Branded Residences - losing sheen

I can't put a finger on a person or entity that got this concept going. Was it Donald Trump or Adrian Zecha who fathered it? Or does the credit go to Four Seasons or some other marquee hotel brand for the same? Or, was it something that evolved as an outcome of the fractional ownership industry where top brands loathe to the road shark selling techniques of timeshare sold a residence with a name guarantee on it. All I do know is that it is an "ego" product that does deliver a quality living space at a hefty price tag and heftier running cost. 

Until some 10 years back; exclusive hotel brands marketed residences at equally exclusive resort locations. It did give a nice high to the buyer who felt that (s)he had acquired the whole resort-hotel by just acquiring one unit within it. And, it gave a bigger high knowing that it would not be used and abused by any other person - like a hotel room is - should the owner not wish to put the unit back on a sale and leaseback basis. For a resort developer, this was the perfect way to recover bulk of the cost (if not make a profit) of very expensive and exclusive developments ensuring the project's financial viability. 

As real estate markets boomed around the world in the last 10 years; branded residences increasingly became a marketing tool to differentiate exclusive developments from those that were labeled with adjectives like luxury, premium, and unique. The brag rights for owning a branded residence in the city where one lived, as compared to some far flung holiday destinations must have been much greater to warrant this concept being adopted by virtually every major luxury apartment developer around the globe. Soon "Trump Tower" was not only a New York feature and "Four Seasons Residences" could be found alongside virtually every new Four Seasons hotel and at certain locations the requirement of a hotel has been dispensed with altogether. It has in time become the path to viability on super expensive real estate as buyers are willing to pay 60%+ premium over similar unbranded assets. At least that is the story being sold by the brands to the developers; and in a country like India - where the people are very brand and brag conscious - this is God's own truth being said. Well - almost. 

The last 2 to 3 years, contrary to market belief; there has seen a dip in luxury apartment sales. The impact of slowdown has hurt this segment of real estate substantially. It is only the innovative off-plan selling by developers - that is -  to defer collection of profit and land cost to the end of the project completion (20:80 payment plans) that has facilitated offloading the US$ 1,000,000+  cost apartments. In addition, developers have had to bump up the percentages and fees paid to brokers and consultants to push sales. The selling community never had it so good. Yes, the falling rupee, new wealth, and ease of borrowing for residential inventory has made acquisition of premium goods much easier under the circumstances. But, there is a growing realization that many of these projects may see a longer than planned for project cycle (if at all); and, should the completion happen in a down cycle then those buying for an investment may get burned. 

Well, the solution for that is easy - have cash - will talk. If the above was not enough, developers are offering deep discounts to make investor exits less risky and the situation is that branded residences are possibly claiming not more than a 10% - 15% premium over similar class unbranded developments. With brands themselves taking away 10%+ as their fees to lend their names - does it make commercial sense anymore to build one? Buyers that have received delivery of such apartments are now questioning their decision to buy. The recent hike in municipal taxes and utility dues; service tax on maintenance bills; high maintenance costs in corrosive conditions of most Indian cities; inadequate water supply; a lack of quick and proper access to emergency services due to poor infrastructure conditions and emergency equipment; sharing of boundaries with undesirable real estate (slums, cemeteries, local markets); and most important inability to get tenants willing to pay that extra premium in rent has made buying a branded residence a big question for many. 

Yes, this land has ego written all over it; but hidden beneath that is a stronger attribute called cost consciousness - the "kitna deti hai" (how much does it average) attitude that overrides the former by miles. I remember the time when I was growing up - the sight of an occasional Mercedes or BMW was a head turner amongst the hundreds of shoddy built local cars. Today; there are hundreds of the big 3 German cars on road blending in unnoticed with thousands of well built cars from Japan, Korea, Europe, and even India. There lies my point that branded residences too will lose their sheen from an ownership brag point of view as more and more hit the RE turf. One would own them purely for self satisfaction and the superior quality and services they promise to deliver albeit at a very high cost. Will they deliver on the promise? Now that's another story and you may want to read my previous blog called "Shitty Shitty Big Brand"

Go InvIT as REIT may be wrong for Indian Hospitality

The hospitality industry in India was probably the first to welcome SEBI's (Securities and Exchange Board of India) decision to permit REITs (Real Estate Investment Trusts). After all REITs have played an important role in furthering the cause of the hospitality sector globally as a major investment asset class. On closer examination however; the set up structure laid out by SEBI does not look too appealing as far as hotels are concerned and in my opinion REITs may be the wrong way to go under the current guidelines. SEBI in its infinite wisdom - and honestly quite rightly - knowing the manipulative mindset that exists in our markets; has put in several checks and balances to protect the investors; but these, while great for real estate - are not really great for the hospitality players.

The key stipulations for a REIT in India:

1. Has to be listed.
2. Minimum corpus INR 5000 million (USD 1 = INR 60)
3. At least 25% offered to the public with a minimum of INR 2500 million
4. 80% of deployment should be in completed assets and minimum of 2 assets required.
5. Single mixed use facility does not qualify for being counted as multiple assets.
6. Maximum of 60% of corpus can be allocated to a single asset.
7. At least 75% of the space owned should be rent earning.
8. No more than 49% leverage permissible on the assets acquired (and is subject to consent of Unit holders)
9. Minimum 51% holding required to qualify as asset ownership.


So effectively, The REIT sponsors would have to create a middle risk company that on one hand would sign a management contract with a hotel operator and also pay a fixed rent to the REIT in order to satisfy the guidelines; as I don't know of many (if any) international hotel operators that would take a property on straight rent for management. There are some Indian operators who make take the risk of a thin fixed and large variable lease linked to operations but then justifying returns to yield based investors may be quite a task.

Then of course there are issues related to tax treatment on the distribution of dividends and interest to Unit holders; as well matters related to Capital Gains tax (applicable) and transfer duties that are making REITs unattractive to even the Real Estate sector.

There is general agreement that an Yield based REIT is not viable but a Yield + growth model may just do it for some subject to getting clarity from SEBI - expected closer to the budget in 2015 when SEBI will probably report a near failure in attracting REIT sponsors to register with it. The poor show has also got to do with the fact that as of now Foreign Investors cannot participate in REITs in India.

Fortunately, SEBI has also laid out guidelines for Infrastructure Investment Trusts (InvITs) that are marginally different than REITs given the nature of the infra sector; but those subtle differences may just make InvITs more inviting to hotels. The key differences being that an InvIT can be set up with a single asset and the rent requirement does not apply in infrastructure. The "Project" will be managed by an independent project manager (bravo - hotel management company). Why do hotels have the privilege of adopting Invits? Well as per Government's notification 3 star and above hotels in Cities/towns with a population of less than 1 million or projects costing more than Rs 200 crores qualify as infrastructure. Why only these? Don't ask me - spin doctoring happens everywhere. Let's be thankful that hospitality now has its 2 legs in 2 different sectors and can take advantage of benefits in both.

For now, the legal and accounting fraternity is raking in the moolah in slicing and dicing the guidelines to create viable structures for their clients. "Trust" is the key word in REITs and InvITs. Transparency, safety and quality along with stable returns is what most institutional and retail investors are after and hopefully both the lawyers and accountants will uphold that fact as primary in advising their clients who would be looking at sponsoring such structures in India.

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.