The hotel industry is impacted by both the overall economic health of the country, and global occurrences, hence, it is important to take on the right kind of debt, says Akshay Kulkarni.
The thought of owning a five-star hotel does bring a smile to most large size investors in the real estate space.
The glamour factor that comes with a hotel asset and the social elevation that it brings, are unmatched by any other asset class, and these were the motivations for the traditional investor.
Today, times have changed, and the average investor is far more focussed on the returns, capital appreciation, and the speed at which cash flows start. This is not to say that these factors weren’t important in the past, but the other reasons were more important drivers in hospitality projects and property acquisitions.
Upon a little study of the holding patterns of the past, it would be obvious that not many individuals held any kind of portfolio of hotels; those that did, actually listed and brought in capital to grow, while others sold out to larger companies.
Hence, for the longest time, hotel portfolios in the country were held either by families or corporate groups. This was followed by a stage when portfolios were held by consortiums of investors who started to see merit in the hotel investment model, and finally came the surge where real estate investor-backed-developers, wanted to own hotels.
This was more or less, the last stage of evolving buyers, and, post the real estate developer boom stage, the sector witnessed the mature, institutional investors in the form of funds or other financial institutions. With the changing nature of the investors, the motivation and focus also changed.
For a long time, the average investor was convinced by what looked fabulous on paper – a doubling of value in an instant.
With no background in the hotel business, this class of investor often made the mistake of classifying the hotel product in the same group as any real estate product, and hence their development strategy too followed a similar course – take a parcel of land, get multiple FSI on it and, almost instantly, the value has increased in proportion; build on it and the per square foot return seems great in theory.
What most of them didn’t seem to account for is the gestation period, cash flows, and returns.
Investments in the sector tend to be capital intensive and brand driven but the ability to sustain the long gestation period is a must for the investor, that is, the total time taken to (a) develop a hotel, (b) get it operational, (c) get it to stabilise, and finally, derive any value out of it.
Consider an apartment complex – positive cash flow can start as soon as the plans are launched, or, in case of a commercial build-ing – where the maximum risk is whether the return will meet expectations – it is possible to start some cash flow in about 12-months from the beginning of construction in order to get/start debt service.
Once a residential apartment/development is sold, the involvement at best for the developer is only two-three years till such time as the society is formed and full ownership handed over to the relevant body.
Commercial developments also offer the safety of a lock-in period from occupiers and hence, a commitment to the product can be made on the back of lenient agreement clauses such as rent discounting and suchlike.
Hotel assets however, are completely different, in that, there are no guarantees or leases (at least in most cases), and the minimum time taken for any cash flow to be generated is an average of 24-months.
The sheer quantum of money to be invested is high, the returns only start once cash flow is stabilised, and not too many people account for seasonality of the business, even though it exists.
The hotel development model is unique in the sense that, for the entire duration of the project there are no returns against any investment made; the returns only start once the hotel is operational.
Even post commencement of operations, it is likely that the hotel would take about 12-18 months to stabilise, before one gets an absolute fix on costs and revenues.
Further, success is highly dependent on the strength of the promoters backing the project. While low risk investments like a residential development offer the option to invest at a pre-launch price and allow a good enough return when the project is ready, the hotel project permits no such thing.
Also, in most residential or commercial buildings, one can make margins on the carpet to build-up (BU) area, and eventually, the super-built up areas.
However, in a hotel development, it is next to impossible to make any premium, since the operators would not commit to revenues based on built-up space, nor does one get any benefits by enhancing BU areas (unless they can be used for some function or the other).
The hotel asset is one which calls for a long term perspective and commitment – where one must look at long term returns, have the ability to weather the storm, as they say, and look at capital appreciation rather than pure operational income.
One important factor that is to be considered while financing projects is that this business is probably one of the most cyclical businesses and thus will see ups and downs.
It is also – even in leisure destinations – driven by overall economic health of the country and further, tends to be affected by happenings in the world. Thus, it is important to take on the right kind of debt which can be serviced over a period of time.
The true value of an asset is on the basis of its cash flows and hence, it is important to be able to exit the hotel asset at the appropriate time, keeping in mind the profitability.
A hotel needs periodic investments to maintain its standards, and so there needs to be continuous improvement. It is not an asset that can be built and forgotten.
Its unique feature is that, while it provides capital appreciation like all real estate assets, if exited at the appropriate time, it can provide annual revenues given the right operators and location.
While most other buildings will depreciate over time, the hotel asset value actually appreciates due to cash flow, profitability and association with the appropriate brand.
The last few years witnessed a series of mixed-use developments with an element of ‘de-risking’, providing the investor with the ability to absorb the initial years of low profitability from a hotel product. The demand environment however, over the last three years, was conducive to provide reasonably short stabilisation and payback on hotel developments.
Going forward, it is likely that incremental and new hotel developments (in addition to the inventory proposed to enter the market), will be based on new and innovative models with investors seeking to achieve stable returns.
With new hotel developments of various categories expected across different cities in the country in the coming three-to-four years, the quantum of new supply entering the market against the current demand has initiated a trend amongst the investor community – where unique concepts are viewed to have potential based on the extent of value proposition derived from the product, in order to achieve a development model that is perceived to be ‘more than profitable on a basic level’.
The year has witnessed suppressed investment activity, with roughly only a third of the amount of investment activity compared to the same period in the last year. Some of the more prominent transactions include investment into Asiana Hotels and Resorts, Mayfair Hotels and Resorts, and purchase of the SeaRock in Mumbai.
As the year progresses, however, and as transaction volumes approach decade trough levels, we believe that the combination of deteriorating trading fundamentals and the build up of refinancing pressures will result in a narrowing gap between buyer and seller expectations, and further retractions in investment yields.
Overall, the hotel business’ success is led by the right products in the right place at the right price, accessible to the right consumer.
Akshay Kulkarni is executive director, South Asia – Cushman & Wakefield Hospitality.
Asset investments decoded
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The hotel industry is impacted by both the overall economic health of the country, and global occurrences, hence, it is important to take on the right kind of debt, says Akshay Kulkarni.
The thought of owning a five-star hotel does bring a smile to most large size investors in the real estate space.
The glamour factor that comes with a hotel asset and the social elevation that it brings, are unmatched by any other asset class, and these were the motivations for the traditional investor.
Today, times have changed, and the average investor is far more focussed on the returns, capital appreciation, and the speed at which cash flows start. This is not to say that these factors weren’t important in the past, but the other reasons were more important drivers in hospitality projects and property acquisitions.
Upon a little study of the holding patterns of the past, it would be obvious that not many individuals held any kind of portfolio of hotels; those that did, actually listed and brought in capital to grow, while others sold out to larger companies.
Hence, for the longest time, hotel portfolios in the country were held either by families or corporate groups. This was followed by a stage when portfolios were held by consortiums of investors who started to see merit in the hotel investment model, and finally came the surge where real estate investor-backed-developers, wanted to own hotels.
This was more or less, the last stage of evolving buyers, and, post the real estate developer boom stage, the sector witnessed the mature, institutional investors in the form of funds or other financial institutions. With the changing nature of the investors, the motivation and focus also changed.
For a long time, the average investor was convinced by what looked fabulous on paper – a doubling of value in an instant.
With no background in the hotel business, this class of investor often made the mistake of classifying the hotel product in the same group as any real estate product, and hence their development strategy too followed a similar course – take a parcel of land, get multiple FSI on it and, almost instantly, the value has increased in proportion; build on it and the per square foot return seems great in theory.
What most of them didn’t seem to account for is the gestation period, cash flows, and returns.
Investments in the sector tend to be capital intensive and brand driven but the ability to sustain the long gestation period is a must for the investor, that is, the total time taken to (a) develop a hotel, (b) get it operational, (c) get it to stabilise, and finally, derive any value out of it.
Consider an apartment complex – positive cash flow can start as soon as the plans are launched, or, in case of a commercial build-ing – where the maximum risk is whether the return will meet expectations – it is possible to start some cash flow in about 12-months from the beginning of construction in order to get/start debt service.
Once a residential apartment/development is sold, the involvement at best for the developer is only two-three years till such time as the society is formed and full ownership handed over to the relevant body.
Commercial developments also offer the safety of a lock-in period from occupiers and hence, a commitment to the product can be made on the back of lenient agreement clauses such as rent discounting and suchlike.
Hotel assets however, are completely different, in that, there are no guarantees or leases (at least in most cases), and the minimum time taken for any cash flow to be generated is an average of 24-months.
The sheer quantum of money to be invested is high, the returns only start once cash flow is stabilised, and not too many people account for seasonality of the business, even though it exists.
The hotel development model is unique in the sense that, for the entire duration of the project there are no returns against any investment made; the returns only start once the hotel is operational.
Even post commencement of operations, it is likely that the hotel would take about 12-18 months to stabilise, before one gets an absolute fix on costs and revenues.
Further, success is highly dependent on the strength of the promoters backing the project. While low risk investments like a residential development offer the option to invest at a pre-launch price and allow a good enough return when the project is ready, the hotel project permits no such thing.
Also, in most residential or commercial buildings, one can make margins on the carpet to build-up (BU) area, and eventually, the super-built up areas.
However, in a hotel development, it is next to impossible to make any premium, since the operators would not commit to revenues based on built-up space, nor does one get any benefits by enhancing BU areas (unless they can be used for some function or the other).
The hotel asset is one which calls for a long term perspective and commitment – where one must look at long term returns, have the ability to weather the storm, as they say, and look at capital appreciation rather than pure operational income.
One important factor that is to be considered while financing projects is that this business is probably one of the most cyclical businesses and thus will see ups and downs.
It is also – even in leisure destinations – driven by overall economic health of the country and further, tends to be affected by happenings in the world. Thus, it is important to take on the right kind of debt which can be serviced over a period of time.
The true value of an asset is on the basis of its cash flows and hence, it is important to be able to exit the hotel asset at the appropriate time, keeping in mind the profitability.
A hotel needs periodic investments to maintain its standards, and so there needs to be continuous improvement. It is not an asset that can be built and forgotten.
Its unique feature is that, while it provides capital appreciation like all real estate assets, if exited at the appropriate time, it can provide annual revenues given the right operators and location.
While most other buildings will depreciate over time, the hotel asset value actually appreciates due to cash flow, profitability and association with the appropriate brand.
The last few years witnessed a series of mixed-use developments with an element of ‘de-risking’, providing the investor with the ability to absorb the initial years of low profitability from a hotel product. The demand environment however, over the last three years, was conducive to provide reasonably short stabilisation and payback on hotel developments.
Going forward, it is likely that incremental and new hotel developments (in addition to the inventory proposed to enter the market), will be based on new and innovative models with investors seeking to achieve stable returns.
With new hotel developments of various categories expected across different cities in the country in the coming three-to-four years, the quantum of new supply entering the market against the current demand has initiated a trend amongst the investor community – where unique concepts are viewed to have potential based on the extent of value proposition derived from the product, in order to achieve a development model that is perceived to be ‘more than profitable on a basic level’.
The year has witnessed suppressed investment activity, with roughly only a third of the amount of investment activity compared to the same period in the last year. Some of the more prominent transactions include investment into Asiana Hotels and Resorts, Mayfair Hotels and Resorts, and purchase of the SeaRock in Mumbai.
As the year progresses, however, and as transaction volumes approach decade trough levels, we believe that the combination of deteriorating trading fundamentals and the build up of refinancing pressures will result in a narrowing gap between buyer and seller expectations, and further retractions in investment yields.
Overall, the hotel business’ success is led by the right products in the right place at the right price, accessible to the right consumer.
Akshay Kulkarni is executive director, South Asia – Cushman & Wakefield Hospitality.
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