For the last year, investors’ appetite for the Spanish real estate market seems to have been reviving— welcome news for everyone in the Spanish economy. The Spanish hospitality sector, in particular, seems to be growing noticeably more attractive for foreign investors. This could be due to a number of factors—competitive price levels; a supply of high quality real estate now being put on the market not only in Madrid and Barcelona but also in coastal cities with a strong international presence and a flourishing tourism trade (there has been significant improvement in foreign tourism demand); and new tax incentives for foreign investors, especially under the SOCIMI (Spanish REITs) regime that we explored in the last issue (see Orson Alcocer, “SOCIMIS—At last, REITs in Spain” Real Estate Gazette (Issue 15, Winter/ Spring 2014) page 70 ff).
There is a mix of properties on offer—some are presented to the market in perfect condition and others require the potential investor to carry out certain refurbishment works in the property before it can be fully operational. The mentality of investors interested in the hospitality business has also changed. Recovery of the investment value is not focused solely on obtaining the greatest possible income from accommodation, its main service; there is growing recognition that the attraction of a diverse range of ancillary service providers may also boost profits. To this end, there are potentially lucrative agreements to be made between hospitality investors and luxury fashion entrepreneurs, jewellery retailers or gourmet restaurants, all of whom may want to open their businesses in Spain’s hotels. This provides potential hotel customers with an exclusive and different atmosphere which gives the business a unique selling point, and allows it to be differentiated from its competitors. Additionally, renewable energy sources are increasingly being used in hotel premises. On the one hand, this results in higher energy efficiency (and cost reduction)—one of the Spanish Government’s key concerns in current real estate matters— and, on the other hand, it helps to attract certain customers for whom awareness of environmental matters is important.
Types of transaction and vehicles for investment also come in a wide variety of forms, each suited to the particular interest of financiers, investors and professional hotel operators.
Direct acquisition of the asset (whether through an asset sale or a share deal) remains the classic way to invest, and here, we are seeing transactions especially related to repossessed assets, that is, assets currently included in a financial entity’s portfolio commonly due to mortgage enforcement processes, and distressed assets, that is, assets currently mortgaged in favour of financial entities to guarantee a loan or a credit in default and which are usually swapped out.
On the other hand, the indirect acquisition route is gaining momentum, in the shape of the acquisition of doubtful or non-performing loans backed by a real estate mortgage on hotels, as a way to acquire the property by way of enforcement of the mortgage (commonly known as “loan to own”).
Some investors acquire hotels for direct operation— this type of operation will require not only the initial financial investment but also a knowledge of the business, being able to put management- level personnel on the ground and often being willing to commit extra resources for the improvement of the asset. We are seeing this happening for holiday resorts rather more than for urban hotels.
In contrast, a pure capital investor will only be interested in the acquisition of the real estate asset, delegating the management and operation of the business to specialized hotel operators in exchange for monetary compensation. This delegation may be implemented in different ways depending on the state of the asset and the degree of risk that the owner is willing to accept:
- A leasehold (derecho de superficie), when the owner only holds land suitable for a hotel development and the operator is willing to build the hotel itself. For the duration of the leasehold the hotel will belong to the operator but the full ownership will revert to the land owner at the end of the lease. This legal arrangement allows the operator to mortgage the building if necessary to pay for its construction, while the owner may actually grant a separate mortgage on the underlying land.
- A real estate lease agreement, where the hotel is built already and the real estate asset is the only object of the lease;
- An industry lease, where the hotel business as a whole is the object of the lease. This generally requires the lessee to be permitted to operate the business immediately (or imminently), and therefore, this type of lease will mainly be applied where the owner of the property already has a hotel business in operation, but is now interested in assigning its operation to a third party. Both the real estate lease and the industry lease will usually be agreed with a fixed rent and often a variable rent linked to the revenue generated by the hotel operation (REVPAR, leases on retail premises inside hotel grounds, ancillary hotel services), but the risk of the business operation will remain with the lessee. This is also generally the case with the leasehold.
- A management agreement. This is the preferred option when the owner is willing to accept the business risk of the hotel but does not have the expertise to operate the asset. Conversely, the operator may not be interested in acquiring ownership of the property or of the business but may simply be interested in running the business. The operator will therefore get a management fee but the revenue generated by the hotel operation will belong directly to the owner.
- The franchise is another formula that was traditionally more widespread in other countries but which is now gaining popularity in the Spanish market. It combines the interests of not two but three parties: the owner, a hotel chain and the actual operator who will run the owner’s hotel under the direction and brand of the chain. In this case, the operator manages the hotel benefitting from a delegation of the franchisor’s rights. The operator will obtain the advantage of operating under a well-known brand and will benefit from cost efficiency in, among other areas, purchasing and marketing. However, the franchisee will be obliged to pay royalties in exchange for the use of the brand. The relationship between the owner and the operator will be ruled by a lease or management agreement while the operator and the hotel chain will be linked by a franchise agreement. A direct relationship between the owner and the hotel chain is not very common under this system.
No single type of investment is perfect or can be recommended as a universal formula for success. The investor should assess the optimum corporate and tax structure for the investment; the state of the real estate asset and the permits necessary for its operation; and the potential employment implications which generally could be a pitfall in this sort of investment. Legal implications will need to be analysed on a case by case basis.