Mad rush to build hotels in expensive India

Written by Reuters | Mumbai, April 30: | Updated: Apr 30 2008, 16:57pm hrs
Developers are rushing to build hotels in India to fill an estimated shortfall of 150,000 rooms, but rising financing, land and construction costs could dent profits for many of them.

With room rates rivalling and often surpassing those in Hong Kong and Tokyo, hotel owners and operators in India are keen to make a name in a market expected to draw millions more travellers as incomes rise and new airports and roads are built.

But some industry executives say developers are taking on risky projects based on room-rate assumptions that could turn sour.

With about 50,000 rooms under construction, premium rates of $500-$600 per night are widely expected to drop, while land prices have quadrupled in many areas over the last three years.

Meanwhile, construction costs have risen by around a quarter in the last year, and salaries have jumped thanks to a staff exodus to new Dubai hotels and cruise ships.

"I wouldn't be surprised if there's a bit of a bloodbath," said Uttam Dave, chief executive of Interglobe Hotels, during a conference held at a JW Marriott hotel in Mumbai, which charges $450 per night.

"Construction quality is getting better but it's expensive. To get quality challenges the entire economies of a project."

Because all of India has only 86,000 hotel rooms, not many more than the 73,300 in New York City, room rates are at a big premium to those in other developing countries in Asia.

A Crowne Plaza hotel that opened recently in the New Delhi suburb of Gurgaon boasts average revenue per room of $330 per night, compared to about $260 for the more up-market InterContinental Hotel in Hong Kong and $150 for top-notch hotels in Bangkok.

"Developers assume these rates will carry on but they're unsustainable," said Paul Logan, head of Southern Asia development for InterContinental Hotels Group Plc, which owns the Crowne Plaza brand.

"There'll be corrections of up to 50 percent."

Local players

"We don't think room rates can go any higher and the cost of operations is rising, so the pace of growth will slow," said Manav Thadani, managing director at HVS Hospitality Services.

"But existing players will still continue to do very well for the next couple of years. Gross operating profit margins in India are still at about 43 percent, compared to 30 percent in mature markets in Europe and the U.S.," he said.

Indicating strong demand, average occupancy rates in India's branded hotels stood at around 72 percent in 2007/08, up from 65 pct four years ago, consulting firm HVS said.

The number of visitors to India doubled in five years to 5 million in 2007, according to government figures.

Leading the charge for new hotels is the country's biggest developer DLF Ltd, which has teamed up with operator Hilton Hotels Corp to build in 75 locations over the next seven years.

Ritz-Carlton, the luxury arm of Marriott, will operate a hotel in Bangalore being built by Indian developer Nitesh Estates and a fund run by U.S. bank Citigroup, and is looking for similar partnerships in New Delhi and Mumbai.

U.S. firm Hampshire Hotels & Resorts plans to build and operate 25 hotels over the next five years, with 2,500 rooms built at 11 locations before 2011, according to Ram Gupta, a managing director at the firm.

Land accounted for 40-60 percent of the cost of a hotel in India, compared to around a quarter in most countries, he said.

But developers doing hotel deals could get some respite from softening land prices in some areas even though demand remains high in prime locations.

Hungry

Gupta believed room rates would not fall by more than 10 percent because huge spending in infrastructure would fuel demand. The Indian government expects some $500 billion to be spent on airports, roads, ports and power in the next five years.

"If you're hungry, you eat," Gupta said. "India has very poor infrastructure but we're still getting 5 million tourists a year. With improvements there'll be more arrivals."

However, hotel developers are also finding equity capital for their projects more expensive as the central bank tightens monetary policy.

In April, Indian Hotels, the country's top hotel operator, extended the close of a rights issue of shares and pushed the exercise of warrants to next year because of volatile markets.

A stock market slump has halved the valuations of many developers since the beginning of the year and initial public offerings are nearly impossible at the moment -- a fact not lost on private equity firms as they invest in projects.

With the cost of equity rising, if developers err in their projections for construction costs and room rates, profits could dwindle quickly, said Gaurav Kumar, vice president for real estate finance at Credit Suisse.

"It takes one year to source land, and three years to get a single penny out," Kumar said. "And a 25 percent variation in costs can make the difference between 15 and 25 percent returns".