Money-Growing: Hotels Poised to Risk

On July 24, 2006 Merrill Lynch Capital Markets Bank and Germany’s Aareal Bank signed the ?160 million (US$205 million) re-financing of The Ritz-Carlton Hotel in Moscow. The new credit facility for the five-star hotel is the biggest re-financing transaction in Moscow’s hospitality and commercial real estate history. Jones Lang LaSalle Hotels and Jones Lang LaSalle Capital Markets advised Capital Partners, an international private equity group which developed the project.

“The re-financing of Ritz-Carlton is the largest refinancing deal the Moscow hospitality market has ever seen, as well as the largest deal involving Western re-financing for the commercial property market of Moscow on the whole,” James Corrigan, Associate Director, Capital Markets and Corporate Finance Russia & CIS at Jones Lang LaSalle said. “At the same time, the deal is the debut for Merrill Lynch Real Estate Lending, that has helped Merrill Lynch enter the Russia market with lowest possible risk.”

The Ritz Carlton hotel is due to be completed in the fourth quarter of 2006, replacing the Intourist Hotel, a legacy from the Soviet era, and is situated 200 meters from the Kremlin and close to Red Square. The luxury hotel will comprise 334 rooms, including 23 suites, and will feature the largest rooms in Moscow, ranging from 42sqm to 237sqm. There will also be a 650-square-meter ballroom, conference facilities, and a health club with spa, a rooftop bar and shops. Corrigan believes that the deal has had no impact on the progress of construction. “However, the re-financing has given the developers access to attractive borrowed funds,” he says.

“The investment boom in hospitality is triggered solely by high returns on hotels,” holds Damir Kaftaranov, chief executive at the City Hotel (Siti Otel) company. In the first half-year of 2006 Moscow’s 5-star hotels reported higher returns than elsewhere in Europe, although hotel projects began much later than offices or retail properties. Today, the average annual occupancy rate at first-class hotels nears the maximum figures of European hotels, of 60 to 70%”

Moscow and Istanbul: Leaving Europe Behind

“The hotel market in Moscow experienced another record year in 2005,” HVS International said in the company’s annual European Hotel Evaluation Index. According to HVI, the hotel market recorded an enormous 35% increase in average room rate in 2005, resulting in an unprecedented 30% increase in RevPar (revenue per available room).

The HVI is a hotel valuation benchmark developed by HVS. It monitors annual percentage changes in the values of hotels in 28 major European markets. The HVI 2006 shows that hotel values (expressed in euro) achieved a second consecutive year of growth. The year 2005 may be regarded as a turning-point, as Istanbul was a star performer, bringing to an end Moscow’s four-year run of being the market that recorded the highest annual growth in values in the survey. After recording an increase in values in 2004 of almost 17%, Istanbul saw a dramatic improvement in trading performance in 2005: hotel values increased by 32%. This increase was driven largely by both occupancy (up by 10 percentage points) and average rate (up by almost 25%); this led to an increase in RevPar of 44%.

The HotelBenchmark Survey by Deloitte says: “The best performing region was the East Mediterranean, where RevPar grew a staggering 29.4% fuelled by the substantial increase in visitor numbers to Israel and Turkey… In Turkey tourist arrivals increased by 20%. Turkey's capital, Istanbul hosted the Formula 1 Racing Championship for the first time in August 2005, which attracted a large amount of visitors.”

According to HVS International, Instanbul also experienced significant growth in the meetings, incentives, conferences and exhibitions (MICE) segment; the number of delegates attending conferences grew by 156% in 2005 compared to 2004. With two exhibition and meeting centers under development in addition to the existing three and EU accession negotiations now officially open there is a reason to believe that further growth in the MICE can be expected.

Just like Moscow, Istanbul plans to launch as many top class hotels as possible. The largest projects are a 300-room hotel in a 50-storied skyscraper to be named “Diamonds in Istanbul” and a complex of two towers – the Dubai Towers – Istanbul. Both developments are to become prominent features on the skyline by 2008. The Dubai Tower – a mixed-use project, which will cost more than 420 million euros – will incorporate a luxury hotel.

Chasing Higher Revenues

Southern Europe was the weakest performing region during 2005 with no RevPar growth. Its performance was dragged down by the significant RevPar declines in both Lisbon and Athens, according to HotelBenchmark Survey. Both cities hosted major sporting events in 2004 – the Summer Olympics and European Football Championship – and naturally could not sustain this performance during 2005. A number of Spanish cities are suffering from over-supply and as a result the country only reported very modest RevPar growth of 1.3%.

Julia Felton, Executive Director of HotelBenchmark(TM) commented: “Prospects for 2006 for the hotel industry across Europe look sound. As Gross Domestic Product expectations remain modest, RevPar growth will be steady rather than substantial. East Mediterranean and Central and Eastern Europe are likely to continue achieving higher growth than other European regions, with business demand as well as tourist arrivals growing. However, hotel performance in Italy and Germany is expected to improve as they benefit from hosting major sporting events - the Winter Olympics and the Football World Cup.”

Hotels in Central and Eastern Europe can also be proud of their performance, as RevPar increased 12.5%. This growth was stimulated by Moscow's exceptional performance where RevPar increased 30.4%. With the continued lack of internationally branded hotels and increasing demand, there seems to be no end in sight in the growth of average room rates in the city. Moscow has 35,000 hotel rooms, of which only 8,000, or 22.9% meet international standards. With a large number of 3-star hotels having been closed, room rates skyrocketed by 35% in 2005, resulting in a 30% increase in RevPar.

European Cities: Hospitable and Not Very

Hotel markets vary considerably across Europe. London has retained its position as the most expensive city, with the average value per room of 516.12 euros (a 7.2$ increase from 2004). London is followed by Paris, with 484.52 euros per room (6.2% increase from 2004), Milan (415.82 euros) and Z?rich (375.99 euros). The lowest room rates are in Warsaw (104.5 euros), Lissabon (121.2 euros) and Athens (132.1 euros).

Hotel values in London grew by 7.2% in 2005. After celebrating victory in the race to host the 2012 Olympic Games, the city was subjected to terrorist attacks on Jul. 7. The initial fear was that these attacks would have a major impact on the overall hotel performance in London. However year-end figures indicate that the effect of the attacks has been limited; occupancy has fallen by 1.4% but average rate has risen by 4%. This left RevPar to rise by just under 2%, to 160 euros.

The resilience of the London hotel industry has been driven by improving economic conditions and an increase in visitor numbers, despite the attacks; figures from Visit London for the year to November 2005 indicate an overall increase in visitor numbers of 10%. Hotel room rates in London could have been even higher but due to the lack of suitable sites in the city center, additions to the supply in the 4-star and 5-star markets have been limited in recent years; however, some significant developments are now under way as new operators enter the market.

For example, Spanish operator Silken Hoteles is currently planning a luxury 170-room hotel behind the fa?ade of Marconi House on the Aldwych in central London. Yotel will be pioneering its radical, new hotel concept; the first Yotels will be operating inside the terminal buildings at Heathrow and Gatwick in late 2006 and in central London in 2007. Hong Kong based Shangri-La Hotels & Resorts recently announced its entrance into the London market in 2009 when the group plans to open a luxury hotel in London Bridge Tower, which is expected to become one of the city’s leading visual landmarks.

Hotel values in Paris increased by 6.6%, an increase that was driven largely by an increase in occupancy of nearly 4% and a relatively stable average daily rate. In 2005 a number of new hotels opened in Paris. Among these were three boutique hotels: the 29-room Villa Malraux, the 17-room Hotel du Petit Moulin and the 27-room Hotel Le Sezz, which is located on the Left Bank on Avenue Fremiet.

A 115-room Express by Holiday Inn was opened in the vicinity of Roissy Charles de Gaulle airport and two Radisson SAS hotels opened: the 170-room Radisson SAS Hotel Boulougne and the 139-room Radisson SAS Val d’Europe at Golf Disneyland.

Shangri-La Asia, the parent company of Shangri-La Hotels and Resorts, has acquired the former home of Prince Roland Bonaparte and has plans to convert it into the 140-room Shangri-La Hotel Paris in late 2008. This hotel will mark the group’s European debut and will be the first luxury hotel in Paris to be fully owned and operated by an Asian hotel group. On the investment side, Paris and the rest of France experienced a truly buoyant year. Among the notable single asset transactions was the 97-room Plaza Vendome in Paris, which was acquired by Marriott for 38 million euros. The hotel is to be rebranded as the Renaissance Paris Vendome. The 438-room InterContinental Paris was sold to GIC Real Estate for 315 million euros and is now managed by Starwood Hotels & Resorts under the Westin brand.

The Moscow hotel market has seen few transactions so far. “Today, we witness a hotel development boom but so far there has been but a handful of acquisitions,” says James Corrigan. “Perhaps, market operators are waiting for a more favorable timing and hold back their assets.” Another obstacle is the lack of vacant building sites in the city center.

“Given the lack of opportunities for new construction, operators invest in operating hotels or redevelopment projects. Recently, the city hall announced the sale of a 69% stake in Baltschug Hotel, with a starting price set at $108 million. Many believe the price to be too high, but Hotel Ukraine was sold for $270 million, while the starting price had been $165 million,” says Damir Kaftaranov of City Hotel. “Revenues are high and investors are ready to pay even for overrated assets.”

Moscow seeks to prove its hospitality and new luxury hotels are opening across the city. In addition to the above-mentioned Ritz-Carlton, in the near future the city will see arrival of several top class properties. A 220-room Novotel, expected to open in late 2007, will be located inside the Gostiny Dvor exhibition and retail complex. Four Seasons has secured a management agreement to operate a property to be raised on the site of the former Moskva Hotel. It is envisaged that the hotel will feature 210 rooms and luxury residential apartments. The hotel is expected to open in 2009. A 360-room Grand Hyatt Hotel will open in 2009 at the Moscow City Business Center (Moskva City) in 2009.

Investment Strategies

To succeed an investor needs a gift of foresight. Successful investors who have amassed multibillion fortunes claim that the key to success is correct timing of entering the market, instead of frantic acquisition of companies, which have already generated a hullabaloo on the market. Thus, one should invest in promising segments of the market and companies with good prospects.

The hotel industry attracts investments from well-known billionaires, fashion designers and even movie stars. Donald Trump, who has established an industry of financial success strategy training, is currently financing development of several luxury hotels, including a 90-storied skyscraper on Chicago River, Trump International Hotel & Tower Chicago, and a 50-storied luxury condo hotel on Las Vegas Strip.

Casino investments are practically always risk-free. Monte Carlo Bay Hotel & Resort in Monaco was nominated for MIPIM 2006 award in the hotel & resort category. The property represents a Mediterranean palace combining elements of neoclassical architecture and traditional Italian mansions. Special features are a computer-operated fountain, hanging gardens, a 1,716-square-meter swimming pool and a casino.

Non-traditional hotel concepts such as remotely located hunter’s lodge hotels or redeveloped historic properties also bring good returns. Such hotels are popular with adventurers seeking solitude and connoisseurs of arts respectively. Another promising concept is gulf resorts. Golf resort hotels’ performance does not depend on the time of the year and visitor numbers stay high all year round.

All those key factors are just as important in Russia where the situation for hotel property investors is now favorable, which results in growth, brought about by bank loans becoming more affordable and competition growing worldwide. While only a few years ago few Russian banks agreed to finance acquisition of commercial properties, today financial institutions have developed their set of preferences.

“Among the banks interested in hotel investment I would name our main partner – Moskommertsbank (Moscow Commercial Bank),” notes Alexander Gusakov, president at Heliopark Group. “The bank has opened two credit lines for our company – for investment projects, secured by real estate (assets), and for development of the chain on security of operating properties. Today, the total amount of cash we operate stands at $31.5 million plus own funds and funds of private investors, i.e. development companies and Russian investment funds.”

Famous investors also warn against being confined to a single market. Successful Russian hotel operators focus their attention on properties both in and outside the country.

Heliopark Hotels & Resorts has taken its first step outside Russia by acquiring what is said to be the oldest hotel in Baden-Baden, the spa town in southwestern Germany. The Bad Hotel zum Hirsch, which was once part of the Steigenberger chain, will be refurbished and reopened next summer as a 71-room, four-star hotel. Heliopark is expected to invest a total of a reported $10 million in the acquisition (the seller was the German real estate fund Adolf Scherer) and the refurbishment. The 1688 building has a unique feature – each room has thermal waters. “After the property is refurbished which we hope will take place by June 2007, we will have a 4+ star hotel providing 71 to 74 rooms with spa facilities,” says Alexander Gusakov. “Dresdner Bank has agreed to cover 70% of refurbishment costs, at the interest rate of 5.5%.”

Brand Investment

This year Russia’s hotel industry has seen the long-awaited arrival of the Best Western chain. The City Hotel company won the right to operate the brand in Russia. “Seven companies took part in the international tender. The tender was closed and names of bidders were kept confidential,” Damir Kaftaranov says. “Both domestic and foreign firms took part in the tender. We had submitted a detailed plan for development of Best Western hotels in Russia. Our vision of business, the company’s growth potential and our plan for hospitality industry development were approved by Best Western as most convincing. By the time the tender was held we had already secured several building sites, on some of which construction works had already begun.”

“A franchise agreement envisages accurate observance of equipment and services standards. We assume an obligation to observe standards adopted by Best Western,” says Kaftaranov. “This pertains to the size of common areas, equipment of hotel rooms and bathrooms, interiors and engineering systems. On the one hand, those are restrictions, on the other, that is the tested know-how successfully applied worldwide. However, our decisions concerning further development of the company or plans to open a new hotel are taken independently from Best Western.”

While some companies secure franchises others sell them. “In long-term Heliopark Group seeks to occupy the largest possible share of the market,” Alexander Gusakov says. “We want to grow and create our product. We have developed our strategy and tactics. For example, we would like to run properties of other companies, to sell the franchise. For example, we have cancelled our tenancy deal with Primorskaya Hotel in Sochi, which we had operated for two years, by selling the franchise to the owner.”