During one of the most disruptive years on record for the hotel industry, government support packages and fiscal backing have provided much-needed assistance. Over the course of 2021 we will undoubtedly see support packages begin to narrow, adding financial pressure on businesses in the sector. However, the UK vaccine roll-out appears to be progressing at a pace and as restrictions ease operational performance will return. The question is whether it will be enough?
The hotel industry has benefitted from the business rates holiday, the furlough scheme and the temporary VAT cut. We’ve also seen unprecedented levels of forbearance from the lending community which has supported its borrowers with interest rate and capital repayment holidays, as well as the Coronavirus Business Interruption Loan Scheme (CBILs), working capital loans and most recently grants to help support hotels’ re-openings. While these life support systems are in place, it’s unlikely that we’ll see a significant increase in the level of insolvency activity, which has been far more muted than many would have predicted last year.
Although we can expect consumer demand to begin picking up once restrictions are eased, the reabsorption of payroll costs coupled with business rates and ongoing (in some instances) rent obligations are likely to add financial pressure to already stressed businesses. It’s likely that these businesses will have accrued more debt during 2020 and will require time to ramp-up and re-stabilise their operations.
Many operators have been forced to pivot to a much more streamlined business model compared with pre-Covid-19, and it is this restructuring which could provide vital breathing room during the recovery phase.
As it stands, hotel insolvencies have been limited bar a couple of well-publicised examples. However, as financial pressures mount across some parts of the market this year, further distressed situations are likely to arise bringing with them opportunities for vacant possession and/or conversion and repurposing opportunities.
The senior lenders learned some painful lessons coming out of the GFC and as such, LTVs have been far more conservative in this last cycle. This in turn has meant that in the situations that we’ve looked at on behalf of insolvency practitioners and lenders, rarely have we felt that senior debt was impaired.
One area in which we are seeing increasing pressure is where poorly structured ground rent deals have been put in place. Invariably in these scenarios the owners have taken most, if not all, of their equity off the table, and this additional liability will complicate how these capital stacks unwind.
What’s unclear is what the appetite of investors and lenders for these structures will be going forwards, as while in a rising market they can supercharge an owner’s returns, they will act as an anchor on income growth in the short to medium term, particularly where the ground rent escalates annually rather than five-yearly.
Another factor that further complicates the likely future rate of insolvencies is the reintroduction of Crown Preference that came into effect in December 2020. The Crown (or HMRC) now sits second in the pecking order behind the first charge holder. With the likelihood that many operators have accrued liabilities to HMRC, any junior or mezzanine debt providers will have a difficult decision as to whether they try and trade these businesses for a period in order to extract value above the level of the debt, or force an insolvency process that could mean they in turn become impaired.
The maturity of the UK’s hotel market coupled with strong underlying fundamentals bodes well for a strong return to investment activity once restrictions ease, but the scaling back of support schemes and the reintroductions of Crown Preference may still cause some disruption in the year ahead.
Further information
Hotel Market Insights: Insolvencies & Transactions Outlook
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