Almost a five-star investment

There are about 2,000 hotels in Poland, half of which experts claim are, or potentially could be, for sale. However, there have only been a few clear-cut sale transactions. And many of these are private investments. The best hotels in the largest cities attract the highest prices, but such transactions are governed by rules of their own. Meanwhile, the hotel chain segment of the market is characterised by different sorts of acquisitions, based on franchising, leasing or management. "With hotel sales we are dealing with two types of transactions: the sale of a hotel business - the real estate including the hotel plus a package of contracts necessary for operating the business - and the sale of the shares in a company that owns a hotel or a number of hotels. The transactions for hotel chains differ considerably from those for ?independent' hotels, the number of which is hard to estimate, and their supply is considerably higher compared to the supply of hotel chains," claims Agata Demuth, a partner at the Schoenherr law office, which advises on hotel sales transactions. There is also another group of buyers on the market. "Opportunistic investors are on the lookout for projects based on management or franchise agreements and that have good locations, but need sprucing up and positioning on the market. The investors expect that the hotels will be sold at an appropriate discount," adds Adam Konieczny, the development manager for Poland and Ukraine at Christie + Co.

Not so simple
Around 80 pct of Polish hotels are not part of any chain, so it is their owners who choose the form and style of their management. Such hotels tend to be those that are put up for sale. Investors dispose of them for a number of reasons: "Some of the facilities for sale are often ill-suited to the needs of the local market with regard to their size, standard or the scope of services offered. They are often buildings that are badly designed, with an inefficient layout. The most common mistakes are an inappropriate ratio of rooms to the area earmarked for additional services, as well as having too high a proportion of common areas, which do not generate revenues directly while their related operating costs (such as the heating and cleaning), adversely impact the financial results. Due to these reasons serious players will not be interested in such a project," observes Dorota Malinowska, a partner of Pro Value, which offers consulting and evaluation services on the commercial property market. Another approach involves the sale of hotel assets to other private investors, as was the case with Ogólnokrajowa Spółdzielnia Turystyczna Gromada, the owner of 15 hotels and three holiday resorts. The cooperative recently sold its facilities in Ostrowiec Świętokrzyski and Przemyśl to a private individual for an undisclosed sum. "These were hotels that were not viable under current market conditions. They also required costly modernisations. We do not know what they will be used for," says Jan Błoński, the president of the board of OST Gromada. The hotel market is fragmented and concentrated in the hands of small investors, meaning that large-value transactions are out of the question. This has also been exacerbated by the relatively varied form of sales. "There have also been transactions just for hotels themselves - as pure real estate - with no contracts, employees, etc. attached," adds Agata Demuth. It often happens that hotel properties that fail to come up to the original investors' expectations or have stopped functioning for some reason are in fact bought, but with the hotel operations discontinued. This has been the case with a number of facilities: in Warsaw (the former Mercure hotel), Szczecin (Neptun) and Kraków (Cracovia), which were bought by developer Echo Investment. The two latter hotels were bought from Orbis, while the Warsaw property was acquired from Ravenna Warszawa. An office tower is to be built on the site of the Warsaw hotel, which was sold for EUR 31 mln and has already been dismantled. Hotel Cracovia has also been earmarked for demolition, but Kraków city council is reluctant to agree to this. Meanwhile, the plot that includes the Neptun hotel (which has been bought for almost PLN 60 mln) will be used by the investor for the extension of the nearby Galaxy shopping centre.

No sale, but...
The hotel chains currently operating in Poland are not interested in purchasing properties, either. They are much keener on franchising, management or - less frequently - leasing deals. This process is one of natural evolution for OST Gromada. "We also aspire to operate on a management basis. This is the offer we want to enter the market with. So we are not planning to invest in the purchase of any more facilities," explains Jan Błoński. The Orbis/Accor chain has also made its intentions clear. At the beginning of the year the chain announced its new 'asset light' strategy. From 2014, Grupa Hotelowa Orbis will no longer build its own hotels. Instead it will focus on the development of the chain through franchise and management contracts. The company is planning to increase the number of hotels in the chain (in Poland and the Baltic states) to 90 (there are currently 57 of them), 70 pct of which will be operated on the basis of management and franchise contracts. Moreover, Orbis will manage its facilities through their sale and back-franchising or back-management. In the case of the Mercure Kasprowy Zakopane, it was a sale and back-management deal that was chosen. Thanks to this chains do not need large amounts of their own funds and can lower their expenditure, while at the same time retaining an established hotel brand and releasing capital through leaseback agreements. The financial burden is consequently shifted onto the investor, whom the chain provides with a brand, a logo, know-how and access to its reservation system. This is also the strategy that has been chosen by Best Western, which continues to add more hotels to its chain. However, the company is not buying them, but signing franchise agreements. Meanwhile, economy-class hotel group B&B has been opting for refinancing. At the end of last year the company carried out a leaseback of its B&B Warszawa Okęcie hotel in Warsaw. The contract was signed with BRE Leasing, but the value of the transaction has yet to be disclosed. "A leaseback is an alternative to purchasing a property on credit as well as a proven and safe way to speed up the development of future projects. At the moment hoteliers mainly want to be the operators of hotels - they do not have to own them, and more and more chains are choosing this option. Sale and leaseback transactions will certainly be used more often in the hotel business in the future," predicts Beatrice Bouchet, the president of the board of B&B Hotels Polska.

Funds to the rescue
The high level of fragmentation of investors on the hotel market is having the effect of making it less transparent. Consequently the largest players are choosing the most interesting projects in large cities. Institutional investors (such as the German funds Union Investment and Deka) have high requirements with regard to the product, which include: a central location in a city with over 400,000 inhabitants, a famous brand, a long-term lease, a bank guarantee with a minimum value of a year's rent, and so on. Such investors are able to offer a price with a yield of 7 pct," claims Adam Konieczny. There has recently been a lot of talk about German funds. WestInvest InterSelect-Deka Investmentfonds bought the InterContinental hotel in Warsaw from Warimpex and UBM for over EUR 100 mln last year. Warimpex and UBM are to lease the hotel in exchange for a fixed rent and will continue to operate it under the InterContinental brand until 2027, in a typical sale and leaseback transaction. "For our new hotel fund, which we launched in April and which is focused on the budget and midscale segment, we are looking for new and innovative properties in Poland with long term leases. For our retail funds we are also looking for hotels in the three- to five-star segment," reveals Fabian Hellbusch, a representative of Union Investment. The German company has established a ten-year fund to invest in hotels in Germany, France, Belgium, Holland, Luxembourg, Austria, the UK and Poland. The eventual size of the fund will come to EUR 250 mln. Polish developer Europejski Fundusz Hipoteczny (EFH) is a company that has been interested in buying hotels, mainly from property portfolios acquired by banks. In 2011 the company made several such investments in Poland. However, EFH has currently been selling its properties off to reduce its debts. The company has announced that it is to sell its hotel properties to Cefarm Nieruchomości and later manage them on the basis of long-term operator agreements. "So there are a limited number of business entities on the Polish hotel investment market that could be potential buyers. But there is also a lack of Polish institutional investors interested purchasing hotels. This includes companies such as PZU, which has no strategy to buy hotels," points out Adam Konieczny. "The hotel business depends on the number of guests, not tenants. Consequently there is a lack of guaranteed revenue or the rents that funds depend on. So it is obvious that these entities will be interested in transactions involving branded hotels with an established position on the market, where the risk of failing to reach the expected profit is normally the lowest," argues Dorota Malinowska.

What's the problem?
What is it that makes a hotel purchase including its operations such an unappealing prospect? "Such transactions do take place. The market is underdeveloped, but it does exist. We are putting our facilities up for sale ourselves - and one is a hotel in Berlin. Everything depends on the valuation and the final price," claims the head of OST Gromada. Indeed, some properties have problems finding buyers because of an inaccurate valuation. "Hotels are a specific product, which is why you need to approach their valuation very carefully. The most common mistakes occur when estimating an average price per room and the level of operating costs, which determine the profitability of a given hotel. All this can lead to an overestimation of the value and ultimately in disappointment due to the difficulties in selling it or sales at a price considerably lower than the one expected by the seller," explains Dorota Malinowska. This is exacerbated by the issue of a suitable cap rate, which currently averages at 7 pct. However, problems can start at the very beginning. "If the analysis and valuation of a hotel business are not carried out properly, and if some design errors occur, such a project has very little chance of financial success, as well as of finding a new buyer, even with a well implemented marketing campaign and long exposure on the market. This is why it is very important to plan the business using common sense," adds Dorota Malinowska. Because the nature of the hotel business is that of a long-term investment, only the most tenacious players can benefit from it. Hotels that have continued operating despite having been sold include: the former Jan III Sobieski hotel in Warsaw, which currently operates under the Radisson Blu brand (sold by Europa Capital and Warimpex Finanz- und Beteiligungs for over EUR 50 mln to Norwegian company Wenaasgruppen) and the Mercure Kasprowy hotel in Zakopane, which was bought by Bachleda Hotel from the Orbis/Accor chain for over PLN 56 mln. Austrian company S+B Gruppe did a similar thing when it bought a property at ul. Wspólna 72 in Warsaw for PLN 5,000. The plot included the unfinished shell of the Salwator development. The cost of the transaction, which included paying off creditors, exceeded EUR 10 mln. A hotel under the Hampton by Hilton brand is now being developed in its stead. Large projects that have recently been put up for sale include such hotels as the Sheraton Kraków, the Westin Warszawa and the Radisson Warszawa.