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Construction : Cover Story | December 2015 | Source : CW-India

The Economics of Hospitality in Small Cities

How long is the long road to profitability in smaller hospitality markets in India? CW PROPERTY TODAY attempts to find some answers.

¨Demand for hotels in Tier-II and Tier-III cities has been very limited so far because customers, business travellers being the biggest consumers, have limited propensity to pay,¨ says Rami Kaushal, Managing Director, Consulting and Valuations, CBRE South Asia Pvt Ltd. ¨Traditionally, the less expensive unbranded segment has catered to this demand.¨

Therefore, the biggest opportunity to break into low affordability markets exists in the branded budget to midscale segments.

Strong growth prospects AccorHotels, a strong player in the midmarket and economy hotels segment, sees solid growth opportunities in Tier-II and Tier-III cities.

¨Visible economic growth, urbanisation, a high domestic travel base, efforts to relieve pressure on burgeoning metro cities, rise in infrastructure development and the emerging middle class, cost competitiveness and a massive talent pool lead AccorHotels to see huge growth potential in Tier-II and Tier-III cities,¨ says  Jean Michel Cassé, Senior Vice President-Operations, AccorHotels India. ¨We view these cities as progress engines of the future and believe they represent hugely untapped assets given the gap between current demand and the availability of rooms.¨

AccorHotels is focused on growing 50 per cent of its hotel network in Tier-II and Tier-III cities through the Novotel and Ibis brands. It has hotels in Nasik, Lavasa and Vizag while hotels in Thiruvananthapuram, Mysore, Coimbatore and Lavasa are under development.

A winning strategy
Industry watchers point out how budget to mid-segment brands such as Holiday Inn Express, Ibis, Ginger and ITC Fortune are creating multiple assets in well-calculated locations in different parts of the country, apparently with the aim to have a portfolio that yields returns even if a couple of properties don´t do well. Their strategy entails deep pockets, not only to create multiple assets but to tide over the longer gestation periods of properties in Tier-II and Tier-III cities.

Stabilisation to gestation
A hotel´s gestation period hinges on the cost of developing the property, including the cost of land, the cost of operations and the time it takes to stabilise earnings and occupancy, and on competition prevailing in the market, explains Amit Oberoi, Head, Valuation & Advisory, Colliers India.

On the one hand, hotels in Tier-II and Tier-III cities cost less to develop, majorly because land costs is less in those locations and land accounts for 35-40 per cent of the total development cost, according to Kaushal. ¨Construction costs vary by 15-20 per cent between Tier-I and Tier-II or Tier-III markets,¨ he adds. ¨Class also has a significant cost implication,¨ says Oberoi.

¨A five-star hotel property can cost upwards of Rs 1 crore per key, while a midscale hotel would typically cost in the range of Rs 40-60 lakh.¨

Coming to the recurring costs, hotels in smaller cities spend less on salaries and wages. ¨Budget hotels additionally incur lower costs from offering fewer amenities,¨ adds Oberoi.

On the other hand, hotels in smaller cities typically yield lower average room rent (ARR). ¨An exception to this is properties enjoying a monopoly position in developed markets, which can command the revenue per available room (RevPar),¨ says Ajay Bakaya, Executive Director, Sarovar Hotels & Resorts.

Overall, lower costs in Tier-II and Tier-III cities do not offset the lower revenue in those markets. Consequently, stabilisation of ARRs and occupancy as well as gestation periods are longer in Tier-II and Tier-III markets by a year or two depending on the market and the region.

¨Stabilisation takes an average of three to four years in Tier-II and Tier-III markets and sometimes four years for resorts in leisure destinations,¨ says Kaushal.

Profitability follows the stabilisation of revenue.

Kaushal pegs the average gestation periods in Tier-II and Tier-III markets at two to three years for budget properties, three to four years for mid-segment hotels and five to seven years for the upscale and luxury segment.

Brands with deep pockets and winning strategies are sure to reach the end of the long road to profitability in smaller markets.

Quick Bytes

  • Demand exists for luxury, upscale, upper midscale, midscale and budget hotels.
  • Biggest opportunity to break into low affordability markets exists in the branded budget to midscale segments.
  • Growth opportunities exist in Tier-II and Tier-III cities.
  • New markets are driven by industrial and residential developments or commercial and residential developments, which are followed by hotel properties.

Trendsetters: Tapping into virgin markets
Hotels by themselves typically aren´t fire starters in new markets, according to Rami Kaushal, Managing Director, Consulting and Valuations, CBRE South Asia Pvt Ltd. New markets are driven by industrial and residential developments or commercial and residential developments, which are followed by hotel properties. Hotels depend on other developments for demand.

Exceptions are hotels developed in new leisure destinations - in virgin territories or near wildlife conserves or adventure activity zones. ¨Such developments generate 20-25 per cent demand from leisure travellers and nearby corporations and industries,¨ says Kaushal. Thereafter, sales and marketing activities help generate more demand from the FIT (Free Independent Traveller), MICE (Meetings, Incentives, Conventions and Exhibitions) and other segments.

Which Tier-II or Tier-III city should you head for?

Here are expert opinions on which Tier-II and Tier-III cities present good opportunities:

State capitals: ¨We see a bright future in state capitals. States perceived on the road to development are preferred destinations,¨ says Ajay Bakaya, Executive Director, Sarovar Hotels & Resorts.

Upcoming Tier-II and Tier-III cities: ¨Some opportunities exist in Tier-II and Tier-III cities with manufacturing or IT infrastructure, and in those that are attracting FDI for specialised projects such as the Multimodal International Hub Airport at Nagpur,¨ says Mandeep Lamba, Managing Director-Hotels & Hospitality, JLL India. ¨Upcoming Tier-II and Tier-III cities are Vijayawada, Bhopal, Bhubaneswar, Chandigarh, Neemrana, Angul, Pune and Ahmedabad, to name a few. Smart cities will also be ideal opportunities for hotel-related investments.¨

Cities in close proximity to metros: ¨If you can afford it, areas in close proximity to metros are good locations to enter, such as Navi Mumbai or Thane near Mumbai, and Noida or Faridabad in the National Capital Region,¨ suggests Rami Kaushal, Managing Director, Consulting and Valuations, CBRE South Asia Pvt Ltd.

Pilgrimage sites: Pilgrimage places are now attracting tourists all year round, weather permitting. ¨Current supply at religious sites is dominated by dormitories, lodges and low-end hotels. Significant demand exists from travellers who are willing to pay for decent accommodation,¨ says Amit Oberoi, Head-Valuation & Advisory, Colliers India. ¨Some pilgrimage places are displaying an appetite for upscale rooms as well, albeit the business generated from that market segment may not be enough to sustain the property throughout the year. This demand creates scope for properties offering suites or penthouses as well as standard rooms,¨ says Kaushal.

Top leisure destinations: Properties in popular leisure destinations like Goa, Kerala, and Shimla enjoy peak occupancy round the year, according to Kaushal.

 
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