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Make The Most Of Your Debt

Four crucial factors that can make or mar your hotel business.
Nandivardhan Jain   New Delhi     Print Edition: February 10, 2019
Make The Most Of Your Debt
Nandivardhan Jain, CEO, Noesis Capital Advisors

The travel and tourism industry accounts for 9.4 per cent ($234 billion) of India's GDP, and creates significant employment opportunities. Currently, there is a total inventory of 1.3 lakh rooms in the organised space and around 3 lakh rooms across mom-and-pop hotels or the unorganised segment. The aggregate inventory of rooms stands at around 4.3 lakh while the US has a supply of 50 lakh rooms and China 27 lakh rooms. So, it is imperative for India to have good quality and well-spread lodging infrastructure to boost growth.

Hotel development is a capital-intensive business. To finance the initial capex, one requires an infusion of debt in the business. But in the Indian context, it is equally vital to structure this debt effectively to avoid any hostile situation in future as it harms not only businesses but also financing entities. With the introduction of Insolvency and Bankruptcy Code (IBC), 2016, banks and financial institutions have enormous powers to deal with defaulters in a swift and timely manner. A delay on the part of the borrower to repay even a single instalment is now met with stringent action.

It is often observed that an inappropriate debt structure leads to a shortfall in a hotel's cash surplus. Under such circumstances, it becomes increasingly difficult to pay loan instalments as per the repayment schedule. To overcome this situation, the management starts cutting corners in operations and maintenance, which ultimately affects guest experience. With unsatisfied guests, the hotel's average rate of return (ARR) and occupancy drop, which could reduce its valuation.

Majority of the hotels which are financially struggling are primarily doing so due to their unsustainable debt structures and not because of operational reasons. Here are four key factors which can make or mar your hotel business.

Loan tenure: Banks or financial institutions in India typically offer a tenure of seven-eight years for project financing/term loans. However, the development cycle - from land acquisition to hotel opening - takes four-five years and post the commencement of operations, it would ideally take another two years to stabilise revenues. Considering these market realities, even if the debt-equity ratio is 1:1 with a shorter tenure, it is difficult to service debt from the hotel's monthly cash flows. Ideally, one requires a loan tenure of 15 years to make it a self-sustaining debt-servicing model.

Interest rate: A business needs to rationalise and justify the interest rate as per its capacity. High interest rate means high cash outflow towards debt servicing, which may not be sustainable. Negotiate effectively and evaluate multiple options while finalising your debt with banks or financial institutions.

Moratorium: It is the initial duration when the interest component of the loan is repaid but not the principal amount. Negotiate well for a moratorium as any lapse on this can lead to unfavourable outcomes. Typically, banks offer a moratorium of one or two years depending on credit assessment of the project, stage of completion and techno-economic viability study.

Repayment: In an ideal scenario, a hotel would take 24 months to stabilise its revenues post the commencement of commercial operations and then the cash inflow keeps growing. Understandably, it is vital to match the debt repayment schedule with potential earnings of the hotel. Structure the loan repayment schedule with an option of ballooning the payment and make sure that the percentage of principal in loan instalment is lower during the initial years and gradually increases later on. It will reduce the monthly cash outflow towards loan repayment in the initial years.

Here is a case in point. The Leela, a homegrown luxury hotel chain, is operating 2,690 rooms across nine properties in cities such as Mumbai, Goa, Delhi, Gurgaon, Chennai, Bengaluru, Udaipur and Kovalam. It is a leading brand in most of the markets where it is operating; its services are excellent and it enjoys strong customer loyalty. But when it comes to the financial health of the company, Leela has been going through a rough patch over the past few years as the chain's cash flows are not sufficient to service its debt.

If you want to structure a debt effectively, prepare a professional financial feasibility report of the proposed project. While doing it, carefully analyse the financial performance of existing hotels, understand industry nuances, look at market trends, and monitor your project's occupancy, ARR, seasonality, future supply and credit terms. Next, prepare a business plan and evaluate the quantum of debt that the hotel's future cash flows can sustain in the given loan tenure. After all, the right or wrong debt structure can be the reason behind the creation or destruction of your wealth.

The writer is CEO, Noesis Capital Advisors, a hotel investment advisory firm

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