Legal Considerations for Hotels: Real Estate Finance

Philip Baker: Europe saw a 45% increase in investment volume in 2024. Is the UK seeing inbound international investment into the hotels sector in that way?

Nick Mumby: Yeah, I think it is. And obviously the UK, forms a fundamental part of the European market. We're seeing investment coming in from North American investors. We're seeing investment coming in from Middle Eastern investors. There's also interest from Singapore and investors who have been increasingly looking for, high quality premium hotels.

The main focus is typically around the London market, but we've also seen, investment into, the key regional cities. And that's included Manchester, it’s included Birmingham. It's included Edinburgh and it's also included Leeds. We've actually seen some of those deals ourselves, and we've been working on, a major development in the Manchester city centre where a joint venture between, Gary Neville's Relentless and Fred Dunn’s Soul Boy, have brought a W-branded Marriott to Manchester.

So that's the first one of those that's outside London. And it's the first one, other than Edinburgh. And, that's obviously a real, positive boost to Manchester as a destination. And particularly as a luxury destination. We're also seeing different types of investment, obviously different types of hotels.

There's been a real shift towards, hotels that are, done under an operational model. So hotel management agreements rather than your traditional leasing structure, which you typically see with more of the brands like your Travel Lodges and your Premier Inns. Again, we've actually seen one of those deals, which was structured originally as a lease.

And then it actually flipped into being a management agreement when both the hotel operator and the investor developer got together, chatted through the pros and cons, and decided that it was better for both of them to move to the operational model.

Philip: Exciting stuff. So clearly, lots going on.

Nick: Absolutely.

Philip: So, with ESG and sustainability becoming more important, how are these factors influencing hotel investment decisions generally?

From a legal and financial perspective in the UK market?

Nick: So obviously ESG is a hot topic, top of everybody's, agenda. And particularly important at the moment, hotels fit into a category where and especially from an operational perspective where efficiencies and energy consumption are, incredibly important in securing a higher net operating income. From a development perspective, it makes the whole scheme much more attractive.

Both from an end user, an end to investor perspective. From a funder perspective. And obviously from an operator's perspective as well.

The other thing to consider, of course, is that anything that has properly green credentials will often be more attractive in terms of, terms for debt. And on the flip side, anything which is, which is sort of secondary stock, is going to trade at a discount, anything that is less efficient and that is going to need, a significant amount of CapEx to bring it up to, proper and modern, operating standards.

It's gonna come at a discount because people are going to factor in the amount of money that they're going to have to spend on it.

Philip: And ESG is likely to have a significant influence on that.

Nick: Correct.

Philip: So how do lenders typically view hotel assets in terms of risk? And what can developers do to strengthen their position?

Nick: So as I mentioned earlier, two typical types of structure for a hotel development, you're going to have, the one which is the traditional model, which is a lease, were typically done on a turnkey basis, where we'll get all of the way through to completion, that it will move into, the lease will be granted.

And from that point onwards, regardless of how well the, the hotel operates, the hotel, the hotel tenant in that instance is fixed into a rent. Second one is the operational model where the developer will build out the hotel, and then once it is, once it's completed, the operator will come in.

The operator will manage the hotel, but the hotel remains the owner or which may well be the developer, but it'll be their asset for a little while. And typically that takes a little while to work up to a stabilised position. At which point it is in a better position to be able to be traded on the market and new investment, brought in. From a funding perspective, funders will look at the quality of the operator on both sides of the table.

But ultimately it's much easier to underwrite the first model where you've got a fixed rent and you know exactly how that's coming together, than it is to underwrite the operating model. Therefore, with the operating model, you're looking at, well known brands, and the, and operators that have, real credibility in the market to be able to secure, the best rates and also to be able to give your lender sufficient confidence that there's an exit plan and that they will get repaid.

And the other thing, of course, that funders will look at is the overall package, on the construction side as you all know too well. They'll be looking at the quality of the contractor. They'll be looking at the, security package that goes behind that and understanding, and making sure that everything is, going to be delivered, and that that is going to feed into the wider business plan and the wider, the wider model which underpins the debt that's coming in.

Philip: Yes. Of course, obviously a robust construction package is preferable if it can be obtained. Of course.

What's one key legal consideration for developers that they should keep in mind early on to set themselves up for success when securing financing for a hotel project?

Nick: So there are loads of moving parts with a hotel project. And especially if we're talking about an operating model, the main thing that you're going to be looking to make sure that the whole package is in place and is ready to be, put in front of your funder so they can understand exactly how it all comes together.

Part of that package is, the hotel management agreement. And with a hotel management agreement usually comes what's called a non disturbance agreement. The non disturbance agreement is one of the key things in terms of the operator's security. But it really feeds into how the debt and how the funder comes, plays into all of this as well.

The typical funding structure a funder will want to take control, the funder will want control over everything, and they will want in an insolvency or in a, default scenario, they will want to have all of the cards, and they will not want other people fettering what they can and can't do. It's often quite a difficult conversation with a funder.

If you've got a top class brand, let's call it a Marriott or something like that, then the Marriott will have a standard form non disturbance agreement. And the non disturbance agreement will effectively mean that they can't be removed as operator.

Even if the funder wants to step in. So the funder wants to sell on to a third party because owner is in default, unless that is as a direct result of the operators default, in which case there are different remedies.

Then the funder has got to engage with the operator. That often, and it's been one of the conversations that we've had with a few, of the debt funders who've come into the market recently who are not perhaps as well versed in the way in which, hotels and hotel operators work.

It's been key in upskilling them in understanding where market practice is. So my advice, if I could give to a developer at the outset would be to make sure that all of those points are clearly understood right from the beginning. so that you don't get a nasty surprise when you find that your funder has got credit approval for something which you then cannot deliver.

Philip: Thanks very much, Nick. That's a lot to think about so much. Appreciate it. Thank you. I look forward to the next session in our series. Legal considerations for hotels.