India: Emerging fundamentals fuel investor interest

INTERNATIONAL REPORT—Hotel companies looking for a market with high demand from business and leisure travelers, a growing middle class and a severe shortage of existing hotels need look no further than India.

The recognition of the economic merits of tourism has been a slow progress that didn’t take hold until the mid to late 1990s, said PR Srinivas, lead, tourism, hospitality & leisure for Deloitte.

“The coalescing of the information boom, economic liberalization and increased disposable incomes have introduced a new generation of spenders who are currently the mainstay of the industry,” he said. “Travel has been an intrinsic part of an Indian’s life and, consequently, there’s need for transient accommodation at various levels.”

India has more than 5 million inbound travelers in addition to its 500 million domestic travelers annually.

India faces a serious undersupply of hotel rooms throughout the country.

 “The fundamentals of the Indian hotel industry are very good medium to long term because you have only approximately 100,000 rooms in the whole country that are of an acceptable standard for the marketplace,” said Arthur de Haast, global CEO of Jones Lang LaSalle Hotels. “New York has about that many rooms in itself, and (India) is a country with a 1.3 billion population.

Hotel supply in India by segment, year-end 2008

Several factors are behind the undersupply, according to Vijay Thacker, director, Horwath HTL-India: the high cost of land; the comparatively expensive debt finance; the absence of meaningful incentives; and longer project periods because of the number of approvals required.

According to Horwath, India had 41,448 branded hotel rooms at the end of 2008, with a total of 79,179 expected in the next three to five years.

Taking a hit

Until recently, there’s been a huge imbalance with demand far exceeding supply, and room rates and occupancy rates were high, de Haast said. That is not the case anymore.

“India has not been immune to the economic uncertainty, and the attacks in Mumbai last year have taken a toll on short-term performance,” He said.

Terrorists carried out attacks on several Mumbai locations, including hotels, on 26 November 2008. More than 170 people were killed.

Hotel performance has taken a hit also because of the global economic crisis, according to Srinivas. Delhi and Mumbai experienced drops in occupancy and rates of more than 50 percent during January through March compared with last year. Discounting is much more common than in previous years, he said.

Thacker said occupancies have dropped 12 percent to 25 percent in many markets, and rates have decreased 15 percent to 30 percent.

This has slowed hotel development, but not stopped it completely, according to Srinivas.

“Sanity seems to have come into play with the economic downturn with many hotel plans being deferred or even shelved,” he said. “Real-estate pricing is still way too high, as are the regulatory issues that delay hotels.”

In the short term, supply will double in some markets, such as Pune, Bangalore, Hyderabad and Chennai, Srinivas said.

“Delhi and Mumbai also will see much development, though economic viability of the hotels at the top end is going to be a concern,” he said.

De Haast said there is a gap in buyer-seller expectations.

“Plots of land that big developers had started to construct usually were part of a mixed-use development, and they are having trouble finding financing, and they’re now looking to sell some of the partly constructed hotels or land parcels,” he said. “They’re still trying to do that at levels investors are having trouble meeting.”

Some of the big international operators have been willing to invest some equity in joint ventures with developers to kick start the rollout of their brands, de Haast said. There had been a growing volume of investments being put together to invest in the hospitality industry in India, but much of the capital is on hold or has pulled out of the market completely. But there are significant amounts of domestic capital in the hands of locals.

James Chappell, managing director of STR Global, said India has two problems it must overcome to be successful.

“One is real estate prices, which have gone through the roof in the past couple of years,” he said. “In a very short time, three or four years, the cost of land has become prohibitively expensive. Once that side of the costs goes up, it makes it a lot less attractive because it’s going to cost more.”

The second problem, Chappell said, is India’s poor infrastructure.

“The infrastructure is not keeping up with the pace of hotel building, and that’s going to make hotel owners very, very nervous,” he said. “You’ve got to get people there, get them around while they’re there and get them out. They’re working on it, but it’s going to take years.”

Goldman Sachs predicts India’s electricity installed capacity will increase 80 percent, and the stock of paved roads is expected to increase 30 percent. The number of Internet users in India is expected to double. Goldman Sachs puts India’s total infrastructure investment through 2018 to be US$620 billion.
Srinivas said work that is already under way will have a positive impact.

“The road and air networks are being upgraded significantly, and this will aid the hotel industry,” he said. “New airports at Bangalore and Hyderabad are already open, and the ones in Delhi and Mumbai are being upgraded and will open by 2010.”

Improvements of highways have enhanced domestic leisure travel, particularly for short holidays, according to Thacker.

Huge potential

Srinivas said the outlook for the hotel industry in India is tricky.

“There is going to be no change in the next year—the externals are just not right for a correction until later this year,” he said. “The five-year cycle will be quite positive, and with the developments currently under way, we believe they will be interesting times to live in, to misquote the old Chinese saying. The 10-year cycle is something that will see consolidation reaching good proportions, and a maturity in the market that will mark the arrival of hotels and tourism as an important economic activity.”

De Haast said the country remains an attractive location.

“For the long term, it remains a market with enormous opportunity because it’s a sizable country with a large population and a high proportion of those are young and are becoming economically active,” he said. “As they come into the work force and begin to become productive, they will travel for business and leisure.

“As soon as the economic crisis is behind us, demand will bounce back quickly. Hotels will bounce back to high levels of profitability, and development will begin to pick up again.”

The market continues to be extremely attractive for the medium and long term given the lack of supply, the concentration in major cities and the nominal branded supply presence in the midmarket segment and other lower operating segments, according to Horwath’s Thacker.

“While development activity has slowed down in the current economic environment, we expect new hotels to continue to be built over the next seven to 10 years in different parts of the country,” he said. “Even if all the hotels that are currently announced get completed (something that is not going to happen), even then there will be a dire shortage of rooms in comparison with market potential. It is in this context that the outlook of this industry is positive in the medium to long term, particularly for developers of midscale, economy and budget hotels.”

Thacker said first-class and higher-standard hotels have potential, but need to be more selectively planned and located.

Chappell said success isn’t a foregone conclusion.

“In a country that size, there’s huge potential for growth, but it’s a big task,” he said.

Also in this special report: