Money-Growing: Investors Suffer Fit of Cordiality

Investors of all shapes and hues, ranging from newcomers to the hospitality business to professionals, have enough faith in the tourist appeal of the city on the Neva.

That motley group is made up of Russian raw materials holdings and banks, local construction firms who earlier focused on residential housing projects, the owners of shopping and leisure centers, foreign investment funds and international hotel chains.

Risky Hospitality

Their interest in the hotel business has been sparked partly by the increasingly strong competition in the office and retail sectors and stagnation in housing construction. Besides, compared to other European cities, St. Petersburg suffers from an acute shortage of hotel rooms.

The MKD audit company reports that St. Petersburg has 7.2 rooms per 1,000 residents, while in Milan that figure stands at 35. “Even in Prague and Budapest that figure exceeds 10 rooms per person, therefore there is a certain growth potential here,” says Yuri Voropayev, general director at MKD.

But investors do not have many reasons to rejoice. Occupancy rates at St. Petersburg hotels are still strongly influenced by seasonal factors.

In January, it does not exceed 35-45%, and as a result the annual average for all city hotels stood at 59% in 2004. And while top class hotels (4- and 5-star hotels) reported an average occupancy rate of 68%, for medium class facilities (3-star) it stood at 56%, and only at 53% for economy hotels (1- and 2-star).

The results for 2005 have still to be summed up. But there are grounds to believe that the average hotel occupancy rates will prove to be even lower for this year. The inflow of tourists over the first three quarters of 2005 was 18% lower than in the same period of 2004; in previous years the number of tourists grew steadily. St. Petersburg remains one of the most expensive cities in the world with soaring hotel rates scaring off Russian and foreign travelers alike.

Officials at the city government’s committee on foreign ties and tourism (KVS) are convinced that the main reason for the lower number of visitors is the high cost of travel packages, especially during the high season that runs from April through September. A trip to the Russian Venice costs foreigners nearly twice as much as a trip to any other major European city.

The Northwest branch of the Russian Tourism Industry Union reports that in the summer of 2005, St. Petersburg hotel rates grew by 30% on average. As a result, the number of guests dropped, KVS officials state. Medium class hotels patronized in particular by foreign tourists suffered the heaviest losses. While the demand for top class hotels dropped 8-9%, demand for medium class hotels fell as much as 20%.

The city government pins great hopes on the program to develop the tourism industry in St. Petersburg for the period 2005–2010, adopted in October of this year.

The program is based on recommendations by the international company Boston Consulting Group (BCG) at the request of the Ministry for Economic Development and Trade of Russia.

The thrust of the plan is reflected in the laconic formula “5x5x5”: in five years St. Petersburg is to become one of the five most visited tourism destinations in Europe, receiving 5 million guests annually. In the years 2003-2004 that figure stood at about 3 million.

Tourism has been declared a strategically important industry. The city plans to spend approximately 1 billion rubles on the implementation of the plan. The money will be poured into the development of transport links, first and foremost, at the airport, simplification of visa procedures, modernization of museums, tourism safety and information support.

Increasing the number of hotels and regulating pricing policies remains a priority task. The authors of the plan, obviously being kindly disposed towards round figures, consider it necessary to increase the city’s supply of hotel rooms by not less than 10,000.

The City Marketing Agency established especially for the purpose has been tasked with shaping St. Petersburg’s image and promoting it on the market. The agency will also act as a coordinator of the measures envisaged in the program.

BCG has proposed the development of two branded slogans for St. Petersburg: Pushkin's "The Genius of Pure Beauty"; the other would suggest an ambiance of "visitor-friendly warmth" to melt away any mental links with the cold in Russia. Considering the state of the city facades and streets today and the general gloom of the city foreign visitors will appreciate the humor of the consultants.

Some experts are skeptical about the program proposed by BCG. But the city government on the whole has welcomed the plan. Governor Valentina Matviyenko said that the necessary spending has already been included in the 2006 city budget and the government should proceed with its implementation forthwith.

Within the next five years Smolny (the city government) hopes to earn some 130 billion rubles from tourism. Today, tourism revenues stand at only 5 billion rubles per year.

“St. Petersburg’s tourism potential is obvious. For the time being, tourism accounts for only 10-12% of the city budget revenues. In comparison, tourism revenues make up 60-70% of the city budget in Paris, Rome, Venice or London,” says Igor Gorsky, head of Becar. Commercial Property. “But for the tourism industry to grow it is necessary to improve the city infrastructure and build an effective hotel industry.

“Today, St. Petersburg uses little more than five percent of its tourism potential, being unable to offer quality services to more than 1.5 million tourists per year. Tourists shun our city due to the lack of hotel rooms, while their shortage results in hotels pushing up rates while the quality of services remains low. And all that undermines the image of the city and scares tourists away, what few of them there are.”

Investors Get Moving

Hotel investment until recently was quite sluggish. The only sector of the hospitality business that has been growing rapidly over the past few years is that of mini-hotels. Today, St. Petersburg has over 400 mini-hotels although no precise statistics are available. Many of those properties are former apartment blocks redeveloped for hotel use.

“The requirements set for small hotels by controlling bodies, such as sanitary, fire safety inspectors and others, are often impossible to meet, which is why it is better for them to keep the status of furnished apartments,” explains Alexei Musakin, general director of Pervaya Kompaniya (First Company) that runs Shelfort Hotel and head of the Center for Small Hotel Development consultancy.

According to Musakin’s calculations, 53% of all accommodation facilities operating on the market have a capacity of 11 to 20 rooms. While the optimal size of such a hotel is 25 to 35 rooms, he says.

Businessmen account for 40% of the guests at mini-hotels, with individual tourists making up another 30%. Those travelers appreciate home comforts and an individual approach, while putting up with no restaurant or fitness center and similar features.

The sector still has healthy prospects although hundreds of mini-hotels may close down within the next few years failing to survive the competition, says Alexei Musakin. The average payback period for the projects is 5 to 6 years. A 20-room 800-square-meter hotel would cost from $1.2 to $2 million. The investor can count on an annual turnover of $380,000 to $500,000. The most sought-after facilities are economy-class rooms at a rate of $40 to $70 per day.

Smolny had pledged to build the city up with hotels in time for the widely publicized tercentennial anniversary of St. Petersburg in 2003. But the expected construction boom never materialized. Not a single large hotel was opened and only a handful of projects out of more than the hundred that were announced were implemented before the festivities.

Nevertheless, the anniversary celebrations served as a catalyst for investment activity. However, the investors had miscalculated their financial potential, failed to take into account all the bureaucratic hurdles they had to negotiate when securing the necessary permission and approval for construction work, and other specifics of the local investment climate. As a result they failed to meet the deadline that coincided with the national holiday.

Most of the hotels that opened in 2005 were actually supposed to open on the eve of the city’s 300th anniversary.

The Magnificent Four

This year saw the opening of four rather large hotels, each claiming the status of a 4-star hotel (or even 4+).

The first-ever hotel to be launched in the city by Accor Group opened in summer near Nevsky Prospekt. The 233-room Novotel St. Petersburg Center occupies two elegant nine-storied towers, built in ancient Roman style and linked with a glazed passage. The ventilated facades are fitted with tainted glass, mirrors, natural granite and 12 types of marble.

The hotel belongs to the Moscow-based West Bridge Hotel. The company’s executives would not elaborate on the founders of the company saying only that it was set up by a “group of individual investors”.

Konstantin Storozhev, board chairman at West Bridge Hotel, says the company is involved in commercial property investment, focusing chiefly on offices and hotels. In Moscow it has already implemented a number of projects, including a class A business center on Leningradsky Prospekt.

Investment in the development of Novotel has already exceeded $30 million, says Storozhev. “We have splashed out on certain extravagances that are not included in Accor’s basic standards, but we do not regret it,” he explains. The projected payback period is eight years. Accor did not take part in financing the project. The landlord has entered into a standard 20-year management agreement with the chain.

According to preliminary calculations the average occupancy rate at Novotel will stand at 60-70%. Double rooms will be available from the rate of $170 per night.

A project by the St. Petersburg Real Estate Agency, or PAN, was commissioned almost simultaneously with Novotel. The new hotel opened at 22 Moika Embankment.

The history of the project began as far back as 1995. At first, the city government contracted the French company Peters Construct to redevelop the historic building. Later, the company was replaced by a local investor. The 197-room hotel is run by another international hotel operator, Kempinski.

Ambassador – the first-ever hotel in the city with a helipad – opened at 5-7 Rimsky-Korsakov Prospekt this fall (though its owners have yet to secure a permission for helicopter flights).

Smolny decreed on the building of a hotel on that site back in 1998. The work progressed to a familiar scenario that has long become a tradition on the local market, with failures to honor obligations resulting in a change of investor. The owner of the hotel is also a Russian company, St. Petersburg Hotels, founded by the Baltic Investment Corporation that was set by a group of individuals who refuse to disclose their identities.

The 9-storied hotel facility measures 19,360sqm and has 255 rooms. The interior and decorations are intentionally luxurious, with marble, stucco details and Swarovski Crystal Chandeliers. The cost of construction amounted to approximately $30 million. Alexander Melnik, chief financial officer at St. Petersburg Hotels, says shareholders’ funds were only used to finance the start-up.

The project was implemented at the expense of bank loans, the largest extended by the Northwest Bank of Sberbank of Russia to the tune of $12 million for a period of five years at an interest rate of 11.5%. The investor expects the project to pay back in eight years, provided the average annual occupancy rate reaches 55-60%.

An economy class room at Ambassador costs $200 to $290 per night depending on the time of year (breakfast and VAT excluded). The owners promise to introduce flexible rates, but their claim that Ambassador will put an end to overpricing in the hotel sector raised many eyebrows.

The St. Petersburg Hotel company is set to run Ambassador on its own. “Modern marketing techniques make it possible to attract guests without having to join a chain. External operators claim 12% of the proceeds on average, without offering any guarantees of success,” Alexander Melnik explains.

The four-star Petro Palace Hotel opened this fall at 14 Malaya Morskaya Street. The facility belongs to the owner of the St. Petersburg-based Season (Sezon) retail chain that includes a hypermarket and a string of supermarkets in commuter areas of the city.

The title to the historic building situated close to Isaakiyevskaya Square was secured on the secondary market. The cost of redevelopment, which took two years, is being kept confidential. The 8-storied building has 193 hotel rooms. The hotel’s interior is designed in the 19th century merchant style: there is a stuffed bear in the restaurant and the guests are greeted by black doormen.

Vadim Lyubich, director of the hotel, admits that for the owner the project is more a matter of prestige and not aimed solely at making a profit. Nonetheless, the payback is expected in 7 to 8 years with a projected occupancy rate of 60-65%. The owner takes an active part in the running of the facility and does not intend to hire external managers.

Earlier, the company launched a motel in Koltushi. A second motel is currently under construction in Yanino, near the outer ring road. Petro Palace Hotel is the first project of its scale implemented by the company. However, all of the above-mentioned prime hotels are the first projects on such a scale for their owners.

Pervasive Idea

These days, St. Petersburg’s hotel sector attracts all sorts of businesses. Among them are construction firms specializing chiefly in residential development. For example, in late 2003 the Elis Corporation launched Dostoyevsky Hotel, as part of the retail and hotel complex Vladimirsky Passazh at 19 Vladimirsky Prospekt.

In the year 2004, the St. Petersburg Real Estate corporation opened the 3-star 140-room Andersen Hotel on Chaplygin Street (Petrogradskaya Storona district), on the premises of the redeveloped Druzhba hotel.

The group purchased the title to the derelict facility from the Lukoil-Garant pension fund; the size of the deal is a secret. Total investment is put at $9 million; payback is expected in five years. The Western firm Antrani worked on the design of the new hotel and the general contract was awarded to an affiliate company of the corporation.

The average occupancy at Andersen Hotel stands at 68%; the average room rate is 2,230 rubles per day. The owner does not plan to hire external operators, believing that the hotel is successful enough as it is. “This is our first hotel project,” says Maxim Shubarev, head of St. Petersburg Real Estate.

“We sought to build a quality medium-class hotel of the economy type which was simple though not something reminiscent of Soviet-era mass production. There is almost no such experience in this field in Russia; that is why we did everything on our own. We plan to launch several other hotel projects in St. Petersburg and Kaliningrad where new facilities will be developed from scratch. We are set to continue working in the same economy-class segment.”

There are other, even more impressive examples. The Baltic Construction Company (BSK) is the owner of the 5-star Renaissance St. Petersburg Baltic Hotel on Pochtamtskaya Street, opened in the spring of 2004 and managed by Marriott International, Inc.

These days, BSK is developing the Admiral hotel (3-4-stars) on Vassilievsky Island, at the corner of Maly Prospekt and Admiral Makarov Embankment.

The IVI-93 company, too, is pursuing a hotel program. LSR Group has bought the rights to the 5-star hotel development on Zoologischesky Lane from Veda Group.

The LenSpetsSMU holding plans a 3-star hotel as part of the prime residential estate At Rostral Columns on Vassilievsky Island. Today, however, the 330-room 18,000-square-meter development, which is nearly finished, has been put up for sale at approximately $1,500 per square meter.

Another newcomer to the hotel business is Adamant Group, St. Petersburg’s leading retail and leisure facilities operator. JSC Investment Center, Adamant’s affiliate, has secured a nearly 70% stake in Moskva, one of the city’s largest 3-star hotels.

Raw materials holdings are also actively investing their free cash in the hospitality business. Hotel Business City, which is a part of Metalloinvest-Market Group, has purchased municipally-owned stakes in the economy-class hotels Yuzhnaya and Tourist.

The company is set to launch two more hotel projects in the city center, at 5 Vladimirsky Prospekt and 4/30 Prof. Ivashentsev Street.

Lukoil-Garant has taken over the hotel Chaika.

ALROSA Hotels plans to open the 4-star Petropol Hotel on Bolshoi Prospekt in Petrogradskaya Storona.

Banks are showing interest in the sector, too. For example, Eurofinance-Mosnarbank took part in the acquisition of the unfinished hotel development of the 5-star Northern Crown on Karpovka Embankment. The bank is also set to invest in the development of medium-class hotels.

Professional hotel investors, too, have been active on the local hotel market. The Maltese International Hotel Investmens Pls (IHI) – owner of Corinthia Nevsky Palace – has launched a project to overhaul the hotel and expand it at the expense of neighboring buildings at 55 and 59 Nevsky Prospekt. The projected cost is put at 60 million euros.

Norway’s Wenaas recently purchased the 4-star Radisson SAS at the corner of Nevsky and Vladimirsky Avenues and joined a project to develop a hotel at 91a Nevsky.

Indonesian company Sampoerna is set to finance the completion of one of the city’s most famous protracted developments – the 5-star hotel on Ostrovsky Square.

Accor is thinking about joining around a dozen projects as a co-investor. For the time being, the chain is taking part in the 3-star IBIS hotel project under construction at 54-56 Ligovsky Prospekt by GVA Sawyer.

The White Days Development company was registered in St. Petersburg in November. White Days Development was set up by the recently established investment fund White Day Invest, launched by a group of U.S. and European firms with a view to expanding their operations in Russia.

The fund has already announced its plans to develop two hotels in St. Petersburg – a 65-room ‘boutique hotel’ on Gangutskaya Street and a 3-star 250-room facility in Kovensky Lane.

A project worthy of attention is the Talion company’s plan to expand Yeliseyev Palace Hotel on the corner of Nevsky and Moika Embankment to 100 rooms. Talion is raising the funds through bond loans and an IPO.

The city government has issued licenses for 100 hotel development projects, the city investment and strategic projects committee reports. It is hard to say how many of those will be completed successfully.

The optimistic forecasts of the development of the city hotel sector have failed to come true. Whether the numerous investors launching their projects these days will succeed in changing the state of affairs in St. Petersburg will become clear in a couple of years.

“The city is still short of hotels during high season. The current average annual occupancy rate is insufficient for the hotel business to reach high cost-efficiency. If St. Petersburg develops congress tourism and the occupancy rate reaches 70%, the return on hotel investment will exceed the current 10-12% and will become acceptable. For the time being, hotels are viewed as an investment target mostly by those who can afford long-term projects,” says Alexander Olkhovsky, a commercial property investment specialist.