The Liquidity Crisis and the Indian Hotel Industry: a Hurdle or a Silver Lining?

The state of turmoil in global financial markets has generated new concerns for the hospitality industry. This article attempts to 'gaze the crystal ball' and see what lies ahead for the industry in emerging markets like India. The state of turmoil in global financial markets has generated new concerns for India: in what ways, and to what extent, will our economy be impacted? Will India continue to be perceived as investment-worthy? And will developments - internal and external - allow different sectors of the economy a good chance for growth?

Where real estate and the hotel industry in India are concerned, the going seems to be good. Within the same week that a Wall Street Giant sold for USD250 million, a 90-odd acre land parcel in the National Capital Region was valued in excess of USD1.25 billion... a sign of optimism and confidence in this sector's future.

In this article, I make an attempt to 'gaze the crystal ball' and see what lies ahead for the hotel industry in India.

In the near term, inflation, growth and liquidity dynamics are expected to make access to debt-based instruments unattractive for most industry players in emerging markets. Real estate, as an asset class, will continue to be under the regulatory microscope especially at current valuations. Investments through dedicated funds and private equity placements will require an enhanced level of due diligence, and this will result in the average time cycle for transactions being extended. Many global funds are likely to re-evaluate their real estate portfolio strategy for India and there are indications of certain fund commitments made in real estate Special Purpose Vehicles (SPVs) having been temporarily suspended. With financing becoming harder to get and hotel projects to take longer to come to fruition, existing players stand to benefit. Hotels constituting the existing market will continue to operate at optimum levels of occupancy, maximise rates and report enhanced profitability.

Existing hotels in India are also likely to benefit from the improved performance of the non-room sources of income, namely Food & Beverage (including banquet operations), Spa, Corporate Club memberships and other ancillary services. The effective use of technology and best-in-class cost management systems will ensure that profit margins are consistent. Though the industry will face cost inflation in the form of more expensive raw material and labor, an enhanced top line growth, coupled with diligent cost management, should offset the negative impact on profitability. Hotels, by and large, have also successfully made a transition to outsourced services in areas such as security, landscaping, laundry and property management, this will enable hotels to operate at reduced employee per room ratios, thereby providing flexibility with regard to department-level income and expenses.

Our assessment is that an additional 160,000 new rooms need to enter the top 25 hotel markets in India, in the next five years, to bridge the demand-supply gap facing by the hotel industry. Since 2004, potential demand in key hotel markets has grown 20-22% year-on-year. While echoes of global market developments are likely to resound here, the economic fundamentals of India continue to remain sound and the growth trajectory of corporate India is testimony to this. Commercial travel by Corporate India will provide the necessary impetus to the hotel industry. In the last few years, some hotels have been guilty of manipulating the delicate balance between price and value. This has resulted in development of parallel lodging markets and led to erosion of effective capture ratios and displacement of demand from traditional high volume segments such as tour groups, incentives and MICE. We expect a rate rationalization to take place in the market by 2010, and at affordable prices demand indicators continue to remain diverse and broad based.

The extended supply pipeline is likely to further transform the market into a supplier's market and this will, naturally, lead to a continued sharp rise in rates in most cities. The mid-level traveler constitutes a key target market for most hotels in commercial destinations and this segment also exhibits comparatively higher average length of stay patterns. Displacement of this business will be available for hotels with a mid market orientation that can satisfy the value-for-money principle. We estimate that, by 2012, macro demand-supply factors and industry dynamics will present an optimum demand-supply balance and yields will be rationalized. Our experience in India indicates that budget hotels will be able to operate at impressive occupancies, maximize yields through proactive rate management, and build a loyal customer among niche markets like the non-negotiated commercial traveler, airline STPC and extended stay.

Post rationalization, the rate adjustment factor will be comparatively lower for hotels with a mid market orientation and these hotels are expected to present a flatter, but more stable growth trajectory over a long term period. The other advantage a country as vast as India presents is a unique opportunity to do multiple, small format hotels, catering to micro markets. A geographically well balanced portfolio will exhibit stability allowing developers a potential cost advantage from construction and sourcing.

The farm loan waiver announced in Union Budget 2008 and the subsequent qualification for re-eligibility will enable most public sector banks to realign their balance sheets leading to more positive lending. Tax benefits will result in higher disposable incomes and induce leisure related travel within India. Another factor that bodes well for our overall economy is the demographic shift in India's population. By 2020, India will be a nation of 1.2 billion people with an average age of 28. Double incomes and lifestyle aspirations are providing impetus to leisure travel within India that includes a new, but fast-growing segment of demand for niche destinations and unique holiday experiences. In the forthcoming future, we expect to see new destinations on the Indian tourism landscape offering experiential holidays and getaways. According to our estimates, there will be sustained demand for weekend travel at major gateway destinations and these markets will grow in the range of 35-40% annually in the next 3-5 years. Destination travel within India is likely to be an important beneficiary and we expect to see the emergence of Integrated Travel Circuits in the years to come.

To conclude, the hotel industry's visible revival starting 2002, owed to strong domestic travel trends and a positive economic and investment environment, will continue. We expect a good GDP growth rate, positive investment initiatives, ongoing efforts towards infrastructure development and the Open Skies policy to provide an important boost to business travel. The hotel industry, we believe, will witness sustained growth both in terms of occupancy and average rate. The industry has, in the past, overcome the challenges posed by 9/11, Pokhran and SARS. We expect it to remain resilient in the face of the US sub-prime crisis, benefiting instead from a well-performing economy and robust demand from within the sector.