smaller operators, the struggle is to service the interest payments on existing borrowed funds let alone make inroads into capital repayments or extend facilities.

Back to top

Efficiency winners and losers

Hotel operators have been tackling costs through a variety of means during the recession. For some, this will have involved a top-to-toe systematic review of all costs and a drive to improved operational efficiency, and for others it will have been more ad hoc – tackling the big budgets in order to preserve cash and please lenders.

For most, there is little more to gain through further cost cutting, particularly where this compromises the overall guest offering or has the potential for a detrimental impact on brand, service quality, or customer perception – and therefore rates. We know that those hotels coming out of the economic recession with 'tired' assets will be less competitive and struggle to win back custom. In pursuit of even greater efficiencies, individual hotel businesses and larger scale operators will be looking for ever more strategic approaches to lower their costs of operation. That need for strategic efficiency planning can be met through various approaches including financial and operational restructuring and stronger partnering arrangements with travel operators or other businesses in the travel and accommodation vertical market, but, irrespective of the route taken, further consolidation of assets and operations is inevitable.

The likely casualties will be non-branded owner-operated businesses and these run the risk of ceasing to trade if they are unable to deal with the twin challenges of an increasingly competitive market and increased costs of financing the business. Another vulnerable category will be those mid-market players with tired facilities and no clear proposition. This group will increasingly find their competitive position eroded by fast-moving and assertive budget operators and a top tier pushing for increased occupancy levels.

For lenders, there is a growing likelihood that the weaker performing customer businesses will breach loan covenants or default completely. David Crawshaw, KPMG restructuring partner comments: "The decisions to be taken in dealing with repossessed assets will again vary from case to case. For some, there will be ready interest for the sale of failing hotels in order to achieve turn-around and consolidation. For others, the task will be a simple asset disposal in a depressed but active market for real estate. Some lenders will choose to take a portfolio position and bundle or merge several businesses or assets into more attractive lots for realisation." There will also be the question of whether underperforming operations can be restored to health or should be recognised as a residential or alternative development opportunity.

Back to top

The road ahead

With the London 2012 Olympic Games in sight there is good reason to expect occupancy rates to rise steadily for most of the coming year, but it is also worth remembering that the peak occupancy for the Games will only last one month. Whether this increase in occupancy will be matched by commensurate increases in rates remains to be seen.

With increased capacity in supply, particularly in London, and extended discounting by some operators to secure occupancy at any cost, it may prove challenging to get back to the room rate levels of 2007. According to Richard Hathaway, KPMG's UK Head of Leisure, "Those hotels that have maintained room rates through the creative use of incentives rather than price cuts will be better placed to maintain favourable prices. As interest rates rise, there will be considerable pressure on regional hotels that haven't returned to growth and with limited prospects for doing so. In 2011, the game may well be up for those hotel businesses with long-standing issues. Increased competition and rising costs of doing business are likely to result in increased rates of failure."

The final point we would make is that there is always the unforeseen to deal with. We have witnessed the effect of natural disasters, natural phenomena and terrorist activity on travel and hotel performance, and those with the best contingency plans are likely to weather all scenarios, be they man-made or through natural causes.

Back to top

Feedback & comments

To provide feedback on this Sector Foresight, or to suggest other sectors you would like us to cover, please email hayley.willans@kpmg.co.uk

Back to top

Unsubscribe | Privacy | Legal

© 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

KPMG LLP, 15 Canada Square, London, E14 5GL

Designed and produced by UK Design Services.
Publication Number: RRD-256825