Money growing: Hotels From Private Hands

Western hotel chains began active expansion in Russia several years ago. Russian hotel chains compete as much as they can, and in some cities control up to half the hotel market. However, according to experts, the majority of Russian hotels are not managed by chains, but are in the hands of private investors. Moreover, such investors are more and more actively buying up hotels, especially in resort areas, for example in Sochi.

If we are talking about large businesses then these purchases can be a basis for investment in the creation of a new chain. If it is an individual person interested in lower investments, they will be interested most likely in small mini-hotels which are capable of generating a flow of if not a multi-million income then a constant one.

A majority market

According to Elena Lysenkova, a member of the board of directors at Azimut Hotels Company, in the Russian hotel market (not taking into account motels, hostel-type hotels, and guest houses), the share of foreign chains stands at 7%. In turn, the share of Russian chains, including small local chains of 3-4 hotels and departmental ones like Gazprom and RPTs is almost 13-14%. The rest are hotels that belong to private investors.

According to vice president of ADG Group Druvisa Murmanisa, private buyers control about 90% of the Russian hotel market, if you consider all Russian and foreign investors.

"The overwhelming majority of sale transactions concerning hotels in Russia are carried out by private buyers. Transactions with the participation of institutional and strategic investors are rather rare. At the same time it is possible to note many cases whereby after a private investor makes a first purchase a second or third purchase follows. As a result on there are lots of investors in the hotel market that have portfolios of 2-4 hotels and are quite capable of creating a local hotel chain from them,” says Lysenkova. According to her, such transactions occur in almost all segments, except probably hotels of the highest level where investment activity is limited by the lack of supply and the high cost of premises. In particular, this is exactly how the Azimut chain was created – after the purchase of several hotels by beneficiary companies of Alexander Klyachinym’s Nerl. Generally behind such transactions there is a large company (as with Alexander Klyachinym).

"For the well-off citizens considering different investments for their own funds, the hotel business is not especially attractive. The barrier of becoming part of a large project – a hotel with at least 150 rooms - is tens of millions of dollars, and the recoupment times are some of the highest, on average about 7-9 years. As a matter of fact, the same returns can be made from putting money in a deposit. As such investment in other formats of commercial real estate - retail, warehouse, office – in the medium term future look more interesting," says Maxim Klyagin, an analyst at Finam Management. According to him, mini-hotels are more popular among private investors.

Partner at Knight Frank Russia and CIS Konstantin Romanov confirms: the market of mini-hotels is most attractive to private investors as it requires a rather small initial investment and has smaller recoupment periods. "This format is quite widespread in large regional centers, and the share it occupies in the hotel markets of Russian cities is growing in volume. For example, according to Knight Frank, the share of hotels with 30 or less rooms in Novosibirsk is 75.6% of the total, in Perm it is 76.1%, in Kemerovo it is 70.6%, in Tyumen it is 61.7%, and in Kazan it is 42.9%.

"There are also examples of the purchase of areas in hostels. Less often, hotels are located in office buildings or restored former monuments of architecture," the expert adds. "An investor may simply buy a municipal apartment block or building to convert into a mini-hotel. Depending on the region this would not exceed $500,000," approves Vladimir Poddubko, vice-president of Unikor.

Returns and expenditures

The smaller the hotel the quicker it will be recoup costs. According to Poddubko, in small premises where investments were initially insignificant, the recoupment period can be less than 3 years and if it is more may take 5-7 years.

According to Murmanisa, for new high-quality hotels that are under the control of international operators, the maximum level of annual profitability is 9.5-11%. "This parameter depends on the region in which the project is being realized, the size of the city and the level of business activity in it, tourist activity, and also the hotel operator, the quality of the premises, and its concept and location," she lists.

Other experts agree. According to Stanislav Ivashkevich, deputy director of the department of strategic consulting and valuation at CB Richard Ellis, in the case of the purchase of a high-grade operating hotel that does not require major overhaul, returns on funds invested will not be made earlier than 10-15 years later. Mini-hotels make returns 3 times quicker than large hotels.

"A widespread way of creating a mini-hotel, besides purchasing a ready business, is to purchase apartments in an apartment block and then transfer them into non-residential classified buildings. The total area of such hotels can be from 100 sq.m. The most popular is 200-300 sq.m. Initial investments start from $260,000, but on average are $1-$3 million. The recoupment period can reach 4-5 years, and profitability is at a level of 20-25%," Romanov says about the high profitability of this hotel segment. According to him, in Europe the profitability of this business is 10-14%.

"Moreover hotels are even more often located in constructed or reconstructed buildings that also have retail or office areas, restaurants, fitness centers, etc. Despite the higher level of expenditures on creating such a hotel, there is an opportunity to considerably raise the profitability of this business due to a synergy of various purpose areas. The recoupment period of a hotel in this case may increase to 6-7 years. As an example of the diversification of business, including by means of investing in the hotel business, Indus-Garnik hotel in Tula can be used, he says.

"On average the buyer of a hotel business can quite rightly expect profit of 10-15%. Although in the current conditions in the Russian market profitability can be much higher," says Lysenkova.

Small, but many

According to experts, there are many examples of private investors purchasing small hotels, but all of them usually pass by the information radar because of the small sums of the transactions.

"There are many such examples. The majority are in St. Petersburg and other cities. In the Far East, Siberia, and Central Russia. Generally it concerns the small family hotel segment where investors with capital up to a maximum of $5 million are ready to invest in the development of real estate premises," Poddubko says. He links such transactions to tourist conditions. For example, the quantity of sale transactions of hotels sharply increased in St. Petersburg prior to the anniversary of the city. There are many private hotels in Golden Ring cities. They may also be camping and vacation spots for hunters, fishers, etc, the expert says.

But big private investors can afford to buy big hotels under the management of a professional chain. " In many cases the proprietor of a hotel is not the operator of the premises," says Murmanisa. In particular, Park Inn Yekaterinburg has been bought by private investors from Norway. Potential foreign buyers, or institutional investors, are interested first of all in quality premises that are controlled by famous hotel operators. "In the regions there are insufficient hotels of this level, and the number of transactions with foreign investors is insignificant, whereas hotels that are owned by Russian investors are bought and sold quite frequently," she notes. However, according to Murmanisa, recently some joint ventures created for the realization of hotel projects from zero have been announced by both regional developers and international investors.

"The hotel market is catastrophically small, and trace the transactions in the segment is difficult. The only thing you can say is that the purchase of 5-star hotels is extremely rare," Ivashkevich says. According to Poddubko, the purchase of a small hotel project by a medium-sized investor, which is not of a public character both for both the press and market players, is not of much interest, and therefore such information, as a rule, is not spread.

Not to our advantage

Experts consider the price of hotels in Russia as unjustifiably high. For example, on the Greek island of Corfu for 23 million euros it is possible to buy a 4-star hotel with 80 rooms, located on the sea front, with an adjoining land plot to construct another hotel. On the Greek island of Paros you can buy a hotel with 20 studios for 1.7 million euros and on the Greek island of Kos a 70-room hotel will cost 2.6 million euro. In Sochi, Mamaika hotel with 34 rooms is on sale for 3 million euro. However some experts say these comparisons are not exactly correct. "The price depends, first of all, on the location – the region, the city, the country. In Russia somewhere the price will be higher," Poddubko approves.

"On average across Europe potentially attractive hotels can be bought from 3 million to 20 million euro. If the purpose of investment is a large hotel complex, then the budget may increase up to several hundred million euro," general director of Vesco Consulting Alexei Averyanov says.

According to Murmanisa’s estimations, hotels in the largest Russian cities are more expensive than in Greece. "This is caused, first of all, by the low level of competition and high profitability," she says. "The majority of hotels abroad are valued by their profitability and are sold as a business. In our country there is practically no hotel business and so to value it is difficult, and therefore a hotel, for example, in Moscow-City is on sale for $12,000 per sq.m. Nobody knows how much profit it will make," says Ivashkevich. According to Averyanov, there are not many examples of hotels being valued as businesses and they are mainly made by western investment funds. In particular, the 4-star Heliopark Country hotel on Dmitrovskoye shosse was bought not so long ago by fund London Regional Properties for $20 million.

It is significantly easier for proprietors of hotels in Europe to sell them. There are constantly a good number of offers on the market to suit various pockets and tastes, starting from low prices by Russian standards for a rather large so-called "separately standing" hotel to portfolios of 5-15 hotels. However rather low prices, as a rule, also reflect the lower profitability of these investments as hotel real estate in Europe is valuated mainly from the potential profitability of the hotel," says Lysenkova. In Russia, according to her, hotels are valuated in relation to the cost of commercial real estate in the region.

Pending investors

In the opinion of market participants, the volume of private investments in the hotel segment in due course will only grow. "Russian share and private investment funds will invest more actively in hotel real estate," predicts Murmanisa.

According to Averyanov, "first of all such investors need to be define the region from the parameters of their budget. Competition in the hotel business grows every year." "The most successful choice is an area that has a shortage of hotel rooms. A year ago, for example, in Moscow the average fillability was up to 97%," says Averyanov. Then it is necessary to solve the problem of personnel: "Many investors consider purchasing a hotel as a stable source of income with the minimum risks. Quite often they employ managers or an operating company to reduce their own participation as much as possible."

"In connection with the development of the tourist and recreational business, hotels are now one of the most attractive segments for investment," summarizes Averyanov. According to him, as a rule, private investors try to invest in hotels with a resort component, and the historical centers of cities are also popular. In Russia the main areas of hotel development by Russian private investors are still in resort zones, and currently mainly in Sochi," says the expert.