The deepest cut

The Bank of England’s decision to cut interest rates to a new historic low of 0.25 per cent – the first cut in seven years – has been expected since the Brexit referendum, and is part of a massive stimulus package launched by the BoE, as it warned growth in the UK economy will grind to a halt over the next 18 months. The Bank has also unleashed a major new wave of quantitative easing which could see as much as £170 billion of fresh cash pumped into the economy.

The Bank will use the money to buy a further £60 billion of government bonds along with £10 billion of private sector debt, while lenders will be able to secure up to £100 billion of cheap loans directly from the Old Lady of Threadneedle Street. The extension of quantitative easing will take the total stock of government debt held by the Bank from £375 billion to £435 billion and add another £10 billion of private sector debt onto its balance sheet.

As with all economic change, one man’s meat is another man’s poison, and there will be winners and losers as a result of the BoE’s latest measures. But what are the likely effects for the serviced apartment sector, and the wider travel and hospitality industries?

One immediate consequence is that UK property has become cheaper to buy due to the weaker pound and the lower cost of borrowing. Foreign investors have already piled into the previously inert UK commercial real estate sector, with Middle Eastern, Indian and German investors all active in recent days. The biggest single deal was the acquisition of insurance giant Prudential’s City of London headquarters at 12 Arthur Street for around £80 million by the Oman state oil fund, represented by US private equity firm CIT Group.

Within a few days of the Brexit vote, Hong Kong-based Magnificent Hotel Investments paid £70.3 million for what it described as an “undervalued” 408-room Travelodge hotel in London’s King’s Cross, and it would be a major surprise if this wasn’t the first of many hospitality plays over the next few months. There are many serviced apartment companies looking to acquire  inventory in London and other major cities who have been put off by the cost – they will surely have fresh enthusiasm, particularly if they are based overseas.

Asli Kutlucan, hotel development director at Cycas Hospitality, which both owns and manages UK extended stay hotels, says: “Lower interest rates along with a lower GBP, certainly makes the UK more attractive especially for the foreign investors. National funds and investors will be looking into taking higher risks or diversifying their portfolio in terms of receiving favourable yields and returns. The extended stay market is still in its infancy in the UK and demand is increasing by the day. Furthermore, during the last financial crises, the extended stay market has shown that it is more robust during the economic downturn than the other asset classes, which was very well noted by investors.”

“With this in mind, I see extended stay investments continuing as a secure, low risk and good yield providing choice, and it allows diversification of the investors’ portfolio compared to other type of investments. However, for the short term I see investors  being vigilant, because it is more likely that another stimulus will be needed due to higher unemployment, falls in house process and household incomes, and a spike in inflation. Without knowing what lies ahead, investors will try to hold on to their investment decisions in the short term, and once the whole picture of Brexit, lower interest rates and higher inflation is in the frame, then they will pursue the investment strategies that best suit the new economic picture. In the short- and medium-term, extended stay hotels and serviced apartments should continue to see interest from investors more than the other hotel type asset classes,” she adds.
 
Andrew Harrington, partner at M&A and private equity specialist AHV Associates, also sees pros and cons to the current situation: “The cut in UK interest rates is both good and bad from the perspective of sale or acquisition transactions in the serviced apartment sector. On the negative side, it is an indication of the nervousness of the Bank of England over the weak state of the UK economy – this weakness is supported by surveys of business confidence, which has shown a marked downturn since the referendum. Weak confidence usually results in a reduction in the number of transactions, and lower valuations. On the positive side, cheaper money means a lower pound, which makes serviced apartments more attractive for overseas visitors and hence acquisitions potentially more lucrative, and cheaper borrowing costs, which should make acquisitions easier to finance and hence more attractive. We will have to wait and see which of these trends ultimately prevails.”

Adam Maclennan, director at PKF hotelexperts, does not expect the cut to have any significant effect on the sector: “I’m not convinced that the rate cut alone will do much to stimulate the transaction market or demand in the serviced apartment sector. The Bank of England has warned of a significant downside scenario which they need to be seen to be trying to mitigate. With interest rates already at historic lows the impact of a quarter point cut is likely to be minimal. Providing some clarity, preventing further declines in investor and business sentiment and avoiding a major recession has to be the goal of the central bank and the UK government given recent events. If the interest rate cut helps to persuade key stakeholders that the British economy is in good hands that is probably the best we can hope for.”

The low business confidence that Harrington and Maclennan allude to is beginning to have an effect on global business travel – a key market for the serviced apartment sector. The major global hospitality players are feeling the pinch, and it is inevitable that UK serviced apartment operators will have noticed a disruption in the travel patterns of their corporate clients too.

Christopher Nassetta, president and CEO of Hilton Worldwide, told analysts the company had experienced “a general dampening of demand across most industries”, while Arne Sorenson, CEO of Marriott International, said room sales of the company’s largest corporate customers had weakened to less than one per cent growth in Q2 2016 with little sign of change on the horizon. “We’re essentially forecasting that kind of steady state – weak corporate transient demand – not falling off a cliff in any respect, but just sort of continuing to bump along,” he said.

In the broader residential property market – the stomping ground of numerous smaller serviced apartment owner/operators – the reaction of the retail banks to the BoE’s measures is key. Naomi Heaton, chief executive of London Central Portfolio, says: “Many borrowers may see the move as headline ‘good’ news. However, a response by the banks, similar to that seen during the credit crunch, could have a particularly negative impact on domestic borrowers. During the global financial crisis, we saw banks widen their margins in the face of decreasing Bank of England base rates to maintain profits and build up capital reserves to hedge against any losses during a period of economic uncertainty. In recent years we have seen those margins contract with the result that many homeowners and investors have been enjoying unprecedentedly low borrowing rates. However, we would expect to see banks reverting to their previous strategy, impacting affordability for new buyers or those looking to remortgage. Another Brexit protectionist measure could be a withdrawal from the market of the highest loan to value products, as banks factor in a potential reduction in capital values across the domestic marketplace. This will inevitably further impact on retail lending and buyers’ ability to trade up, potentially restricting capital growth potential in the domestic market and becoming a self-fulfilling prophecy.”

The UK hospitality sector in general is certainly seeing a ‘swings and roundabouts’ effect from recent events. The UK has suddenly become a lot cheaper for visitors from overseas, but a convergence of negative sociopolitical factors are acting as a counterbalance.

Following the BoE’s decisive moves, the new UK Chancellor Philip Hammond is under pressure to act to boost the economy, and he is widely tipped to cut VAT, something the hospitality sector has been lobbying hard for. British Hospitality Association chief executive Ufi Ibrahim says: “The UK hospitality and tourism business remains open to welcome visitors from home and abroad. Most  people will have already made their holiday plans before the Brexit vote but in the mid-term the fall in value of the pound should encourage more foreign tourists, and those already here may spend more. But we cannot, and do not want to, rely on currency fluctuations, or trouble abroad, to bolster our home tourism economy which is worth £127 billion. Shockingly, the UK’s Tourism VAT is twice the European average rate. We need to address this so that we compete on an equal footing. It is something the government could do at a stroke.”

The interest rate cut has largely been portrayed as a swift reaction to economic uncertainty over the UK’s decision to leave the European Union, and there is certainly some truth in this. But let’s not forget that when rock bottom interest rates of 0.5 per cent – at the time the lowest in the BoE’s 322 year history – were first introduced back in 2009 (cut from five per cent), they were presented as an emergency response to the global financial crisis.

We were told that a return to normality was just around the corner, and mortgage borrowers were warned not to overstretch themselves ahead of the inevitable and imminent return of ‘normal’ interest rates. Many borrowers opted for fixed rate mortgages, rather than trackers, as the prevailing wisdom suggested that rates could only go up. But seven years later and the basement interest rate has been trimmed still further. The economy has not recovered sufficiently for the BoE to raise rates in all that time, and now the fresh Brexit shock has resulted in a further cut. BoE governor Mark Carney has hinted that a further cut before the end of the year is likely, although said that he is strongly against negative interest rates.

The fresh round of QE – the other post-crisis emergency measure which is still very much with us – is an indicator that the economy in the UK and beyond is still in a vulnerable and unpredictable state, with the fresh waves of uncertainty generated by Brexit amplifying those still being felt from the events of 2008 and 2009.