Formulating “Asset Light” Strategies In The Hospitality Industry Through The Spin-Off Of Real Estate Assets

The objective of this article is to analyze the strategic approach that lodging corporations with owned properties in their portfolio are conducting, which advocates for a bifurcation between operational and asset management orchestration. Such approach is originated inside big hotel chains and is opposite to another industry widespread practice in which a third-party owns several hotel properties and rents those to hotel chains (i.e. Blackstone, Starwood Capital Group, Bain Capital, etc.).

The allegation that commonly stands out when this divorce on good-terms is enforced, is the fact that the accommodation industry is embracing an “asset light” mindset that calls for a switching cost advantage and a relief of heavy burdens properties hold which are relegated to standalone legal entities normally eligible to leverage on fiscal benefits. The footprint of this shift is incontestable, and everyone, it seems, wants to be “asset light” these days. Lets go over some of the key aspects that justify this split.

Interests

  • Real Estate arm. Mainly focused on keeping an asset portfolio in perfect condition, both from an economic and commercial perspective.
  • Hotel management. Focuses on adjusting an operational engine that streamlines guest service and elevates overall experience. Furthermore, today, more than ever, hotel companies are prompted to become flexible, unencumbered and fast-moving organizations.

Cost structure

  • Real Estate arm. Takes care, primarily, of fixed costs coming from acquisitions, funding of new developments and renovations on existing properties.
  • Hotel management. Needs a flexible variable costs setting to accommodate seasonality and room’s perishable condition that may require occasionally additional capital injections. To this end, the Uniform System of Accounts for the Lodging Industry (USALI) makes the process of routing direct and indirect costs to operational and functional-wise departments much easier.

Revenue

  • Real Estate arm. Business model is nurtured by rental income and capital appreciation.

The bottom line to keep an eye on is the Net Operating Income (NOI) that analyzes the ability to generate income from investments once property-related operating expenses have been deducted (i.e. insurance, property management, property taxes, etc.).

  • Hotel management. Business model is based on cash flow swollen in many hotel groups by heavy indirect inflows driven by conversion models (franchise and management). It is worth mentioning that now, more than ever, direct cash flows are opened to a new world of opportunities given the continuous advancements in revenue management and pricing sophistication techniques.

The key indicator to examine is the Operating Cash Flow that displays the balance of all the cash flowing in and out of the company.

Challenges

  • Real Estate arm. Property is not liquid and therefore this sector displays high exit barriers. In addition, the Real Estate industry exhibits a complex environment that can be explained by aspects such as: information flows are complex and scarce; information is not freely available to all investors; and asset valuation involves subjective methods (i.e. comparison with similar properties). It is worth keeping on the radar the so-called “proptech” startups that aim at tackling these pain-points by utilizing big data. United Kingdom has spearheaded this transformation with over 250 registered startups exploiting this opportunity.
  • Hotel management. Scaling and fierce competition driven specially by alternative lodging formats.

Financing

  • Real Estate arm. Companies float on capital-intensive environments fuelled by debt and auto-financing levers (amortization and net equity). Funding strategies are long-term driven with all the uncertainty this entails (i.e. interest rates, access to credit, ability to repay debt, etc.). Therefore, it is paramount that a portfolio is built with reliable Return On Investment (ROI) figures. For instance, renowned hotel chains operating on destinations afflicted by severe weather elements (i.e. hurricane seasons in The Caribbean) engineer precocious ROI models to oversee such risks.
  • Hotel management. Leverage on short-term and common business loan arrangements (i.e. on average 30-40 days deferred payments, short-term loans) to ensure adequate levels of liquidity for business continuity.

Taxes

  • Real Estate arm. Companies holding heavy asset portfolios normally abide to the legal nature of a Real Estate Investment Trust (REIT) that provides interesting fiscal benefits if specific requirements and obligations are met. Although diversity prevails in country’s legal frameworks, the mainstream addresses aspects such as: minimum share of properties that must be held in the balance sheet as well as minimum share of participations owned from other REITs; minimum share capital; minimum number of shareholders; minimum available free-float proportion; specific debt ceilings for property acquisitions; and mandatory dividend distribution.

REITs are taxed for their dividend yield or regular payouts and such imposition is typically around 20%. In-house tax teams design optimal tax-strategies and all property transactions come through with a tax angle to it.

  • Hotel management. Hospitality-service companies pay corporate income taxes and it is worth remarking that there is also here a lot of room for tax engineering (i.e. write-offs).

Shareholders profile

  • Real Estate arm. Normally investors in REITs hold extensive acumen on asset management and valuation and include additional asset-related investments in their diversified portfolios. As external investors may obstruct coordinated action between an hotel’s group Real Estate arm and its operational division, REITs set Articles of Association that require that the parent company (hotel corporation) remains largest shareholder and holds solely voting rights.

Following this last line of thought, we must bear in mind that both entities must be able to coalesce when it comes to defining hotel development strategies which entails acquisitions, renovations and repositioning.

  • Hotel management. As opposed to the Real Estate arm, service companies attract investors with myriad profiles that are driven by overall market performance and a healthy balance sheet.

Legal obligations

  • Real Estate arm. In an overregulated environment, an optimal transfer of responsibility and duty is strongly recommended. Thus a Real Estate company will have to deal with: building risk management, compliance to territory planning regulation, land and building registration, property insurance, property rights and liability rules, etc.
  • Hotel management. Obligations on this side are also noticeable and include the compliance and overseeing of: hygiene standards, food handling provisions, safety and security requirements, in place liability insurances, etc.

To condense all these ideas I would like to quote Sebastién Bazin (Chairman and Chief Executive Officer in AccorHotels) when he announced the creation of the Real Estate arm HotelInvest. Today, external investors own this REIT by a +50% stake.

“…This way, each business will be able to continue to grow within the Group based on a valuation that reflects its specific business model and growth outlook. At the same time, all of our teams will remain under the AccorHotels umbrella brand.”