The availability of debt has emerged as the primary barrier to development in the United Kingdom hotel industry, according to hoteliers surveyed. Over the past 15 years, debt finance has been easily accessible due to near-zero interest rates.

However, since 2022, interest rates have steadily increased by approximately 50 basis points per month, implemented by the country’s central bank to counter inflation.

Hotel owners are now apprehensive about refinancing properties as the costs of debt rise and lenders become more cautious about taking risks. Economists argue that hoteliers and other borrowers must recognise that higher interest rates are the new norm and a necessary cost of doing business.

Debt becomes a global concern

During a recent webinar hosted by HVS London, Chris Sheppardson, the managing director of EP Business in Hospitality, emphasised the significance of debt in the UK, considering it both a political and economic concern.

Globally, the total amount of debt stands at $42.9 trillion, twice the 2022 figure. This highlights the major debt challenge faced by the world, with the availability of debt finance being the most significant barrier to hotel development.

Hoteliers predict that the debt crunch will persist until the second half of 2024, further complicating the situation.

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Interest rate increases and economic stimulus

Tim Barbrook, head of debt advisory at HVS Hodges Ward Elliott, points out that economic stimulus is the potential solution to overcome the current challenges.

However, it is not surprising that the real estate landscape experiences corrections periodically, whether due to a shock like the Covid-19 pandemic or a macroeconomic event.

The recent increase in interest rates has been particularly challenging, coming in the wake of the pandemic. Barbrook connects this rise to significant government intervention, such as the £6,000 ($7,741) per person stimulus package in the UK.

The increased money supply leads to inflation, which has forced the Bank of England to raise interest rates 13 times to the current level of 5%.

It is estimated that £43 billion of hotel debt in the UK is approaching maturity. To mitigate potential losses, bankers are actively divesting their commercial real estate exposure, preferring to sell at a loss rather than hold onto bad debts.

Uncertainties in hotel transactions landscape

The uncertainties surrounding pricing in the bricks-and-mortar sector are further complicating the situation. The bid-ask gap has resulted in fewer transactions and increased uncertainty over true asset values.

However, this uncertainty has opened opportunities for a significant number of alternative lenders who are eager to provide financing.

June is the month when hotel covenants in the UK are stress-tested, potentially leading to a wave of breached loan agreements. Sophisticated borrowers are informing lenders that they will breach covenants not due to poor hotel performance, which remains strong, but due to interest rate increases.

Solutions and future outlook

Borrowers seeking to refinance might face reduced debt amounts, necessitating additional equity, mezzanine debt [a hybrid of debt and equity financing that gives the lender the right to convert the debt to an equity interest in the company in case of default] or asset disposals. Over-leveraged deals, hotels in non-prime locations and assets facing challenges will encounter difficulties in securing financing.

Balancing the need for amortisation with the owner’s return on capital will be a complex task.

While mezzanine financing is seen as an unlikely solution, equity deals may become more prevalent. However, borrowers will face tough decisions regarding interest rate hedging. Capital will remain more expensive in British pounds than in euros, making continental assets more attractive than British ones.

Despite the challenges, experts anticipate “soft enforcement” rather than formal insolvency, with lenders likely to push for debt reduction or asset sales. The market may see growth in preferred equity transactions to better structure deals and reduce risk.

Higher interest rates are expected to persist, leading to a drop in hotel values and increased exit risks. The hotel industry faces a new reality in which the era of 0.5% interest rates is unlikely to return in the foreseeable future.