Forward buying, or investing in hotel rooms with a view to reaping the revenue, sounds enticing, but the high-profile collapse of companies including Northern Powerhouse Developments reveals that it is fraught with complex issues. Neil Gerrard asks if there is a successful model for both hoteliers and investors.
If buy-to-let could work so spectacularly well for homes, then why not for hotels?
It's a question that enterprising developers and hoteliers have asked themselves several times over the past couple of decades, but the boom in the residential market that saw so many independent investors ride off into the sunset on huge returns has never quite materialised in the hotel sector.
And now the high-profile failure of Northern Powerhouse Developments (NPD) and certain hotels within the Signature Living Group (see below) has brought the so-called "forward-buying" model into question.
So how does the forward-buying of rooms work, what is to be gained for both investors and hoteliers, and what are the risks?
Simply put, the scheme involves asking investors to pay a sum of money – normally ranging from five to seven figures – to purchase a room in a hotel that is either yet to be built or is due to be renovated, on a long leasehold. The investment helps fund the development, and investors receive an annual return for their outlay, normally guaranteed for a period of time. In some cases, they also have the right to use the room themselves for a limited number of days per year.
It sounds attractive, but when it goes wrong, it can go spectacularly wrong. In the worst cases, investors are unable to recover the returns they were promised, or sell on their asset. "I think there have been a lot more failures in this space than there have been successes," said one finance industry figure who spoke to The Caterer off the record.
That's certainly the case for NPD's creditors, who face the prospect of receiving back very little of their original investments.
‘The strangest form of investment'
The forward-buying model appears to have emerged in the UK at some point in the early 2000s. And early schemes perhaps ought to have set alarm bells ringing for some of today's investors. As far back as May 2008, a www.thisismoney.co.uk article asked if "one of the strangest forms of property investment" could catch on. It explained how, for an investment of £50,000 to £250,000, investors could earn "50% of the income" from the hotel room's occupancy to put into a self-invested pension plan (SIPP). Among the companies promoting such schemes, it said, were Guest Invest. However, just five months after the article was published, Guest Invest collapsed. Its rival, Owner Hotels, also mentioned in the article, failed a year later.
That's not to say that there haven't been successes. Perhaps the best-known hotel to have been delivered under the model is the Park Plaza Westminster Bridge (pictured above), which was developed by Galliard and completed in 2010. Around half of the rooms in the hotel (535 out of a total of 1,019) were sold as what Park Plaza terms "income units". The rooms were marketed to investors under a 999-year lease. Upon the completion of the sale of each room, Park Plaza, through a wholly owned subsidiary called Marlbray, entered a complicated-sounding "income swap agreement" with investors. Under the terms of the agreement, investors had the right to receive net income derived from the rooms, with an annual rent guarantee of around 6% of the purchase price for five years.
Since November 2014, Park Plaza has bought back 23 rooms from investors, and there is a secondary market for the rooms, which are being marketed by a firm called ROC Invest, with prices starting from £295,000 and returns based on accounts showing how that particular room traded over the past three years.
Will Tindall, who is in the process of developing Escapade Silverstone, a collection of 60 two-, three- and four-bedroom residences at the world-renowned racetrack, set to open in 2022, also has faith in the model.
Tindall's business, which has already opened a similar project on an island off Bali, will run the residences as a hotel operation. Two-bedroom residences away from the track start at £650,000, running up to £1.65m for a four-bedroom trackside residence. Owners can choose to buy the units as a pure investment with no usage nights, or take a reduced return in exchange for 21 nights' usage for themselves. Investors take a share of gross revenue, which Tindall says allows for greater transparency than would be the case with operating profit or net profit. The firm has calculated the annual yield of a four-bedroom trackside residence at 4.71% if an investor takes up their full allocation of usage nights, running up to 5.92% without any usage nights.
Explaining why he chose to fund Escapade Silverstone in this way, rather than taking a more traditional route, such as a loan from a bank, Tindall explains: "The reality is it is a bit of a strange funding landscape at the moment and this effectively builds equity. When a debt funder is looking at this, we get them comfortable by the fact that there is a little bit of a proof of concept in there in terms of people are buying it and showing interest and staying in it. But also it is partially about building a bit of a community around it."
The fact that many schemes sit outside of the regulation of the FCA (see below) and can vary in terms of the way in which they are administered still make some in the industry uneasy, however. One hotel industry figure, who spoke to The Caterer on condition of anonymity, warned that investors often don't have a sophisticated enough understanding of how the hotel market works. "At the moment, there's the question of where the hell do you put your money, if you have got any. People see this sort of scheme and think ‘I will invest in a hotel – hotels are good business. What can go wrong?' Well, quite a lot actually.
People see this sort of scheme and think ‘I will invest in a hotel – hotels are good business. What can go wrong?' Well, quite a lot actually
"You can have hundreds of different owners in a property and that becomes quite cumbersome in itself. Each of those owners have different perspectives and requirements. Then, if you want your capital back, you have to find someone who wants to buy it. If you bought it seven years ago on the basis of a five-year guarantee and the guarantee comes to an end, and the operator needs some cash to refurbish the hotel, then you can see that the investment doesn't necessarily look particularly pretty."
Tindall accepts that such schemes can become complicated, with many different investors, each of them with differing objectives and expectations, to manage. "Some people aren't at all interested in the yield and it is more about the lifestyle side, whereas others don't want to use it at all and want more yield, so that is a tricky one," he acknowledges. "It is a balancing act to try to find something that feels right."
Partly in response to this, the Escapade Silverstone residences are all "dual key", which allows a four-bed residence to operate as two two-beds, or a three-bedroom property as a two- and a one-bed, and so on. "That gives flexibility from an operational perspective, but also from an owner's perspective because if, for example, they have bought a four-bed, they could actually use a one-bed and let the rest out," explains Tindall.
Tindall is also clear that the Silverstone project will not pool revenue from investors so that it will not be deemed to be a collective investment scheme and consequently require the involvement of the FCA (see below). Investors' returns are based solely on the performance of their own residence and no others. Meanwhile, the firm's booking technology randomly allocates guests to properties to ensure that revenue is evenly distributed. "It is just about being open and transparent about it – that is the key," says Tindall.
In any case, however, such forward-buying initiatives are likely to stay relatively rare for the time being. That's in part due to the Covid-19 pandemic, one finance industry figure explains: "There are really interesting ways of funding things when the deals get more expensive. But with pricing likely to drop and there being more distress, there will be fewer new developments. Investors will be looking to buy existing hotels rather than building new ones over the next 18 months and there is plenty of money to invest with regular finance, without having to go and find financially engineered ways of making a deal work."## NPD and Signature Living: When forward buying goes wrong
The thousands of people – many of them private investors from places as far-flung as China – who funnelled £80m into Northern Powerhouse Developments (NPD) thought they knew where their money was going.
The scheme was an attractive one – in return for buying a room on a long leasehold in one of the many hotels that NPD was accumulating and promising to refurbish to a high standard, such as the 61-bedroom Llandudno Bay hotel or the Fourcroft hotel in Tenby, investors would receive annual returns of 10% on their investment, plus the chance to sell the room at a 25% profit after a decade.
While investors believed they were funding one individual room, which would then generate their return, it was in fact run as a collective investment scheme, where hotel investors' cash was pooled into a central account and appears to have been used to fund other loss-making enterprises within the group. Such collective investment schemes are regulated by the Financial Conduct Authority (FCA), but the FCA said it did not authorise NPD to run such a scheme.
NPD collapsed last year, with administrators Philip Duffy and Sarah Bell of Duff & Phelps looking after eight of the hotels, and administrator CG&Co dealing with another three.
Meanwhile, administrators have obtained a freezing order against the personal assets of NPD founder Gavin Woodhouse after discovering an overdrawn director's loan account at £615,000. Woodhouse has served his defence, along with a request for additional information, which is under review.
A report by Duff & Phelps likened NPD's business model to a Ponzi scheme. A Ponzi scheme is characterised by the promise of larger-than-expected returns, and new investors' money being used to pay old investors.
Duff & Phelps also revealed that NPD paid £895,000 to four separate hotel proprietors for the acquisition of their hotels. The company exchanged contracts for the purchase but did not complete as it had insufficient funds. Nonetheless, it still raised funds from investors by pre-selling investments in the hotels. Duff & Phelps said it had reported the matter to the authorities.
Signature Living has also used the forward-buying model for some of its hotels. A report by Duff & Phelps on Signature Shankly, the company that holds the long leasehold interest in the Shankly hotel in Liverpool and is part of the Signature Living Group, noted that the company had historical rent arrears, with a number of bedroom investors that had purchased a leasehold interest in individual rooms in the hotel. The company went into administration this year.
The report continued: "In addition, a number of investors had exercised their contractual option to sell their leasehold interest back to the company after the three-year anniversary of their purchase, although the company failed to meet its contractual obligations in this regard."
Signature Living also raised funding via what administrator Duff & Phelps described in its report as a "collective investment scheme" to purchase and develop the George Best hotel in Belfast. Investors were due to be granted a long leasehold interest that would be leased back to the company on a 10-year leasehold with a guaranteed return on investment of 8%, rising incrementally to 10% by year five. Investors were promised their capital back if they sold the room back, plus an uplift of 12%.
The hotel in the former Scottish Mutual Building was originally due to be completed by 2018, but a series of planning and building control issues caused delays in its completion. The onset of the Covid-19 pandemic caused further delays as the development of the hotel was suspended due to government restrictions. The firm also faced a winding up petition, which was presented in January 2020.
The FCA told The Caterer that it had not authorised Signature Living's collective investment schemes.
Signature Living has been contacted for comment. Gavin Woodhouse was unavailable for comment.
What regulations govern the forward-buying of a hotel room?
"If a property, or portion of a property, is sold to investors with a view to enabling their participation in future profits arising from that property, then, depending on the specific structure and arrangements, this might constitute a form of collective investment regulated by the Financial Conduct Authority (FCA). In such cases, the promotion and operation of the scheme would need to comply with FCA regulatory requirements and may even require FCA authorisation.
"The application of the FCA's rules to these types of schemes is complex and the legal position will depend entirely on how the specific arrangement is structured and operates, and the facts surrounding it. It's important to seek legal advice before operating or marketing such a scheme in the UK."
Clare Reynolds, senior associate for law firm Taylor Wessing
Featured photo: Shutterstock
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