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South Asia Hotel Values - Scaling the Peak
The performance of Hotels across South Asia over the last 24 months has been consistent and impressive. Let's take a look at the effect on hotel values in India and Pakistan of a strongly improved industry performance.
By Siddharth Thaker, HVS International
The hotel industry in India witnessed a visible revival in the second half of 2002-03 due to strong domestic travel trends and a positive economic and investment environment. The performance of the country on the economic front over the last 20 months has been consistent and impressive. A strong GDP growth rate, positive investment initiatives, continued efforts towards infrastructure development and the "Open Skies" policy provided the necessary impetus to business travel, and the hotel industry witnessed sustained growth both in terms of occupancy and average rate.
Now let's take a look at the effect on hotel values of a strongly improved performance of the hotel industry in India. We have also presented our findings for the three key cities of Lahore, Karachi and Islamabad in Pakistan. Pakistan has recently emerged as an important investment destination for new hotel development. After a gap of almost five years, hotels in Pakistan are witnessing substantial increase in growth, both in terms of occupancy and average rate and this trend is expected to continue. Since Pakistan is on the rising curve of the trend cycle, hotels will show signs of better performance in yields through consistent occupancies and higher average rates.
I have also attempted to explain the rationale underlying the investment decision for hotel development. The feasibility of new hotel development is determined by the relationship between replacement costs and existing values for hotels, as is explained later in this article. Based on hotel value per room and the associated cost benefit ratio, we have ranked key cities in India and Pakistan. The rankings may be used as a measurement index and should enable investors to choose the city of development.
Our valuation methodology is based upon actual operating data from a representative sample of four-star, five-star and five-star deluxe hotels in eight important hotel markets in India and three markets in Pakistan. The data is then aggregated to produce a proforma performance for a typical 200-room hotel in each city. Based on our day-to-day experience of real-life hotel financing structures, which arise from knowledge gained during the various assignments undertaken each year, we have determined appropriate valuation parameters for each market, including loan-to-value ratios, relevant interest rates and equity return expectations. These market specific valuation/capitalisation parameters are applied to net income for a typical hotel in each city.
Hotel Values - India
As reflected in Table 1, with the exception of Kolkata and Chennai, most cities had started showing signs of revival in hotel values in 2002-03 due to growth in occupancy levels. In 2002-03, since the trend in occupancy revival had just taken off, rates in these cities were still under pressure. In 2003-04 Bangalore, Hyderabad and Chennai registered the highest value growth, followed by Goa, Jaipur, Mumbai and Delhi. The only city to register a negative value growth was Kolkata. The impressive growth in hotel values in 2003-04 can be attributed to higher yields achieved across most markets due to continued occupancy revival and appreciation in average rates.
As illustrated in Table 2, the strong growth trends witnessed by most cities in India have continued in 2004-05. Average occupancy growth has been strongest for Jaipur (6.7%), Mumbai (6.5%), and Hyderabad (6.2%), followed by Delhi, which witnessed an occupancy increase of 5.6%. Whilst demand for hotels is expected to remain robust, there is not much supply coming into the market, and the demand-supply imbalance will enable hotels to increase yields through proactive rate management across all channels of distribution.
Growth in average rate in 2004-05 was highest for Hyderabad (32.6%), followed by Delhi (31.4%), Bangalore (29.1%) and Mumbai (28.7%). However, average rate in absolute terms continues to remain highest for Bangalore. We believe that the positive growth rally exhibited over the last 18-24 months, both in terms of occupancies and average rates, will provide the necessary impetus for appreciation in hotel values and most cities across India are expected to witness robust growth in values in 2004-05.
Table 3 presents average rates for key cities from 1997-98 to 2004-05.
Value per room in Indian Rupees and US Dollars, for the eight cities, is presented in Table 4 and Table 5.
In terms of value per room, Mumbai is expected to witness the highest value appreciation, followed by Delhi and Jaipur. Hotel value per room in Mumbai is expected to increase from Rs 7.3 million in 2003-04 to Rs 11.7 million in 2004-05, a growth of 58.5%. Value per room in Delhi is anticipated to grow by 41.6% during the same period, from Rs 8.1 million to Rs 11.5 million. For Jaipur, a 33.5% appreciation in value is expected, from Rs 3.6 million to Rs 4.8 million.
There is little correlation exhibited between hotel value per room and the CAGR ratio for cities. This lack of correlation can be attributed to variations among the cities, in demand growth patterns and market segment mix.
Markets like Bangalore, Mumbai, Delhi and Hyderabad have, over the last 18 to 24 months, witnessed strong demand growth from the extended-stay and domestic commercial travel segments. A higher demand base from new segments enabled better yield management and, therefore, values in these markets have seen a steady growth curve. The emergence of relatively new feeder markets and consistent demand for quality accommodation across most business destinations from niche markets, such as the extended-stay segment, will ensure that hotels now have a base demand that ensures certain minimum level of occupancy. This type of demand will be advantageous to hotels because it would provide a base level of occupancy over a long period that normally includes weekends and slow seasons. The occupancy benefit will be marginally offset by low contract room rates, which may have an adverse impact on the overall average rate. Skilled hotel operators, however, will successfully use the demand from newer segments to fill periods of low occupancy, and quickly displace this demand when higher-rated market segments offer better potential during peak periods. Proactive yield management and micro segment planning will facilitate hotel value appreciation in key business destinations across India.
Cities like Jaipur and Goa, on the other hand, have moved very rapidly due to exceptionally strong seasonal demand growth from domestic leisure, higher inflow of foreign tourists and a consistent demand for meetings and conferences.
Based on current macro economic trends and the business outlook for the country, and with Gross Domestic Savings at current prices touching an all-time high, we firmly believe that India is expected to witness a stable and continued trend of boom in consumption, influenced by higher disposable income. This is good news for the hotel industry: higher disposable incomes are also expected to enhance the concept of travelling, especially to key leisure destinations. Strong domestic demand and continued foreign tourist inflow will enable popular leisure destinations to readily absorb future hotel developments, thus enabling a continuation in the present trend of value appreciation.
Our research and the associated valuation of hotels reveal that Goa is among the markets most neglected by hotel developers. The inventory of rooms in the branded segment for Goa has almost doubled over the last three years. The rapid addition to inventory in the market was readily absorbed by strong demand from domestic tourist segment. Goa has, also over the past few years, been the most preferred destination for hosting meetings and conferences.
Replacement Cost Vs Hotel Value
HVS research in markets across the world indicates that hotel development, internationally, follows a seven-year cycle. To understand this in the Indian context, we analysed cost benefit ratios for hotels in the year 1999-2000. This was the period when a large number of hotels that have opened in the last 12 to 18 months were conceptualised and planned. The cost to benefit ratio is the value of the hotel divided by the replacement cost of the hotel. The relationship between a hotelís market value and its replacement cost is important to hotel investors. New hotel development generally occurs when a market exhibits positive feasibility: a hotel project is considered feasible when its market value upon completion is higher than its replacement cost, and the cost benefit ratio must exceed 1.0.
Having arrived at hotel values for the last seven years, we analysed the replacement cost of a 200-room five-star hotel in each of the eight cities during these years. Replacement cost has been estimated as the cost of developing a 200-room hotel (including land cost), having facilities that are currently being offered by most five-star hotels of international standard. We then compare the hotel values in each city during 1999-2000.
Table 6 illustrates a citywise comparison for the year 1999-2000.
As is evident from the above analysis, in 1999-2000, cities like Mumbai, Delhi and Bangalore had a cost benefit ratio greater than 1.0: this prompted hotel investors and developers to look at these cities for potential hotel development. Mumbai had the highest cost benefit ratio, followed by Bangalore, Delhi and Chennai. Mumbai, Delhi and Bangalore have seen more hotel development, since 1999-2000, than any other city in India.
Table 7 illustrates a similar comparison for the year 2004-05.
Based on our analysis of historic trends, forecast growth rates and associated cost benefit ratios for each market in 2004-05, we expect that Bangalore will see the maximum development projects followed by Delhi, Mumbai and Hyderabad.
Hotel Values - Pakistan
Wide-ranging structural reforms, prudent macroeconomic policies, financial discipline, improving relations with India and a consistency and continuity in policies, not seen before, have transformed Pakistan into a stable and resurgent economy. The stage is now set for economic growth to accelerate with the private sector expected to play the leading role in taking the economy on a higher growth trajectory. Riding on the strong economic fundamentals of past few years, market growth for transient accommodation in Pakistan has gathered greater momentum over the last 12-18 months. The acceleration in growth is accompanied by a sharp pick up in average rates, and with very little supply planned, hotel values in Pakistan for Lahore, Karachi and Islamabad will witness rapid appreciation.
The aggregate room count for the Lahore market is 790 rooms. Commercial demand predominates, and is equal to 52% of the estimated market demand. Meeting & Conference is the second largest segment, accounting for 41% of the total room night demand. The Extended Stay and Airline segments account for 9% and 4%, respectively, of the estimated market for Lahore. Occupancy for the market increased from 73.0% to 85.0% between the years 2003 and 2004. The increase in occupancy was accompanied with an impressive growth in average rates. Average rates increased from Rs 3,950 (Pakistani Rupees) to Rs 5,800 between 2003 and 2004.
For the Karachi market, the room count is 1,404 rooms. Commercial demand constitutes 75.0% of the estimated market demand. Extended Stay is the second largest segment with 12.0% of the total room nights. The Meeting & Conference segment accounts for 5.0% of market demand, while the Airline segment constitutes the balance 8.0%. Occupancy for the Karachi market increased from 66.0% to 76.0% between the years 2003 and 2004. Average rates increased from Rs 2,990 to Rs 3,750 between 2003 and 2004.
With an aggregate room count of 728 rooms, the hotel market in Islamabad constitutes 45.0% Commercial demand. Diplomatic and other government related travel constitutes 28.0% of the estimated market demand. Meeting & Conference contributes 5% of market demand, while the Extended Stay and Airline segments account for 18% and 4%, respectively. Occupancy in Islamabad increased from 74.0% to 82.0% between the years 2003 and 2004. Average rates increased marginally, from Rs 5,020 to Rs 5,650, between 2003 and 2004.
Table 8 illustrates the operating performance for key cities in Pakistan from 2002 through 2004.
Based on our in-house library of operating statistics for various hotels, in Tables 9 and 10, below, we have presented our calculations of hotel value and the corresponding percentage change in value for Lahore, Karachi and Islamabad.
The annual growth in hotel value per room from 2003 to 2004 has been the highest for Lahore (76.0%), followed by Karachi (44.4%), and Islamabad (24.7%).
Table 11 illustrates the comparison and the cost benefit ratio for each city in Pakistan for the year 2004.
Based on our analysis and associated cost benefit ratios for each market, we expect that Lahore will see the maximum development projects, followed by Islamabad and Karachi.
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