Braced For Growth
Aatish Nath January 21, 2019
Over the past few years, the iconic Hotel Ashok, in the heart of Lutyens' Delhi, has been grappling with an uncertain future. First, there were talks of disinvestment, and of late, plans are afoot to lease it out for 60 years to allow private players to redesign, rebrand and run the business. It may sadden old loyalists, but the leasing model seems to be gaining traction as real estate is exorbitantly priced and no one is too keen on large-ticket exposure.
The hotel industry has witnessed two key business models - brand-owned and operated properties and those managed by brands under management contracts. Now comes the leasing model, under which a brand takes over both day-to-day running and the P&L of the asset, for which the lessor gets a fixed return and at times, an added revenue share, as per the deal. According to Saurabh Gupta, Managing Partner at the Gurgaon-based hospitality consulting firm Hotelivate, "Leasing works for property owners who are looking to invest in the hospitality industry but need the comfort of assured returns. It also incentivises fresh capital to enter the sector. In addition, leasing of hotels allows brands to grow robustly, thus paving the path for some investments."
Leasing of hotels is yet to take off in a big way in India (even the ITDC-owned Ashok is getting few offers), but some operators are quite bullish about its growth prospects. "We handhold owners until the completion of the asset, and when the hotel is ready, we take possession," explains Zia Sheikh, Chief Managing Director and Chief Executive Officer of Svenska Hotels. This Swedish boutique hotel chain runs as many as 21 properties in India while 20 more projects are on the cards. Svenska started onboarding leased properties in FY2014/15, around the same time when the model became prevalent in the Indian market.
Some hotel chains are getting leases directly from owners, and most of the luxury properties are now managed for 10-35 years. "These are typically very long-term leases, say for 25 years. The minimum guarantee is what an owner would typically expect to receive in the first or the second year until the hotel stabilises. After that, revenue share usually kicks in," adds Sheikh.
Besides Svenska, a few other players, including Howard Johnson, Royal Orchid and Bloomrooms, have adopted the leasing model. But right now, there are too few 'leased' properties in the market compared to 'owned-and managed' and 'managed' ones. "The lease is a contingent liability on a balance sheet, a key reason why many international chains operating in India do not adopt it," says Gupta of Hotelivate. Nevertheless, a few Indian brands such as Ginger and the Indian Hotels Company (Ginger is part of IHCL) have a blueprint in place for leasing fully fitted assets.
"In fact, fully fitted leases are the preferred lease model for growth," says Deepika Rao, MD and CEO of Ginger. "We have a new design prototype that can be synced with the construction capabilities of our partners to ensure faster hotel opening. Besides, this model will enable optimisation of resources and deliver an appropriate level of profitability." Ginger currently operates 25 leased properties in locations such as Indore, Vapi (Gujarat), Faridabad and Jaipur.
According to Hotelivate's 2018 Indian Hospitality Trends and Opportunities report, "Proponents of this structure (leasing) are of the view that the true 'skin in the game' factor by leasing of hotel assets offers a huge confidence boost to developers in a sector that is sometimes criticised for its uneven risk-reward ratio. The leasing model is essentially an inverted management contract in some ways. The operator/brand takes the P&L risk whereas the owner/landlord is offered returns off the top-line of the asset."
A look at the industry's growth will further explain the scenario. An ICRA report released in December 2018 says that the Indian hospitality sector is expected to grow by 9-10 per cent per year until 2023. The Hotelivate report also points out that the highest growth in revenue per available room has been in the three-star hotel segment, with an increase of 8.2 per cent in 2016/17. Next comes the two-star segment, with a 7 per cent increase.
Moreover, domestic travel is growing at a fast clip - a total of 16,525 lakh visits were clocked in CY2017, the latest year for which data is available. Hence, it is no surprise that brands, especially mid-market operators and budget players, are looking at aggressive expansion in cities, both big and small. The new model looks increasingly attractive as they can take on ready assets and invest in their upkeep and branding.
Kashyap Shah, General Manager, Business Development, at Ahmedabad-based Unique Mercantile India, is optimistic. His company has secured master development rights for the US-based Wyndham's Howard Johnson brand and plans to develop and operate 35 hotels in India over the next 15 years. Howard Johnson currently operates two hotels in Bengaluru and Kolkata but has projects under development all over the country - from Lonavala to Ludhiana and Bhubaneswar to Coorg. And Shah is actively evaluating the leasing model for future projects within the country.
"Most of the hotels in India are owner-owned and owner-operated," he says, adding that these could be missing out on "the opportunity to make a lot more money and a lot more revenue and might be short selling themselves". As more brands move towards the leasing model, Shah sees operators - with their sales offices, consistent brand standards, loyalty programmes and of course, brand recognition - massively benefiting the owners who "are not juicing their profits".
Anshu Sarin, CEO of Berggruen Hotels, which runs the Keys Hotels chain, admits that none of its current properties falls under the 'leased' category, but the model is being evaluated for new assets that the company hopes to bring into the Keys' fold. According to Sarin, "(The) fundamental leasing model has been there for a while; it is not a new concept." However, long-term leases benefit operators as they can avoid "high development risks associated with owning an asset", namely, access to and cost of capital, completion time and permissions required.
Sheikh of Svenska Hotels has a different take. "If (an owner) is happy with other businesses he/she may have and there is just one property that needs to be converted into a yield-producing asset, we would normally recommend a lease and the entire operating risk is transferred from the owner to the operator." Plus, there is another upside, he points out. "As soon as the asset is completed, (the owner) starts getting returns. Normally, during the first year, (the hotel) bleeds, but you are getting minimum guaranteed returns from the very outset."
However, not everyone buys into the concept. Take, for instance, what InterGlobe Hotels is doing. This 60:40 joint venture between Indigo Airlines owner InterGlobe Enterprises and Accor Asia Pacific (part of the French hospitality major Accor) is developing purpose-built hotels under its ibis brand for every market it is entering. The benefit: One has control over everything, from room size to the number of keys and more. Says J.B. Singh, President and CEO of InterGlobe Hotels, "It was a kind of reverse engineering in terms of what the market was looking at and how we could deliver it with the highest level of product, and that brought us back to the drawing board saying: Okay, we need to build our hotels." To date, 17 ibis hotels have been built and at least five more are in the planning or construction stage.
The Bottom Line
In spite of debates and differences, most of the stakeholders agree that a healthy mix of business models is necessary. "For example, Ginger has evolved through various business models. We have a mix of freehold, managed and leased assets," says Rao.
Industry experts also think leasing would become a more accepted growth strategy in the coming years, especially in the budget segment as more operators with bigger risk appetite enter the market. Brands are cautious, though, and say certain factors must be considered before leasing a property. According to Sarin, "The leasing model is business and leisure-agnostic, and in my opinion, leisure is going to be the way forward for the industry. It has immense growth potential and also offers immense scope in terms of experiential products and the ability to re-price yourself."
Shah of Unique Mercantile thinks leasing in established markets like Goa, Mumbai or Bengaluru is not a high-risk proposition. But in each case, the micro-market, or the area around the property, should be studied beforehand. Then, there are other things which act as a trigger, he adds. "The way we pick our properties is based on how a customer thinks and chooses when she is looking for a hotel. And we have to look at different demographics for that."
The writer is a Mumbai-based freelance journalist