State of play
The hotel industry has seen sustained growth in the last few years as the construction of new properties boomed, driven by fast-growing Asian economies, improved connectivity, and strong hospitality fundamentals. According to the World Hotel and Resort Development Congress, the number of hotels in the Asia-Pacific region will grow by about 410,040 rooms in the next three to five years.
“The only place that they are really building hotels is Asia,” says David Blumenfeld, chair of the Asia Hospitality practice and partner at Paul Hastings, “Deals are being done in the U.S. and in Europe, but it’s mostly repositioning and every once in a while, they will build something. But for true development and the adding of rooms, Asia is the place to be.”
A 2012 year-end survey conducted by Jones Lang LaSalle indicated that Asia-Pacific hotel transaction values are projected to reach $3.5 billion in 2013, driven by strong investor sentiment to purchase assets in the region. From traditionally strong markets to emerging jurisdictions, five-star developments to mid-market chains, the hotel industry is going from strength to strength.
Conrads and Ritz-Carltons in China
China’s growing middle class has been a strong driver of growth for the industry, as they seek to travel both regionally and internationally. “Beijing, Shanghai and Guangzhou; those are the gateway cities that have seen a huge amount of development, especially in luxury, upper upscale and upscale type hotels,” says Andrew MacGeoch, partner and head of Mayer Brown JSM’s Asia Hospitality and Leisure group, “Also in Hainan, which has seen a plethora of large luxury resorts under development.”
However, at the moment, all eyes are on the mid-market segment given the recent headline-grabbing deal that was Home Inns & Hotel Management’s $470 million acquisition of the Motel 168 chain, China’s biggest budget hotelier with 45,669 rooms in 81 cities across the country. “Everyone expects the mid-market segment in China to grow,” says Blumenfeld, “They’ve realised that this is a great race in which Home Inns may now be in the lead, but in which there is more than one worthy competitor; the race to aggregate so many hotels rooms and mid-market hotels that you become the market leader.”
As China continues to grow at 8 to 10 percent a year, the middle income class correspondingly expands, travelling for business and leisure. Unlikely to stay at luxury hotels, market sources say this is where the real future lies, as businesses try to keep pace with these travellers’ demands.
Secondary and tertiary cities have also seen much hotel development. However, the challenges of working in this market are unique and complex. One of the key problems that lawyers point out is that five-star hotels are not built for classic underwriting reasons, but are rather being developed because local governments believe that from a strategic standpoint, they should be constructed. Often, mayors or other government officials of these cities grant permission for mixed-use developments, but include the caveat that a five-star hotel must be a part of the development.
“We have also seen the same focus on the luxury sector in secondary cities, but it’s almost impossible to make a good return on your expensive five- star hotel,” says MacGeoch, “ as you can only charge out the rooms at a fraction of the regular luxury hotel cost. The demand for this type of hotel product in this kind of city isn’t there.” Effectively, local governments and hotel developers are at cross purposes in these secondary and tertiary Chinese cities.
What is the impact of that? “It will lead to some financial distress down the line,” continues MacGeoch “and then, the developer may not want to keep the hotel as part of the mixed-use development. Many are trying to sell off the hotel assets, but the prices are too high. So, we should see more trading of those hotel components once the prices are more realistic.”
The next big leap will be one in which homegrown Asian brand will take their business global, with many commentators believing it may well be China’s Jin Jiang Hotels group. With over 111 star-rated hotels in 73 cities, their latest coup is developing the world’s tallest hotel on floors 84 to 110 of the Shanghai Tower, poised to be the world’s second-tallest building when it opens in 2014.
Blumenfeld reports that: “Shanghai Tower is government owned. The desire to flag and manage such an exclusive hotel should have been great. All of the super-premium brands would have liked to have done it. This is going to be the first premium hotel from Jin Jiang, and now the question is whether they will be looking to roll out this brand internationally.”
Bali and Jakarta: A tale of two markets
Moving away from China, Indonesia continues to attract investors’ attention. “Bali is still a phenomenal market,” says David Mallinson, a Hospitality and Leisure partner at Mayer Brown JSM, “Most of the leading hotel brands are already represented but others continue to pour in. Alongside Phuket, it’s far and away the strongest resort market in terms of demand and development.”A report released by Horwath HTL indicated that the tourism market in Bali is buoyant, despite having 12,000 new hotel rooms in the pipeline with a spike in hotel-branded villas and condos.
“Historically, Indonesia had two distinct markets; Bali and the rest of Indonesia,” says Mallinson, “But now that is slowly changing as a lot of operators are becoming more interested in the rest of Indonesia. In particular, Jakarta; as business is booming, business hotels are starting to boom.”However, the city has its own unique set of problems when it comes to hotel growth. Sources say that it doesn’t hold much attraction on the weekends, leading to heavy occupancy during the week, thanks to business travellers, but followed by a mass exodus on the weekends.
As in China, Indonesia is also seeing growth of the middle class, leading to an emerging mid-market segment. “At that mid-market level, because there is so much domestic travel, a lot of the international brands are coming in and trying to develop in Indonesia in order to capture these domestic mid-market travellers,” says Rhonda Hare, partner at Ashurst. She points out that the larger brands, such as Accor, are looking at multiple hotels in second tier cities, following the growth of new airports and new businesses.
Challenges remain however; with an uncertain regulatory regime, legislation can be issued but not implemented, and the prospect of litigation in Jakarta’s courts can be daunting. “Notwithstanding the challenges of doing business in Indonesia, people are still keen to develop and consider Indonesia an exciting opportunity,” says Hare.
Swooping into Sri Lanka and Myanmar
Emerging markets are a core part of Asia’s growth when it comes to hotels. Sri Lanka, in particular, is gaining momentum, after a protracted civil war kept tourism development at bay. MacGeoch says, “This is definitely a location where there is demand. With the political climate settling down, the number of tourist arrivals has gone up exponentially and the number of hotel developments need to match that.”
A transparent legal system, growing infrastructure, and the low cost of land are also attractive points for investors, who see great potential in the country. “In 1983, when the civil war began, Thailand and Sri Lanka had exactly the same number of inbound foreign tourists (500,000),” said Kevin Wallace, CEO of JA Resorts and Hotels at the recent Hotel Investment Conference Asia-Pacific, continuing that: “Today, Thailand has more or less 20 million, while Sri Lanka is hitting a ceiling. They thought by 2015, they’d be at 2.5 million tourists. But it costs several billion dollars to build those rooms; you have to mobilise the capital markets, equity, debt and so on.” However, measures are slowly being taken to improve the situation, and sources agree that Sri Lanka is quickly gaining traction as a hot market for hotel growth.
Undeniably the story of the year, the opening up of Myanmar has sent ripples through the hotel industry as well. “It’s a balance between hype and reality,” says Hare, “But it is a virgin market, and a lot of people are actively looking at Myanmar and working out how they can build, develop and manage these hotels, even though the legislation is either very old or very new.”
As the second-largest Southeast Asian country with a population of more than 60 million, the opportunities are huge. At the moment, the country is much undersupplied, and sources indicate that it’s a problem booking hotels at certain times of the year. However, given the complementary aims of foreign investment and economic development for emerging countries, it’s likely that the government will look to issue regulations about the hospitality and tourism industry shortly.
“As always, these developments can go in fits and starts,” says MacGeoch “So both Sri Lanka and Myanmar will have times of great accelerations leading to oversupply and then periods of consolidation.”
Cashing in on condos
A trend that cuts across jurisdictions in Asia is the ever-growing condo-hotel concept. A popular way to fund construction of hotels, the residential condo portion is sold off and the profits are applied to building the hotel. Pre-financial crisis, this model was prevalent in Thailand, Bali, and Singapore; the St. Regis Residences in the latter is one such successful example.
When it comes to China now, Blumenfeld says: “There are lots of developers that would like to do this, because it unlocks the underlying real estate value of the hotel, but current Chinese ownership and land use regulations make it difficult to craft a solution that allows for a property to be operated as a hotel and, at the same time, to allow individual hotel rooms to be owned with the same type of legal protections that residential owners have come to expect in China.
Complexities arise in other markets because of the fact that many individual buyers are involved. “These structures often provide for guaranteed returns for buyers,” says Hare, “but there are also ongoing costs associated with these structures. So if you’re not dealing with a sophisticated buyer, someone who is looking at the purchase as a leisure product as opposed to an investment product, then these structures can create operational challenges in the future.” Despite the fact that many developers are very keen on this model, there are myriad legal and practical issues remaining depending on the jurisdiction, lawyers say.
A legal minefield
From a legal perspective, “the Asia-Pacific industry is very much in a development phase that is predicted to continue, “ says Mallinson, “compared to Europe or the U.S. where the industry has been mature for some time now, and a lot more of the M&A work is further down the legal pipeline.” While the U.S. and Europe see more transactional work, especially M&A and franchising, Asia is full of large amounts of development work including hotel management agreements and land acquisitions.
We have seen more disputes coming through,” says MacGeoch “This non-alignment of expectations (particularly in China) is going to lead either to more distressed assets and distressed owners, or stressed relationships between owners and operators.”When owners expect more delivery and the operators can’t produce those returns due to market conditions such as oversupply or just incorrectly located brands, this in turn will lead to owners looking at their contracts and perhaps perusing litigation.
The year ahead
In the larger picture however, the future remains bright. “In 2013, you will see people looking to develop their brands and expand their market share but perhaps exercising some caution. This is the time to look at opportunities, be aggressive and take advantage of the market to expand,” concludes Hare.
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