Funding Real Estate Projects For the Hospitality Industry – Emerging Perspectives

Up until 2007, most hoteliers, investors and developers were buoyant when it came to the growth prospects in the Hospitality industry. They had enough reason to be optimistic as every factor which would influence the industry, directly or indirectly, was on a growth trajectory.

The GDP was growing like never before and the whole world had its eyes on the Indian growth story. Plans of expansion filled the newspapers and press releases and investors were more keen than ever to get a fair share of the pie.

The recession, however, had plans of its own and devoured most of the pie. The global economic slowdown and its effect on the Indian economy has doused the fire of excitement of even the most optimistic developers and investors.

It has resulted in an extreme crunch for investment in the hospitality sector, coupled with the decrease in demand for rooms. This double whammy put to rest most of the ambitious plans of expansion across the country.

All players have been reviewing their plans of development, owing to the increasingly challenging macro economic situation at the moment. The total number of rooms estimated to be added is today nearly half of what was announced earlier. One-fourth of the plans announced so far have failed to materialize, while the rest are hanging on the edge of viability.

DLF, Parsvnath and other developers of similar cadre have scaled down or slowed down their plans of expansion. Parsvnath which had plans of adding at least 10,000 rooms has now stopped acquiring land for any further plans other than the twenty hotels for which they have already done the same.

There have been reports that DLF has been in talks with various Hotel companies to sell eight to nine of their land parcels demarcated for Hotel projects to raise funds. Unitech has sold its Gurgaon Hotel project to reduce its huge debt burden.

Developers are more focused on finishing the projects on hand than on making plans for the future. Divesting the investment heavy Hotel plans seems to be the best way out for the cash strapped, heavily indebted players to survive the present-day economic scenario.

Financial Projections Going Awry

The seeds were sown, the crops were nurtured through the tough inflationary times but when the time to harvest came, the floods of recession washed away the anticipated bounty. Cost and revenue assumptions made during the good times have thus gone for a toss.

When it comes to loan disbursements, real estate is presently the black sheep of the family. Private Banks from which loans were freely available earlier have dried up. Public sector banks which continue to lend, albeit cautiously, now require a higher collateral to lend the same amount.

Non-banking finance companies are either not lending at all or looking at returns in the post 20% range. Private Equity interest in the Hospitality sector has all but dried up. Due to the severe global liquidity crunch and flight of capital to ‘places of origin’, there is a diminishing interest for Private Equity players in foreign markets. This has added to the financial woes of the capital-thirsty developers.

The risk associated with a Hospitality project being relatively larger, the premium at which funding is available has gone up. Due to this, only the most stable projects in the market would be able to take up the risk of delivering higher returns to the lenders.

Many developers had invested heavily in land in the past when the land values were significantly higher. At present, the value of the same land parcels has come down significantly. The excessive reliance on the appreciation of these assets has turned out to be a serious dampener to the development plans of various developers. The lower value of land means that the value of collateral has come down for project loans.

The cycle of cost of construction has taken the industry on a roller coaster ride over the past couple of years. The global commodity cycle has drastically changed its course. Steel and cement which form a significant chunk of the civil construction costs have lost up to 40% from their historic highs twelve months ago.

The hotels which have opened recently have faced the brunt of the cost fluctuations in a similar fashion. Greater costs were incurred, owing to the period in which their construction phases passed through. The cost of materials was higher, the market was booming and along with the high material costs, the various architects and consultants demanded a premium as a result of a never-before-seen demand. Despite the increased amount of investment that the developers had to put in, they now face a world with reduced revenue prospects.

The main factor that has directly and indirectly influenced the stability of revenue-side financial projections in the Hotel industry is the lack of ‘stickiness’ relative to other real estate sectors. For the record, the stickiness of the Hotel Industry is relatively low. In order to explain, take lease agreements into consideration. These are long term in nature and hence revenues are more secure in the case of an Office or Retail space as they have a considerable lock-in period.

However in case of the Hospitality industry, the revenues are more directly susceptible to market conditions. This being the reason as to why other sectors have been relatively less affected by the present day scenario. The main factors influencing this stickiness are occupancy rate and Average Room Rate (ARR).

Occupancy Rate is a function of supply and demand. The present scenario is affected by both the demand and supply factors, with demand having the more potent influence. The two main demand drivers, the leisure and business travelers, have contributed to the reduction occupancy rate. Overseas travel has been affected to a large extent due to the economic slowdown.

Corporates have found innovative ways to cut down on their expenses and there is a growing need for them to rationalize business travel. They have reduced their travel budgets, are staying at serviced apartments and guesthouses or even looking at options where they can avoid staying overnight.

MNCs with significant exposure to the developed markets are taking the lead to drive travel associated business expenditures down as a part of their global strategy. Spending sentiments of consumers has been hit to a large extent owing majorly to fears of job loss and a resulting lack of confidence and low morale. The leisure consumers are hence looking to spend lesser on travel.

In addition to the demand slowing down, the supply is on the increase which would mean that the occupancy rates are set to reduce further at least for the next one or two years. All these factors contribute to a significant reduction of occupancy rates, and this is a primary reason contributing to the instability of the financial projections made by various players.

On the supply side, although there is an inherent demand for more supply in the long run, occupancy rates would see an improvement only with the revival of the economy.

Due to the hit on occupancy rate, Hoteliers have been forced to cut down on the ARRs to attract both their business and leisure customers. The occupancy rate has also negatively affected the other closely linked revenue sources such as Food and Beverage, Conferences and Banquets.

Role of Funding Options

Traditionally, most developers have tended to plough back the surplus that they earn, into their business via investing in land banks. This makes them highly dependent on external sources for funding. The various equity funding options available in the market till now have been Public or Private Equity which can be Foreign (FDI) or Domestic Funding.

In the present market scenario, there is a lot more uncertainty in cash flows associated with Hotel projects than usual. This has led investors to be quite cautious when it comes to investing in or lending to hospitality projects.

Private equity, while still being an option, has seen a slowdown. Investors are worried about the market bottoming out and there is a feeling that the correction in the Hospitality sector is still not complete. PE players are avoiding common equity in SPVs but looking at structured investments with greater security and preferred returns. However, there are a number of funds which are actively looking to buy out or invest in distressed assets at enticing valuations.

Having said that, owing to the severe capital crunch, the market for new PE capital raising especially in Real Estate is difficult right now and is likely to remain so for the next two to three years. Where funds have already been raised, there have been cases of Limited Partners (LPs) not honouring their capital commitments.

Project Loans for under construction projects are harder to come by with only the public sector banks lending. These loans are being disbursed primarily to promising projects with substantial asset cover guarantees. We have also witnessed cases of liquidity-hungry developers borrowing from HNIs at extremely high rates.

Bailing Out Stranded Projects

A million dollar question on everyone’s mind would be on how to bail oneself out of stranded projects.

Divesting a part of the stake in the project to gain capital may be one of the options. This may not be very easy in today’s market. The project maybe valued at a much lower price than what is expected and may leave the seller with a raw deal from the transaction made.

One could also think of repositioning the project. Instead of increasing the investment requirement for a project by planning a high end luxury hotel, one could look at serviced apartments and budget hotels at the moment to get through the times of credit crunch.

Another option would be to reduce the scale of the project. One could reduce the size of the project in one go or could phase out the development. Phasing the project out in stages where part of the hotel could be operational in relatively less time and with less investment than earlier planned would help ease the credit and liquidity crunch. There are quite a few operators who take a stake in the project as well. Accor is a good example of such an operator who have significant expansion plans in India.

Tying up with suitable investing operators would, however, not be as easy as it may seem, since these operators would choose only the best of the options available and they would have their own plans in place already.

Going back to the lender may be an option worth visiting, to see if they could restructure the existing loan. One could also go for refinancing or extending the loan. If the borrower has a good record, they could also look at finding a new lender as well, probably an HNI who would be willing to invest.

However, if the only option left is to exit the project, the timing would need to be well thought out. If one waits too long for a good price, the price might just go lower. On the other hand one also needs to assess the urgency to exit the project as we would not want to end up in a situation where we would be forced to accept a price which would normally be unattractive.

Liberalization of FDI Norms And Its Impact On Expansion Plans

FDI has the promise to be a major factor in the economic development of the many developing nations of the world. With tourism being a major revenue earner for countries across the world, FDI norms liberalization in this sector is a definite boost for the Indian economy.

The government has been very liberal when it comes to FDI regulations in the Hotel and Tourism industry. According to the Government of India – Ministry of Commerce and Industry Press Note 2 (2000 series), 100% FDI is permissible in the Hotel and Tourism sector on the automatic route subject to the automatic approval clauses.

The additional restrictions, applicable to some sectors of real estate, such as area of development being at least 50,000 sqm, 50% of the project to be completed before 5 years, no repatriation of funds before 3 years from date of minimum capitalization released in 2005, are not applicable to the Hotel and Tourism industry.

The government has thus made a conscious effort knowing the fact that tourism can be a major source of revenue for the country which is still relatively untapped. Hence, the only effect that existing FDI norms can have on the industry is on the positive side. It is only a matter of time before investments in the Hotel and Tourism sector start flowing in freely once again.

These investments would be more dependent on the inherent demand in the industry and the overall economic scenario across the world. Once the credit crunch situation gets better, the inherent demand in the industry that one senses should help attract funds easily as compared to some of the other sectors.

Some say the worst is over and India will be getting back on its feet soon. However, the key is not just to wait and watch but to try and be one step ahead. Be ahead and decide on when to stop waiting. Only the best would survive and we would be lying if we said we weren’t all eager to see who they really are.

Sudeep Jain is Executive Vice President, Jones Lang LaSalle Hotels, a division of Jones Lang LaSalle India, the Indian operations of the international real estate consultants, Jones Lang LaSalle.

With an extensive geographic footprint across ten cities, Jones Lang LaSalle India provides investors, developers, local corporate and multinational companies with a comprehensive range of services including research, consultancy, transactions, project and development services, integrated facility management, property management, capital markets, residential, hotels and retail advisory.

Article Source: http://EzineArticles.com/?expert=Sudeep_Jain

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