Hotels - It's BUY BUY for some and BYE BYE for many

Flashback circa 2006 - GRI - New Delhi. I was working as a consultant to a Real Estate Fund back then advising it on the hospitality sector, and attended this event on its behalf. All I heard there was that every known and unknown developer attending the conference was going to build more hotels than the number of  fingers and toes he had combined in the next 4 to 5 years. Such scale of development had eluded the best of the best in the Indian hospitality industry until then. Each one of them was sold on the story that the whole of India has lesser number of rooms than Bangkok. India had some 90,000 hotel rooms (of which some 50,000 were branded) back then and needed to double its inventory real quick - that is by 2010. Then, I heard a sane voice from one of the attendees (who was leading Accor's initiative in India at that time) that the real number is closer to 500,000 when all forms of temporary accommodation were added up and doubling the inventory was not really the answer. But like all sane voices; it was drowned by the noise created by every hotel and property consultant ridiculing that claim.  The great gold rush in the Indian hospitality sector had begun. Projects were being conceived at unheard of land rates with occupancy, average daily rate and valuation assumptions to justify the financial viability to the numerous bankers and private equity players waiting to pour money in this game.

Yesterday; 18th Nov. 2014, I was invited to attend a seminar organized by a leading law firm on "Issues affecting Indian hospitality sector". Got to hear some interesting facts; some amused me and others that got me thinking on what's in store for this sector next. I learnt that the industry compounded annual growth; charted for the last 15 years tells us that demand and supply have kept pace evenly at about 11% with the demand a tad ahead of supply. Then, all hotels should be theoretically clocking at least 80% + occupancy; which is far from the truth. The same statistician rolled out more numbers that the first year performance for new hotel openings has progressively declined from 47% in 2009  to 35% now on account of supply pressures. Occupancy percentages overall for the last 5 years has been stagnant at about 58% and average room rates (ARR) have actually shrunk 3% or more depending on segment. The dark horse holding up the gloom seem to be the 2 star hotel segment that has seen ARRs climb 7.7% in last 5 years with occupancies averaging around 62%. To put all these numbers in a better perspective; India today has some 180,000 hotel rooms across all categories of which 100,000 are branded; and wait; the next couple of years will see the total number cross 250,000 rooms with at least 150,000 of them in the branded category. I am not sure if these totals include the temporary accommodation units as my take is that by year 2016 - India would have close to 1 million units servicing this type of stay need.

As of today, the situation looks more than terrible. Travel around the country and one will see several hotel skeletons doting every city; as much as those of residential and commercial buildings. It's easy to understand why this situation is staring at our face. The nation has gone from a rising to a falling star status in the last 10 years as has its currency. Global economies have not done much better either. Unplanned developments with very little thought, study and planning fanned by developer egos and easy finance from all kinds of investors and lenders has not helped the cause either. From a hotel perspective, the only places that have a smile to show are Mumbai, Delhi (not NCR), Goa and kolkatta. Rest of the Country has over supply written all over it. Pune and Bangalore are inching back to survival from an occupancy but not a rate perspective. Thankfully, India's natural inefficiency in delivering project completion on time has saved the industry from a situation that could have been much worse than it is now. Despite all the technological developments in the construction sector; India still requires an average 29 months to deliver an affordable hotel at a cost of between 24 lakhs to 40 lakhs a room (without land) whereas the same hotel could be built in less than 14 months at the same cost per room inclusive of land. With occupancy and rates continuing to remain the way they are for the next couple of years, most hotels will find it very hard to justify their viability to money backing them. It is certainly going to be a time when a lot of owners holding completed and incomplete assets are going to check-out saying Bye Bye to this industry.

Yet, before the industry decides to cry tears of blood in unison; there is not only a glimmer of hope but a fantastic opportunity waiting out there. Hotel industry usually trails the spurt in economy by about 8 quarters and that means that by 2017-18 the industry should start correcting upward. Anyone committed to this sector and sitting on cash is in a driving position to acquire quality finished and unfinished assets. Specialization in hospitality, along with efficiency in executing projects, managing operations and a strong marketing backbone are keys to winning this game. While I doubt if the Indian REIT structure in its current context will help this sector; hotels being classified as infrastructure can certainly benefit from InvITs (Infrastructure Investment Trusts). Further, the entire lending industry is ready for a reshape and it is not impossible now to get financial institutions to commit longer duration money with repayment programs tailored to the health of the asset - as well as take a more rational approach to security and collateral. I am already hearing the call of Buy Buy getting louder on this street called the "hospitality world".

Pain is good - and like it signals healing in our body - it's also a sign of healing in the industry. Everyone has learnt lessons in the last few years. No longer are hotel brands and operators (new or old) spoiling the developers by offering them ridiculously high fixed leases or making investments in shells that the former do not own or control. Leases and investments are increasingly linked with performance and secured by contracts that make operators virtual owners of the property. Developers have understood that hotels are not the classic real estate business with a build-sell-value formula. Building hotels requires sustainable quality which they don't care for when making inventory to sell; and running hotels needs micro attention which can sap a lot of time from their super profitable construction business - which means finding operators to run their properties. Hiring an operator is not the same as hiring a contractor as developers have learnt and getting away with under performance is now increasing unacceptable as operators have learnt. Recognizing "Prefered Owner Returns"; subordination of fees to debt service; linking fees to operating results are increasingly making life difficult for international brands to conclude business in India and better for domestic operators who understand these issues well - and are ready to commit money if need be to ensure the health of the hotel they put their name on. The best is that most developers are now understanding that the land pricing for and yields from hotels are just not the same as commercial or residential or retail. But, the long term value that wellrun hotels command are unmatched by other spaces they build - and that's driving committed developers into this segment; ones who understand that the pain experienced in the first few years is more than made up by the gain that hotels deliver thereafter.