In this article, we take a look at the impact on hotel values during a time when the hospitality industry in India is expected to deliver results that would qualify as the best performance in a decade!
In our 2005 HICSA edition article 'Hotel Values - Scaling the Peak' we analysed the performance of the hotel industry in India and the impact on hotel values of a strongly improved performance of the industry starting 2002-03. Since the feasibility of new hotel development is determined by the relationship between replacement costs and existing values for hotels, we also attempted to explain the rationale underlying the investment decision for hotel developments.
A year has just gone by and hotels continue to scale new heights in performance and profitability. Riding on the rising curve of the trend cycle, with no substantial change in the supply scenario, hotels across key markets have delivered better yields through consistent occupancies and higher rates. In this article, we take a look at the impact on hotel values during a time when the industry is expected to deliver results that would qualify as the best performance in a decade. Based on the hotel value per room and the associated cost benefit ratio, we have once again ranked key cities across India. The rankings may be used as a measurement index and should enable investors to choose the city of development.
Methodology 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. 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.
Market Overview
As illustrated in Table 1, a majority of markets in India have shown robust growth in occupancies over the last two years. With increased demand and limited availability of quality accommodation the average rates in these markets have grown by 50.5%, the exceptions being Bangalore and Kolkata where the rates have appreciated by 132.0% and 9.0%, respectively. For 2005-06, the year-on-year occupancy growths have been marginal and some markets such as Bangalore have seen a negative growth.
For 2005-06, occupancy growth has been strongest for Kolkata (7.50%) followed by Hyderabad (4.40%) and Goa (4.20%). The average occupancy for Mumbai was up by 1.60% from 72.4% to 74.0%, while the Chennai market registered a growth of 1.3% for 2005-06. The occupancy growth for Delhi was positive inspite of the addition of a 323-unit Shangri-La hotel, which entered mid financial year. The average occupancy for Bangalore market fell by 1.8% while Jaipur witnessed a modest growth of 1.8% in its occupancy.
In terms of average rates, Bangalore once again registered the highest growth with 41.0% year-on year appreciation, followed by Delhi (35.6%) and Goa (32.8%). Average rates for Mumbai and Hyderabad grew 30.2% and 30.4%, respectively. The average rate growth for the Chennai and Jaipur markets was 27.7% and 22.1%, while Kolkata registered the lowest growth of 13.6%.
Table 2 presents average rates for key cities from 1997-98 to 2005-06.
In our previous edition we had observed that since demand for hotels had witnessed robust growth trends starting 2002 and there was not much supply coming into the market, the demand-supply imbalance would enable hotels to increase yields through proactive rate management across all channels of distribution. In 2005-06, hotels across India benefited from higher demand from the commercial travel segment. The absorption of prime commercial space from IT, ITeS and the financial services sector in cities such as Bangalore and Hyderabad continues to grow and this has provided for induced demand for room nights in these markets. The entry of new companies, typically, generates significant room night demand during the start-up period, for extended periods. Since there are very few branded extended stay products, the demand is absorbed by hotels.
Hotels are now able to guarantee a specific level of usage from the extended-stay segment on a daily basis, and this has enabled them to substitute business from airlines and group bookings that usually negotiate deeply discounted room rates. Hotels across India are now adopting an integrated dynamic pricing model for their commercial clients as opposed to the traditional fixed-rate allotment model. They have also aligned the process of commercial rate contracts to fill periods of low occupancy, and quickly displace this demand when higher-rated non-contracted business offers better potential.
We believe that the positive growth rally exhibited over the last 18-24 months, both in terms of occupancies and average rates, will continue for the next three years and provide the necessary impetus for further appreciation in hotel values.
Hotel Values
As reflected in Table 3, the highest year-on-year appreciation in hotel value was witnessed by Bangalore where value has appreciated by 72.1% followed by Hyderabad (38.5%) and Chennai (38.0%). The average rate performance of Bangalore continues to be impressive and the enhanced revenue performance has translated into stronger profitability. Hyderabad and Chennai have traditionally been low-paying markets; however, in the last few years these cities have seen a change in their customer profile and market segment mix. Proactive sales and pricing strategy in anticipation of change in demand has enabled the two cities to better rate performance and this has translated into better profitability and higher valuations.
The two leisure destinations of Goa and Jaipur have seen hotel values appreciate by 21.6% and 21.0%, respectively. In our previous edition we had mentioned that Goa is a market with immense potential for new hotel development and the operating performance along with the derived values justify our claim. Jaipur is a key destination of the golden triangle circuit and is the gateway into the famous Rajasthan travel circuit. The growth in domestic travel within India and higher inflow of international tourist has benefited the market. Jaipur has also witnessed robust demand for quality accommodation from the gems, jewellery and handicraft industries based there and this has further enhanced its performance translating into improved valuations.
The hotel values for Delhi and Mumbai have appreciated by 13.9% and 25.0%, respectively, due to consistent demand from commercial travel segment. Kolkata has, once again, seen the lowest appreciation in value and this can be attributed to the comparatively lower profitability margins for hotels in this city.
As demand continues to be higher than supply, most markets while maintaining stable occupancies, have made substitutions to their demand base so as to improve rate performance. Performance improvement through occupancy growth has a cost implication and its impact on profitability is marginal when compared to rate improvements that flow directly to the bottom line. To conclude, the impressive growth in hotel values in 2005-06, as in 2004-05, can once again be attributed to higher yields achieved across most markets due to continued occupancy revival and appreciation in average rates.
Value per room in Indian Rupees and US Dollars, for the eight cities, is presented in Table 4 and Table 5.
Replacement Cost Vs Hotel Value The cost to benefit ratio is the value of the hotel divided by its replacement cost. 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. In our earlier article we analysed the associated cost benefit ratios for hotels and provided our comments on how the relationship between a hotel's market value and its replacement cost is important to hotel investors. In this edition we have once again analysed the replacement cost of a 200-room five-star hotel in each of the eight cities for 2005-06. 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 the corresponding period to derive the cost to benefit ratios.
Table 6 illustrates a city-wise comparison for the year 2004-2005. 
As is evident from the above analysis, in 2004-05, most cities, with the exception of Kolkata and Goa, had a cost benefit ratio greater than 1.0. Based on our analysis of historic trends, forecast growth rates and associated cost benefit ratios for each market in 2004-05, we expected that Bangalore will see the maximum development projects followed by Delhi, Mumbai and Hyderabad.
Table 7 illustrates a similar comparison for the year 2005-06
While we have seen impressive growth in the hotel values for all markets across the board there has been a sharp decline in the cost benefit ratios for future developments in these markets. The cost benefit ratio has in fact depreciated for all markets and for 2005-06 six out of the eight markets have a cost benefit ratio of less than 1. The sharp depreciation can be attributed to the associated land values in these markets. Land values over the last one year have appreciated by an average of 53.7% with the highest appreciation in Bangalore (80.0%) followed by Hyderabad (70.0%) and Chennai (65.0%). The feasibility of a hotel as derived through project IRRs are highly sensitive to the replacement cost component and the cost of land acquisition will render most projects unfeasible, at least in the short term horizon.
The high replacement cost further limits the market positioning for new builds. The project costs will force most developers to position their hotels at the luxury end of the market and they will compete for the same business at similar price points. When the demand-supply imbalance situation improves, which will improve once the planned supply is phased in, only those hotels that are planned and conceptualized to cater to the ideal business mix will be able to sustain themselves. This enhanced competition will make it difficult for hotels to achieve their fair share in market penetration thereby creating a downward rate spiral. We all agree that at some point in time macro economic factors and industry dynamics will present an optimum demand-supply balance and rates will be rationalized. Post rationalization, the rate adjustment factor will be comparatively higher for hotels with luxury orientation and this will impact the profitability of hotels thereby eroding value.
What India needs today is development of hotel projects across multiple price points catering to different segments of travel to sustain a flatter, but more stable, growth trajectory over a long term period. To make this possible there needs to either be a rationalization in existing capital values of land or a revision in existing land usage and development norms. In India things are easier said than done and if wishes were horses everyone would ride them, till such time its boom time for existing hotels and land owners and hotel values are likely to touch dizzying heights….so fasten your seat belts and enjoy the ride to 'Cloud 9'!
Siddharth Thaker, Associate Director - Consulting & Valuation, joined HVS International, New Delhi in August 2004 as Consulting and Valuation Analyst. Formerly, he worked as Revenue Manager with Le Meridien Hotels & Resorts at UAE, Tashkent and Kuwait. Prior to Le Meridien Hotels & Resorts, he worked with the Taj Group of hotels for two years as a Revenue Management Executive. sthaker@hvsinternational.com www.hvs.com
