Money-Growing: Regions Call for More Hotels

But while in Moscow and St. Petersburg the hotel sector is more or less developed, in other Russian cities, even those with population over 1 million, the shortage of quality hotel rooms is downright disastrous. Although developers realize that given the acute shortage of rooms any hotel project is simply bound to succeed they do not rush to develop the hospitality sector across the country. Projects underway in the province are anything but numerous.

Inhospitable Russia

Speaking at the Luxury Forum held on the sidelines of the Millionaire Fair organized by the Publishing House Independent Media & Sanoma Magazines, Regis Bulot, president of Relais & Chateaux, said that the Russian hotel sector has a great potential. As soon as foreigners learn, for example, that Russia promotes small quality hotels with good cuisine the demand for their services on the part of Western clients will be enormous, Bulot assured the investors. “Today, all Russian provinces are clearly short of quality hotel rooms,” says Heliopark Group CEO Alexander Gusakov. Investors and developers are beginning to view hotels as a promising investment target.

“Today, practically all major financial groups have announced their interest in creation of hotel chains, but they are yet to proceed from words to action,” holds Stanislav Kapinos, general director of the company Russkiye Oteli (Russian Hotels). “Some revise previously announced concepts, many plans undergo changes, some operators give up the idea for good. On the whole, we do not witness any serious progress on the market.”

“Only small local firms or large international chains can be successful in the province,” holds Dmitry Shmelyov, commercial director at ST Group Region. “The former are involved mostly in small projects, e.g. hotels providing some 60 rooms and are ready to put up with a longer payback, deriving stable income from hotel operations. The latter are ready to put up with longer paybacks as in the West a payback on hotel development is long, too, that is why unlike their Russian colleagues, foreign investors normally accept the payback on their investment of at least 8 years.” ST Group Region does not consider any hotel projects, Shmelyov said.

“For the time being the main commercial activity is concentrated in St. Petersburg and Moscow, where new hotels are being built, at least. In most regional cities hotel projects stall at the negotiations stage,” says Marina Smirnova, deputy head of valuation and consulting at Colliers International. The markets of Moscow Region, Krasnodar, Kazan, Yekaterinburg, Kaliningrad, central Russia (Tula and Voronezh) are believed to offer good prospects for hotel development. Colliers International acted as a consultant for quite a few regional projects but only two of those have been finalized so far – a hotel in Voronezh and a large leisure center in Moscow countryside. One more hotel is currently under construction. The majority of projects are still in design stages. Smirnova admits that analysts take little interest in the province and prefer working with Moscow developers. “Market research requires huge efforts and risks of failure are high,” she says.

Kapinos notes that even in Moscow the hotel property market is only being formed. “The supply of hotel rooms in Moscow is far from sufficient, even in the 5-star sector,” he notes. “Although today the authorities, both in Moscow and on the federal level, apply huge efforts to boost the development of the hospitality sector, by selling government-owned hotel properties, initiating new construction on the sites of old Soviet-era hotels Moskva, Intourist, Rossiya, etc, and boosting operations of all kinds of agencies in charge of hotel classification.” The increased attention towards the sector is not a fortuity. The inflow of tourists has dropped considerably since the 1990s. “The number of tourists visiting this country annually is 2 to 3 million,” says Sergei Shpilko, chairman of the Russian Tourism Industry Union. “That is a shame for Russia.”

Among the key reasons why tourists shun Russia are poor transport infrastructure, rundown yet expensive hotel rooms and poor quality of service. Provincial Soviet-built hotels have long grown obsolete, whereas the demand for quality accommodation remains largely unsatisfied. While the sector of first class hotels and smaller individual hotel properties is more or less growing, such accommodation facilities as motels or congress centers are non-existent, Shpilko admits.

Even refurbished hotels operating in Russian provincial cities fail to meet quality standards. “A couple of years ago I went on a business trip to Tambov,” Valery Kazeikin, first vice-president of the International Association of Mortgage Lending Funds, recalls. “I stayed at the hotel Derzhavinskaya. The most striking memory I still have of that hotel is when I tried to take a shower. The water pouring from the tap was boiling. Today I recall the incident with a smile but at the moment I did not feel like laughing. The plumber whom I called in explained that the hotel had purchased expensive water supply equipment but decided to save on temperature regulating devices. Instead, the company hired two local chaps who seating in the basement were supposed to push some buttons manually. But those whiled away the time with a bottle of vodka, oblivious of their duties.”

Government’s Pledges

Governments in most Russian regions publicly announce their interest in bringing investment to the hotel sector. Certain provinces adopt special plans to boost hotel development, or hotel development is included in the general program of regional development. Speaking at the 1st Moscow forum of real estate market leaders hosted by Vedomosti, governor of Kaliningrad Georgy Boos said that his region placed utmost priority on development of the tourism industry.

“We have 250 km of sandy beaches, including Kushskaya spit -- few know that that is where [the celebrated Soviet-era movie] “Beloye Solntse Pustyni” was filmed – and ancient Teutonic castles currently undergoing restoration. By climatic and natural conditions Kaliningrad Region is by no means inferior to international resorts and is superior in terms of historical content.”

Authorities in Kazan also pledge their support for hotel investors. For the time being, says Marat Zagidullov, head of the executive committee of the municipal government of Kazan, the city has 37 hotels providing a total of 3,200 rooms while the number of tourists who visited the capital of Tatarstan this year has already reached 600,000. The mid-October saw the launch of the hotel, shopping and leisure complex Korston Hotel & Mall Kazan featuring a 4-star hotel with a total area of nearly 17,000sqm. Another ambitious project underway in Kazan is Millennium Zilant City. The author of the project – the executive committee headed by Zagidullov urges investors to take part in development of 2.5 million square meters of all sorts of properties, including a yacht club and hotel rooms on the right bank of the Kazanka River. The project to be developed on a 300-ha territory is estimated to be worth 3 billion rubles.

Nikolai Lyubimov, minister for economic development of Kaluga Region, believes in good prospects of agricultural and weekend tourism in his province. “We are ready to help investors, offer them benefits and work towards creation of necessary infrastructure, such as roads, for example,” he said. In 2006, the region applied for a status of a tourist and recreational zone for the areas around Tarusa and urged international investors to join the project Kaluga City Park that will feature sports and leisure facilities and a hotel complex Kosmos.

Authorities in the capital the Urals Federal District plan to open 10 hotels as part of the general plan “Yekaterinburg Hotels”; by 2015 the city will have over 60 new hotel properties.

Unbidden Guests With Cash

Nevertheless, all experts polled by Vedomosti confirm that developers who venture on hotel construction in the province face a great deal of problems. Most builders encounter opposition on the part of local bureaucrats and difficulties arising during reclassification of land for different uses, etc. “Local governments’ attitude toward external investors, including those from Moscow, is complicated,” Smirnova says. “In my practice I have never seen projects successfully implemented by outsiders without support from local firms and individuals.”

Participation of a local partner is a guarantee of success, says Irina Zharova-Wright, board chair at Sesegar Investment Group. “A regional partner is not only versed in local developments; he understands what clients and lenders want,” she says. “He is informed about all details, of which outsiders often have no idea, such as competitive environment and specifics of local commercial and administrative ties. Besides, a local partner has established relations within the region.”

For example, when Sesegar Investment Group moved to launch a project in Novosibirsk that would comprise a 4-star hotel, a business center and underground parking facilities, the company established a partnership with a local company IC&M, which already had a successful project on its track record – construction of the plastic windows production facility Veko. “The developer acted as a general contractor as well, as Novosibirsk has problems with supplies of concrete; it is available only to the well-connected,” Irina Zharova-Wright says. “We negotiated all deals together, as I, a Moscow resident, experienced difficulties in assessing building plots offered for construction while the locals saw all advantages and disadvantages perfectly.”

“Today, by working in any sector of real estate everything depends on availability of administrative resources (i.e. government backing),” Kapinos admits. “That is why it is so hard for international investors to enter the Russian market. The Russian real estate market is a Klondike but it is hard to work there. Investors and developers need to be versed in specifics of decision-making in each given province, the political situation and possible scenarios of its development.”

While several major international hotel operators – Kempinski, Rezidor SAS, Marriott, Accor, Best Western – have already established their presence across the country, they operate here mainly as management companies. For example, in 2005 Rezidor SAS Hospitality signed 29 deals to operate new hotels. By the end of the year 15 properties were launched under Radisson SAS and Park Inn brands. By late 2006 Rezidor SAS plans to increase the number of Park Inn hotels to 100.

Hotel projects in the regions are few. Many cities experience an acute shortage of hotel and office space, Kapinos says. City halls when allotting building plots for development are interested primarily in increasing the stock of hotel rooms whereas investors, on their part, seek to secure a sooner payback on their investment and to this end include offices in the project, he continues. The sides come to terms with each other, as a result of which the city receives a sort of a symbiosis – hotel & office complexes or mixed-use developments, providing a hotel property with a longer payback and facilities that pay back much faster, such as shops, leisure centers, offices, etc. “Businesses need optimal plans of return on their investment, they do not want and must not solve social problems. This is the job for local authorities,” Kapinos insists.

“Seeking to diversify risks developers build multifunctional complexes, which enables them to optimize their financial results,” Smirnova explains. “Comparing returns of hotels and offices shows that proceeds from hotel projects are much higher. But while in office projects operating costs are paid by tenants, leaving property owners with net income practically unburdened by any additional spending, in hotels operating costs account for nearly 50% or even more of the total costs. Taxes, which may be included in the prime cost or not, loan repayment, etc, make up general costs typical of all commercial properties. It is also worth noting that in terms of construction costs hotel projects are more expensive than offices, which are leased without fine finish and decorations and the landlord reimburses to his tenants fit-out costs in the course of several years.”

When Russkiye Oteli (Russian Hotels) presented its concept on the market, the company opted namely for hotel development across the country and planned to create a chain of 3- and 4-star hotels. Later on the developer had to revise those plans and reconsider conclusions of market analysts. All the developments launched by the company from scratch are based on the original concept, which, however, is adjusted to local market situation in each given region. “In Novosibirsk we have designed an office and hotel complex; our projects in Yerevan and Kiev are predominantly office projects, while in Dushanbe we are raising a hotel providing office space and an office center featuring hotel rooms,” Kapinos reports. Thus, Russkiye Oteli still has not established a chain of hotels but succeeded in creating a pool of projects varying in class and quality but built in accordance with a common concept.

According to the company’s reports, today depending on location and the project itself the cost of construction of 1sqm a hotel varies from $1,500 for economy-class and first-class hotels (3- and 4-star properties) in a provincial town to $3,000 and over for a luxury hotel (5-star properties) in the capital and other big cities. The upper limit does not exist, as everything depends on engineering solutions and design. “As to expensive boutique hotels there is no limit for implementation of architectural fantasies. That is why, we usually estimate the cost of an average 4-star hotel in the province at $15 million,” Kapinos says. That amount comprises costs of securing an investment contract, acquisition or long-term lease of a building plot and construction costs. Russkiye Oteli specializes mainly in luxury hotel development. The cost of raising buildings of a 4- and 5-star hotels are comparable, the difference is determined by the interior design and fittings. Rooms in luxury hotels are more expensive, hence, the payback period is shorter. The same may be said about comparison of payback periods for 3- and 4-star hotels.

“The main problem is the choice of the region,” Gusakov says. “It is necessary to carry out an in-depth market research in order to figure out what kind of a hotel the given city needs, who will stay there. That is what the profitability will depend on.” For example, St. Petersburg is short of moderately-priced hotel rooms, according to a survey by Knight Frank. But the majority of new projects underway in the Northern capital are positioned as first class and luxury properties. In the first six months of 2006, Knight Frank reports, no hotels were launched in the city, with the exception of several mini-hotels (approximately 10 such properties providing a total of less than 30 rooms entered the market in 2006).

Not all regions feel the need for five-star hotels, Kapinos says. “If we are targeting business travelers, they do not always need luxury accommodation. More sought-after are 3- and 4-star properties. As to which hotel to build is for investor to decide, who proceeds, first and foremost, from the payback period,” he notes.

Unskilled Staff

The lack of skilled workforce in the hotel sector is the problem that worries most operators. “Raising a box of a hotel building is not enough, it is also necessary to avoid typical mistakes during creation of a hotel,” deputy mayor of Moscow, Iosif Ordzhonikidze, told a hotel industry forum. The official admitted: “Moscow is short of professional hotel staff, hence staff pirating.” The situation is like in other Russian cities is even worse.

“The regions often ignore consultants’ advice and build by eye, which is unacceptable in the case of a hotel,” says Vadim Prasov, vice-president of the Federation of Restaurateurs and Hoteliers. “A hotel is a special property with a variety of nuances, which the developer, who specializes, say, in housing construction, may simply be unaware of. In Russia hotel architects and designers are so few you could count them on the fingers of your hand.”

“Usually developers hire a mixed team of designers: external architects design the project, locals present it to the authorities. Although it sometimes happens that the whole job is done by local architects, depending on the market situation and the client’s wishes,” Smirnova adds.

“We invite architects in whom we are interested to work on our projects,” Kapinos says. “For example, our project in Novosibirsk was designed by Yugoslav architect Miodrag Zviic; the Yerevan project is designed by Russian architect Andrei Savchenko; the project in Dushanbe was created by the U.S. design firm NBBJ. The choice of architects is always made by the company management depending on the concept of the project, its importance and designers’ skills. The company has no prejudice against Russian architects; by selecting a designer we proceed from the search for new partners and our desire to find the best way to realize our ideas.”