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Saturday, January 21, 2012, 16:00 Hrs  [IST]

Hotel Investment in India: A Challenge, yet an Opportunity

Since hotel development requires huge capital investment, the first hurdle for any developer is arranging finance/debt for the project. Although investment in hospitality ventures in India promises good return on investment (ROI), availability of debt for such projects depends on various factors. Maansi Sharma ponders the issues related to hospitality financing

The Indian hospitality industry has always had its highs and lows. Governments, both central and state, were the initial investors in the hotel industry in India in the early decades of independence.  Private investments in the hotel business were limited to small guest houses in the early years.  Hotel business was not considered as a lucrative business venture in the country till 1980s. The sector was largely dominated by India Tourism Development Corporation of India (ITDC) or brands like the Taj or the Oberoi. However, after liberalisation in the 90s, investments in the hotel industry started gaining momentum with major real estate groups started showing interest in the sector.

As per 2010 statistics, hospitality industry, which includes hotels and restaurant chains, is valued at approximately USD 23 billion (Rs 113,976 cr) of which hotels comprise 75 per cent of the total market size. And the size of the hotel market is expected to double by 2018, and attract an additional investment of USD12 billion (Rs 59,442 cr)  in the coming years.

Given the growth prospects of India in the coming years, the country would require an additional 100,000 hotel rooms in the country to service the demand in the market. Tourism is also booming in India with both inbound and domestic travel increasing year on year. The tourist footfall to India has been increasing steadily over the years, across all segments. In 2010 alone, India recorded 5.6 million foreign tourist arrivals and 740.21 million domestic tourist arrivals. This is a great opportunity for investors, who are really looking for viable investment options in the market. However, hotel development requires a huge capital investment. Investment requirements of large scale hotel projects cannot be met by a single person or developer. Availability of debt is crucial.

Debt availability is, however, no longer a big issue in the market place if the viability and return on investment (ROI) can be proved convincingly

Debt availability is, however, no longer a big issue in the market place if the viability and return on investment (ROI) can be proved convincingly. Sources of debt available in the market include family members, funding from venture capitalists, public stock sale, or through corporate investors or joint venture partners. While options are numerous, there are risks of varying degrees associated with all these debt channels. Another important factor is that being highly capital intensive, hospitality projects would require solid commitments or assurance upfront in terms of finance before commencing the projects. In order to address issues related to hotel and other tourism-related projects funding, government of India had set up Tourism Finance Corporation of India (TFCI) in 1988. Over the last two decades, the corporation has participated  in financing of as much as one-third of all the existing hotel rooms in the approved category in the country, says Rajendra Sharma, Chief General Manager, TFCI.

Hotel investment, irrespective of its capital intensity, is still seen as a potential profitable business venture in the country.  Naveen Jain, President, Duet India Hotels says, “Given the economic growth story of India and the burgeoning demand for hotel rooms due to increasing domestic and international travel, hospitality as a sector remains a profitable investment option in India. There is a major gap in the mid scale and upper mid scale categories of hotels catering primarily to the domestic market which presently has 740 million domestic travelers.” As an investment, hospitality, Jain observes, has mostly given consistent returns and is, thus, not very risky for an investor who understands the supply and demand dynamics. However, one has to take a long term view as the assets take time to stabilise. Being cyclical in nature it is important to time the investment and exits.

Nitty-gritty’s of  investing
As is the case with all growing markets, investing in the Indian hospitality industry has its pitfalls as well. One of the key challenges in markets like India is availability of land. Land is pretty costly in key markets in the country, and given the very low Floor Space Index (FSI), and the long gestation period, hospitality ventures become a bit unpredictable. Unlike many other real estate investments, the viability and sustainability of a hotel venture depends on numerous external factors. Yes, of course, the first key word for a hotel is obviously its location.  

The investment decision into a green field project can broadly be broken further  into four stages - screening, planning, implementing and operating
President, Duet India Hotels

For an interested investor, according to Jain, there are broadly three investment options are available, namely the listed companies, operating hotels and greenfield hospitality projects. “The investment decision into a green field project can broadly be broken further  into four stages — screening, planning, implementing and operating,” Jain reveals. But, what are the key parameters that should be borne in mind before jumping into a project. Jain underscores six broad parameters:

1. City and Location; 2. Market Dynamics of Demand and Supply; 3. Competitor Performance; 4. Security Available/Ability to Leverage; 5.  Catchment Areas; 6. Returns.

TFCI does a complete viability study of the projects before they commit any kind of project assistance. “Besides economic and technical viability, we appraise the financial viability of the project in detail by assessing the market, likely competition, arrangements made for meeting the completion, size of the project vis-a-vis market in terms of number of rooms, cost, sources of funding, quantum of interest-bearing funds, etc. Location, seasonality of business at the location, political and social environment, strength and character of the promoters exhibited by historical records of their performance and behaviour and market reports are among the other factors taken into consideration,” adds Sharma.

TFCI generally invests 60 per cent of the cost in hospitality projects. The investment share dips depending upon capacity of the project to service the debt. Duet India typically follows a 60:40 debt equity ratio provided the land cost is not more than 30 per cent of the project. In a lease deal, however, the quantum of debt is typically lower since the lease payments are phased over a longer period.

Opportunities in mid-market segment
Indian hospitality scene has been dominated by premium luxury hotel segment for a long time.  There was a vacuum in terms of mid-scale hotels till recently. However, a clear segmentation of sorts have come into play in the last few years with the coming of mid-scale budget brand, both international, domestic. However, there are plenty of opportunities and scope for investments in this segment in Tier II and III cities and along destinations of pilgrim importance.

The major limitation of investing in India is the long pay-back periods for the projects. Typically, the revenues follow semi-parabolic model and the project becomes a cash cow in the medium term
Chief General Manager,
Tourism Finance Corporation of India

According to Jain, Duet has recognised a gap in the mid-market hotel space and has entered into a joint-venture with the Intercontinental Hotel Group (IHG) to develop hotels branded Holiday Inn Express, in key Indian metro cities. “Duet currently has a 76 per cent share in this partnership, with IHG contributing 24 per cent equity for the development of the hotels. At present, five Holiday Inn Express hotels owned by the joint venture (JV) are under development in Ahmedabad, Hyderabad, Chennai and Bengaluru,” he added. Duet recognises a supply gap in three and four star business hotel segment and is focused on addressing this need in the market. “Hotel investment feasibility is primarily determined by the entry price and market. Both business and leisure segments are growing and have their own demand and investors,” said Jain.

Echoing similar sentiments, Sharma stated that the mid-market segment in India is most viable for investments. “As a venture capitalist looks at the longer horizon, it fits into his domain as the hotel projects achieve higher Internal Rate of Return (IRR) as compared to his peers in the medium to long term coupled with safety of the investment. As such, downside risk is insignificant and returns are expected to be very high on the long time horizon. The present uncertain economic scenario is not going to continue in the medium term when the venture capitalist envisages exit/return on his investment and in the short term, there is hardly any downside risk,” added Sharma.

The best options to invest for a foreign player is through hospitality focused private equity funds who understand locally the dynamics of the industry

220112_cs_4.jpgOn the budget accommodation front, State  tourism boards own and manage around 950 accommodation units in India. Most of the state tourism boards are looking for private investors to manage these properties on long term lease contracts. Being in prime tourist circuits, these establishments present viable return on investment for investors.

While hotel investments are lucrative in developing and emerging markets like India, there are challenges as well when it comes to investing in the sector. According to Jain, although investment in greenfield projects offer maximum return, there are few challenges on the way.  These are:
  • Valuations for operational properties in India are very high and do not offer a significant returns to a rational investor
  • High land prices in key Tier I markets, coupled with related issues on land ownership and titles. The land titles and the governing development norms are at times unclear and require detailed legal and technical due diligence
  • Obtaining approvals is time consuming and obscure as a process, especially for institutional investors
  • Exit options for investments in India are also limited. The existing regulations do not allow presence of REITs which are a viable exit option in mature markets. Further, India has not seen too many sales of individual hotel assets or portfolios. However, capital markets in India are mature and provide a decent exit option.
Given these challenges, the best options to invest for a foreign player is through hospitality focused private equity funds who understand locally the dynamics of the industry, opines Jain.

Long pay back period is a big challenge for investors in Indian hospitality market, feels Sharma of TFCI. “The major limitation of investing in India is the long pay-back periods for the projects. Also, operations are very sensitive to the various environmental factors like economic, political and social. Typically, the revenues follow semi-parabolic model and the project becomes a cash cow in the medium term.”

(with inputs from P Krishna Kumar)
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