Strong underlying real estate fundamentals stand-out

In the current hotel investment environment, we’re witnessing just how crucial strong underlying real estate fundamentals are when it comes to desirability amongst investors and resultant pricing. Like what’s being experienced across the broader CRE sector, certain assets are standing out amongst the pack.

As we discussed in our previous article, year-to-date Australian transaction volumes remain subdued as the cost of debt drives a bifurcation of hotel capital markets, with the mid-markets (≤A$40 million) segment of the market having been the most active for the year to date and seeing the greatest depth in capital.

Hotel fundamentals such as assets with strong historical and current trading, those that are land rich, or have some form of genuine value-add or repositioning potential (brand or use), have proven to be key in the majority of completed sale campaigns over the past 12 months. In addition to this, investors are leveraging the potential for vacant possession (VP) by taking advantage of the competitive landscape in which operators now find themselves in, following the recent new construction wave.

Assets that are seen to meet any of these investment criteria continue to attract the strongest investor interest and attract new capital, as well as still achieving, and in some instances exceeding, pricing expectations. We estimate that approximately 71% of total transaction volumes as of YTD August 2024 (~A$537 million) have fit this mould and included one or more of these asset fundamentals.

Conversely, hotels with less favourable title or location characteristics or viewed as ‘passive’, have proven challenging to transact in the current environment. Given investors and institutional capital are now more than ever focused on running yields, there is a noticeable reluctance to pay for blue-sky or base pricing on projected stabilised earnings, as was the norm only a short time ago, unless the asset is considered trophy or strategic.

These investment trends have been demonstrated by a number of recent noteworthy transactions, in which both existing and new to market investors were provided with increased comfort for assets with strong fundamentals and/or repositioning potential.

A clear demonstration of this was the recent offering of Rydges Hobart, where contracts are now exchanged, which possessed several of the most attractive attributes and fundamentals currently being sought after by investors. These included a large freehold landholding (11,860 sqm), vacant possession of management, an attractive price point, and flexibility of alternative land use potential. This translated to an extremely competitive sales process, culminating in an excess of 100 enquires and seven attractive bids. 

Another example is the recently completed sale of the Great Eastern Motor Lodge in Perth, which sold for A$40 m to Singapore based Hiap Hoe Limited. The successful transaction reflected an extremely competitive EOI process, given the opportunity to acquire a significant freehold landholding (11,892 sqm) as well as also being offered with vacant possession.

^{Great Eastern Motor Lodge}

This was also an overarching theme in a majority of deals last year, including the notable landmark sale of the Sheraton Grand Mirage Gold Coast and Mercure Sunshine Coast Kawana Waters. The Sheraton, which achieved the largest ever single asset price on the Gold Coast (A$192 million), was driven a number of strong fundamentals including, being a unique irreplaceable trophy asset, vacant possession of management allowing for a wider buyer pool, positive spread vs cost of debt at stabilisation and a value-add proposition through refurbishment. This process attracted a global pool of investors comprising of a range of capital and strategies, which fuelled increased competition and drove pricing and terms of sale.

Similarly with the transaction of the Mercure (A$21.3 million), the competitive sales campaign which attracted 115 enquiries, 14 inspections and 10 offers, was driven by qualities such as vacant possession of management, strong trading performance but still with trading upside, unique demand drivers and quality of asset.

^{Left to right – Sheraton Grand Mirage Gold Coast and Mercure Sunshine Coast Kawana Waters}

One conversion example is the recently settled transaction of the Bayview Eden in Melbourne which was bought by HOME for a complete redevelopment to build-to-rent (BTR). This hotel conversion thematic has been progressing for some time now and has especially been a stand-out within the Melbourne market over the past 24 months. Transactions of typically underperforming assets on large and well-located landholdings have attracted the strongest depth of capital from both hotel groups in search of value-add opportunities (refurbishment or rebranding) and developers looking for assets for conversion or redevelopment to alternative use.

The JLL team has been extremely active in this space and has had the pleasure of transacting the majority of these, in which the hotel was no longer the highest and best use, including Hotel Lindrum to Time & Place for redevelopment to strata office, Bayview on the Park to Altis Property Partners for complete redevelopment to BTR and essential worker housing, and Fraser Place Melbourne to Paloma Property Partners for conversion to co-living.

^{Top left to bottom right – Hotel Lindrum, Bayview Eden, Bayview on the Park, and Fraser Place Melbourne}

We have also seen hotel investors and developers take an interest in the challenged office sector, targeting specific office assets for potential conversion to hotel, with a number of examples of this already in Sydney, Adelaide and Canberra. One of the most notable being JLL’s sale of office building 39 York Street, Sydney. The property sold for A$52.6 m to Singaporean group Invictus Developments, who plan on converting the prized-located asset into a hotel, with the potential to open by 2025.

Other notable sales this year have since seen a wave of refurbishments and rebranding’s, such as the Woolstore 1888 by Ovolo which has joined Accor’s Handwritten Collection, The Pacific Brisbane rebranded as a Mercure, and Sebel Ringwood which has become a Rydges.

As hotel investment levels continue to recover, another significant emerging fundamental is ESG, which continues to become increasingly important for investors and broader stakeholders. New metrics announced for the 12th Uniform System of Account for the Lodging Industry (USALI) will require hotels to take into account their Energy, Water and Waste (EWW) expenses, which will provide further transparency. Public policy and regulation across Asia Pacific and more locally continue to evolve to provide further guidance to ESG to investors.

Like what we’ve seen for some time in the UK and throughout Europe in particular, it’s increasingly obvious to investors that not transitioning to ESG principles will result in brown discounts and a stranded asset in a complex future. Conversely, hotels that clearly articulate a commitment to sustainability, wellness, and authenticity will have a competitive advantage in terms of increasing market share and driving higher asset values. That said, investors must look towards sustainability as a core component of hotel underwriting and investment decisions, with ESG now being an industry focus.