This second part of EHL Institutional Visibility’s three-part series on China looks into the long-awaited return of Chinese tourists. It also addresses shifting trends in Chinese travel. We turn to Dr Yong Chen, Associate Professor of Economics at EHL Hospitality Business School, for insights.
“The problem is serious.” And when it’s the head economist at the International Monetary Fund who says so, eyebrows are indeed raised. The comments made by Pierre-Olivier Gourinchas in early October at an IMF meeting in Morocco underscored the gravity of China’s current economic balancing act. The world’s second-biggest economy is staring down an unprecedented real estate crisis that could drag the country down with it.
The US government first established Real Estate Investment Trusts (REITs) in the 1960s, allowing retail investors access to the nation's vast portfolio of income-producing real estate assets. Since then, the REITs market has expanded significantly across many real estate asset classes, including hospitality. The first hospitality REIT (or lodging REIT) was introduced in the US in 1970, but this asset class didn't start to gain popularity until the mid-1990s when investors realized they could own and profit from lucrative hotel assets without having to spend a significant sum of money to acquire the asset.
India’s initial public offerings (IPO) market has been thriving for the past few years, and 2021 ended up being a record year with over 60 IPOs, as the country’s stock market reached new highs, putting the COVID fears to rest. This positive trend has continued in 2022, with 19 companies launching their IPOs so far. However, hotel industry IPOs have been few and far between, with Lemon Tree Hotels and Chalet Hotels being the noteworthy ones, but even those were before the pandemic.
According to a recent GlobalData report, 573 deals (including mergers & acquisitions, private equity, and venture financing) were announced in the global travel and tourism (T&T) industry in the first half of 2022, reflecting a 3.1% increase over the same period last year. However, before these deals are concluded, the asset needs to be valued. So, how do we determine a hotel's market value and what exactly is valued under the category of hotels? The main valuation techniques are briefly covered in this article.
According to a recent GlobalData report, the global mergers and acquisitions (M&A) activity in the travel and tourism sector was worth US$155 billion in 2021, representing an 84% increase year-on-year, with the lodging segment accounting for the largest share in terms of deal value and volume. During the year, the sector saw 27 billion-dollar-plus global M&A deals, up from 20 the previous year. This, however, is a sharp contrast to the situation in India. Hotel transactions in the country have not increased significantly post-COVID, and the sector has not yet seen a flurry of distressed transactions, as was expected as a likely result of the pandemic.
COVID-19 and the ensuing travel restrictions have wreaked havoc on the travel and hospitality industries all over the world. To mitigate the impact, governments around the world have taken a variety of measures over the last two years, ranging from prioritizing vaccination for tourism employees to providing financial and liquidity support as well as making policy changes to aid the recovery of their respective travel and hospitality sectors. In fact, with low international travel demand, governments in some countries like Singapore, Hong Kong, Slovenia, Switzerland, and Thailand, have even introduced incentives and refunds to encourage citizens to travel within their own country.
The Indian hotel sector is finally breathing a sigh of relief as demand has recovered dramatically in recent months, even helping push occupancy and average rates closer to pre-pandemic levels in a few markets. However, the hotel sector, like most others, is reeling under the pressures of rising prices, affecting not only operations but also hotel development plans in the country.
In the aftermath of the ongoing pandemic, brand signings by keys in India witnessed a year-on-year decline of 42% in 2020. Signings were especially low in the first half of the year, due to the uncertain market conditions and challenges related to closing deals on virtual platforms because of the COVID-19 lockdown and restrictions.
Hotel transactions value in India contracted by approximately 50% to reach INR24,611 million (approx. US$332 million) in 2020 compared to INR49,372 million (approx. US$690 million) in 2019, but was still higher than the previous peak of INR19,929 million achieved in 2015.Going into 2020, mergers & acquisitions (M&A) activity in the sector was expected to be stronger than that witnessed in 2019.
After making several representations to the government, the Indian hospitality sector, one of the worst-hit by the pandemic, was expecting some game-changing announcements during the Budget 2021 speech which would help accelerate the sector's recovery.However, the first ever 'digital' budget of the country failed to provide any direct and immediate support to the sector.
In the past few months, several state governments have been proactively lending a helping hand to the tourism & hospitality sector in their respective states, providing various relief measures to help the sector stay afloat during these trying times. Last month, in a move to reboot the sector, the Maharashtra government conferred 'industry' status to the state's hospitality sector.
All hotels strive to improve and reduce costs on an ongoing basis. During the normal course of operations, hotels try to achieve this by implementing various techniques, such as using alternate products, implementing process improvements, enhancing inventory management, and evaluating more efficient equipment, which allow them to save certain costs during the year. But the question here is whether these efficiencies are significant enough.
Asset-light operating models have become the main stay for growth of many of the major hotel companies in India, with Management Agreements being the preferred structure. The other major asset-light model - Franchising - though is yet to gain significant traction in the country. Approximately 14% of the total brand signings in 2019 were franchised properties as compared to 10% in 2018. On the other hand, Management Agreements accounted for 76% of the total brand signings in both 2019 and 2018. In contrast, hotel franchises are the most popular model in mature markets like the US, where almost 80% are franchised.
In a market like India, where land most often than not is mis-appropriately valued resulting in exaggerated project costs and hotel transactions are limited in number, the only viable methodology that remains relevant especially in the current uncertain & volatile market scenario is that of Discounted Cash Flows (DCF). Moreover, the current pandemic has had an unprecedented impact on the hospitality sector, with hotels being temporarily closed and the sector witnessing all-time low performance metrics, by the virtue of which, assessing the value of a hotel on current income fails miserably.
As a hotel consultant, I am often asked a pertinent question: Do hotels make profits in India? The challenges in building, operating, buying and selling hotels are a plenty. Investors frequently point to the relatively lower risk associated with other commercial asset classes such as office buildings, retail developments and warehouses. The highly dynamic and perishable nature of the hotel business pushes them to question the very veracity of it.
For long, hotel owners have been trying to find ways to safeguard their investments and interests during negotiation of management contracts with potential operators. And indeed, they have made notable headway. There was a time when a performance test clause featured sparingly in management contracts. Over the years, however, it became a standard provision in most agreements being signed in the west. Today, owners across the globe, including in Asia Pacific, insist on this requirement even as operators continue to wrap it with several riders. An equitable performance test clause protects the hotel owner from an incompetent operator, while at the same time assuring the management company that it will not be terminated for circumstances beyond its control.
The critical challenges as identified by the owner community (Addendum) bear a strong correlation to a hotel's typical life cycle. While some of these challenges are self-created, others are beyond an owner's control. Either way, these set an incorrect precedence for new hospitality ventures, reflecting poorly on the Indian hotel industry at large.