In-Depth: Until Third Star Rises

Investors opt for office complexes and shopping malls as letting those properties guaranties less burdensome, stable and predictable income. Hotel projects today constitute one of the most popular and important sectors of real estate. But while the segment of luxury and first class properties witnesses active developments (cancellation of the results of a tender to reconstruct Rossiya Hotel or the launch of Ritz Carlton’s first project in Moscow), the 3-star hotel sector is growing slowly, as investors show little interest in moderately-priced accommodation.

A hotel is the most complicated and slow-payback product of all commercial properties. Construction of a hotel requires huge spending in early stages of the project, is fraught with risks related to long money and long payback periods, as compared to other commercial projects. Construction of offices or shops is a more stable and predictable business. On the other hand, a hotel built and operated correctly yields incredibly good returns. Given low competition in the sector almost all professional hotel projects prove successful.

The upper price segment is the most highly developed. In Moscow practically all premium hotel chains have already established their presence – Marriott, Hyatt, Swissotel and Kempinski; the city’s first Ritz Carlton hotel is due to open soon. The latest arrivals are Hilton and Four Seasons; those chains are yet to launch their projects here. Hilton plans to run the former Leningradskaya Hotel; Four Season is expected to operate a property on Sofiiskaya Naberezhnaya [Embankment].

But while premium, luxury and first hotels already have secured a foothold here, 3-star hotels are only beginning to appear. The only major player active in that segment today is Holiday Inn that runs four properties in Moscow. The latest project by Holiday Inn, Sokolniki, opened in September of this year. The development located not far from Moscow’s three main train stations had remained uncompleted for many years.

Investors are reluctant to undertake three-star hotel projects because of high costs and lengthy paybacks. For comparison: a luxury or a first class hotel pays back in six years on average, while a payback on a 3-star hotel project is 8 years. Although, the cost of construction is almost the same as the case is with more expensive properties.

The key difference between upper class and moderately price hotels is the area of rooms – five-star hotels provide larger rooms and public use zones – and the cost of internal fit-out, room equipment, interior and furniture. The difference in the total cost of construction is insignificant. But prime hotels pay back sooner due to high room prices and developed amenities.

The key factor that appeals to few investors about moderately priced hotels is that there is virtually no competition in the sector. Across the globe three-star hotels form the most numerous group of properties, accounting for 60% of the entire supply. Obviously, as soon as the upper class segment is saturated, investors – domestic and international alike – will focus on medium price segment. For the time being, three-star hotels may bring quite high returns. The demand for three-star hotel rooms is generated chiefly by business travelers and middle-income tourists. Those groups of consumers are widely present in Moscow but due to scarce supply they are forced to look for accommodation in mini-hotels, rent private apartments or rooms in more expensive hotels.

In line with the formal plan adopted by the Moscow city hall, before 2010 the city’s hotel stock is to increase by 240 properties, mostly three-star hotels. According to the estimates of the mayor’s office, the total number of hotel rooms is to reach 200,000.

The year 2006 saw the launch of two medium-priced hotels by Holiday Inn – Holiday Inn Sushchyovsky (opened in February) and Holiday Inn Sokolniki (Sept.) plus several smaller projects.

As far as I am informed, the government has already distributed twenty building plots as part of its program to promote the hotel industry in the city. Investors, however, have shown little enthusiasm about many of those offers, as while location is of fundamental importance for a hotel project, undertaking a hotel construction on a site within a former industrial zone, for example, means the developer will have to brace for serious problems and a slow payback. But then, in October of this year a new 3-star hotel was launched in Kapotnya. The property is relatively small, so it had not required huge investment in early stages given its remote location at a distance from the city center.

The price of land must make up 10 to 30% of the total cost of the project, depending on its star category. In Moscow that figure is considerably higher. Besides, the city is running out of vacant building plots, suitable for hotel development, and quite often plots that are available are heavily encumbered.

Programs to support the hospitality industry have been adopted by the city hall many times. At first, their implementation was planned till 2005; later the program was extended till 2010. Unfortunately, many measures announced in those programs are of purely declarative nature.

For example, this last summer the government promised a 50% discount on plots designated for hotel development but at any rate Moscow has seen practically no acquisition of hotel building sites. Usually, those sites are let to developers. Or, take the city hall’s announcement to reduce the rate of lease to 1% of the cadastre value of land – a progressive move, of course, but in absolute figures this would not represent a major reduction in the cost of a project.

The most significant initiative of the mayor’s office is to partially reimburse interest payments. Nowadays banks are reluctant to finance hotel projects due to lengthy payback periods. The compensation for part of interest payments is supposed to facilitate the procedure of raising bank loans.

The government could offer strong support to investors by lifting encumbrances pending construction and providing them with access to the city engineering infrastructure, and also by allocating more attractive sites for construction and facilitating access to tenders for leaseholds on plots for 3-star hotel construction.

As early as when registering a title to a plot, the developer begins working on the concept of the future property. Mixed-use projects are becoming increasingly popular. Those are multifunctional complexes comprising hotel rooms, offices, shops and entertainment facilities. The composition and size of functional zones is defined proceeding from specifics of the plot, its location and infrastructure. Such projects are more successful than hotels proper as office and retail investments are more predictable.

Office centers rank first in terms of payback followed by shops, while hotels rank third. But rents at office centers and shopping malls are set for a long period of time while the cost of rooms may be revised by hotel operators quite freely at own discretion.

Thus, mixed-use projects reduce risks and bring maximum profits at different stages. At this, the investor may retain title to the entire complex and run several businesses at a time, or he may sell part of properties as early as during construction and in doing so get a return on his investment.

Besides, mixed-use developments offer an additional synergic effect as returns grow at the expense of human flows generated by other commercial properties. For example office tenants become clients of retail zones, shop employees and office tenants visit restaurants operating in the complex and rent hotel conference facilities.

Our company is currently working on fourteen sites in Moscow where we plan mixed-use complexes providing hotel and office space. Several projects also feature retail space. Offices and shopping centers do not belong to our core assets and we plan to put them on sale afterwards in order to secure a sooner payback on our hotels. We also have plans to develop multifunctional complexes in St. Petersburg and Cherepovets.

The work on the concept of the future hotel begins as soon as the process of registration of the developer’s title to the building plot is launched. The investor determines the class of the future hotel, the number and size of rooms, their cost and area, the area of additional amenities, conference rooms and reception halls, shops and leisure facilities, fitness and spa centers, lobbies, relaxation rooms and other services.

The size of spaces and internal organization of the hotel depends on specifics of its neighborhood, the planned star category, size and shape of the building spot. As early as at the stage of the development of the concept the developer selects a hotel operator. Where an international hotel operator is invited to run the property the concept and design of the project is prepared on the basis of standards set by that particular operator worldwide. Those requirements usually cover the size of rooms, equipment (covering even size of beds and number of hangers), the size and equipment of restaurants, area of entrance zones, corridor width, ceiling height, engineering communications, etc.

In terms of internal zoning the hotel constitutes a highly complicated architectural project in commercial real estate. The base element of design – the size of a standard hotel rooms – is determined by requirements set by the operator and the star category of the future property. Window and bay spacing depends on width and depth of rooms. At first the exterior of the building is designed. The number of floors and architectural style of facades depend on location and town-planning restrictions. The project needs to be approved by the municipal committee for architecture and construction.

In October alone two major projects were sent for reworking in Moscow – a project of a mixed-use complex on the site of Rossiya Hotel designed by prominent British architect Sir Norman Foster, and a project to build a 5-star hotel on Pushkin Square (former editorial office of Moskovskiye Novosti).

Facades and the architectural concept must not go against the planned number of rooms. A successful solution is the traditional U- or T-shaped building, where a large number of rooms may be created in long internal corridors. We have a similar project in the Moscow Region. The 19th century building is the first project in Russia built using industrial concrete. The building is T-shaped, with long corridors. Currently the property undergoes reconstruction. Hospitality developers prefer practical design, while unique designer projects are used solely for top class properties, such as for example the sky-high towers of Swissotel. The area of section in those towers is small and each floor can comprise only a few rooms.

Special attention should be attached to the design of the entrance zone and restaurants – the most active and crowded zones of the hotel. The flows of visitors in those spaces should not intersect with hotel employees; the zones are to be equipped with air conditioning systems and emphasis should be placed on details of zoning – the number and placement of dining seats in the restaurant, placement of the reception desk and the lobby bar.

Textile, furniture items and other decoration features are usually drawn and approved during design stages whereupon furniture is manufactured to order while textile and decorations are chosen from suppliers’ collections. Active operation calls for use of special heat resisting and durable materials. For internal fit-out ceramic granite or granite and carpeting are used (depending on the star rating of the hotel).

Operation of the property begins as early as during concept and design stages. The investor and future owner decide on the scheme of operation of a hotel, either to be run by the owner himself with a view to promote own brand, under a franchise agreement with a popular brand owner or by inviting an international hotel operator (direct operation, preferable for first class and luxury hotels).

Our company focuses on construction and operation of three-star hotels; in this segment the priority is given to franchises and use of influential hotel brands. We have opted for cooperation with the international chain Best Western, which has a strong presence in the medium-priced segment. The choice is predetermined by our focus on the 3-star hotel sector and Best Western’s loyal requirements towards hotel equipment. The chain’s standards allow not only for new construction but also for refurbishment of existing properties.

Besides, our cooperation with Best Western gives us considerable independence. We are absolutely autonomous and free to make all decisions on our own. The company undertakes to observe quality standards adopted in all Best Western hotels across the globe. Those concern the fixed area of public zones and rooms, engineering equipment, interiors and staff. On the one hand those are restrictions, on the other, the tested know-how successfully applied worldwide. All decisions on future growth of our company or opening a new hotel are made by City-Hotel independently from Best Western.