Hotel Transactions
Earlier this year, two portfolio deals shaped the hotel transactions market of India with a consolidated transaction value of approximately US$85 million. This is no mean feat for a country where buying or selling of hotel assets has historically been as rare as sighting a snow leopard! Sarovar Hotel Group’s acquisition by Louvre Hotels Group was primarily a non-asset deal aimed at gaining the scale and distribution of a management vehicle, with management income from over 70 hotels.
In addition, Whitbread PLC from the UK exited India and sold their hotel real estate of five assets. However, other than these, the transaction market has been rather dull. Dry powder reserves for hotel real estate from most PE funds have remained undeployed.
Systemic issues have been preventing hotel transactions in India. Some of these are: powerless lending institutions that are unable to exert pressure on debtors; unwillingness on part of both the developer and lender to take a haircut; unrealistic expectations of the sellers; owner’s emotional attachment to the asset; perceived real estate value being higher than the value of the business; and finally, the lack of institutional equity capital that recognises the specific needs of hospitality industry.
Buy-in from the Buyer
The good news is that buyers have started returning to deal tables. Value buyers are already on a look-out for good deals. We, at Hotelivate, are hearing a clear message from serious buyers – they want tradeable assets (i.e. branded hotel with 100+ rooms) that are operational, or close to completion, in the top eight markets in India where the seller is ready to price the asset at a logical multiple of its income.
Savvy buyers do recognise that the earning multiple cannot be based just on the trailing 12 month’s net income in a market that has been depressed for several years and is only now on a cyclical uptick. They understand the need to look at the potential (future) rather than performance (past).
The Seller’s Dilemma
On the other side, slowly but surely, sellers of hotel assets have started getting a reality check. Long after the hedonistic days of 2004-2009, when a new breed of first-time hotel developers went in for the gold-rush associated with hotels, the romance with hotels has got over for many. Some business houses/families do not find hotels to be in congruence with their long-term strategic objectives. They have held through the downturn and, favourably view the current opportunity to exploit the market and return the long-awaited capital to investors. We find that the motivation for such sellers is self-induced and so, most genuine.
Owners may also be forced to seek exit if they are unable to invest capital for property renovations and refurbishments. And lastly, there is a breed of reluctant sellers that have appeared on the scene, due to issues of debt service repayment or impending loan maturities; here the external pressure is at work in creating a sell motivation.
Distressed Assets
What is conspicuously missing from this cycle is distressed hotel sales flagged by the lenders. Opportunistic buyers have been wanting to acquire such distressed hotels at a substantially discounted price but, such opportunities don’t really exist because of the holding power of owning companies as well as the notional increase in land prices. With the passage of Insolvency and Bankruptcy Code 2016, the government has brought in a law which should have a domino effect on the investment climate of hospitality projects in India.
The new law will help the banks in faster recovery of dues, much before the erosion of significant amounts of capital. This would also help in cleaning up bad businesses from the system and would facilitate deployment of fresh capital to more deserving enterprises. Simply put, it will elevate and empower the lenders, who are currently a harried lot themselves. However, it is still difficult to say if all this would bring in hotel assets at discounted prices into the market.
Investment Trends – 2017 and Beyond
It is never easy to predict investment trends and themes in small, niche sectors. Nonetheless, some broad hotel transaction trends are clearly visible and, we believe they will fashion the hotel investment climate over the next two years:
- Hotel performances have arisen from their all-time low. Operating metrics in hotels are showing consistent improvements. Going forward, with increase in occupancy and average room rates, hotels will see more than proportionate increase in bottom-lines.
- The stress created by the supply glut is abating. Compound Annual Growth Rate (CAGR) of supply over the next five years is under 7% in 12 out of the top 13 markets in India.
- Perceptions about the lodging industry as a laggard investment class, is also changing. However, the paucity of tradeable hotels is going to be a major handicap.
- In the last investment cycle, hotels attracted private equity but failed to offer profitable exits in most cases. Over the next 24 months, we expect at least two privately held companies to offer exits to investors either by way of strategic sales or via the public market.
- Profitable exits for a few will most likely kick-start more activities like FOMO (fear of missed opportunity) in the deal-making world.
- Replacement cost often moves in tandem with inflation and, so deals will get more expensive with every passing year. The gap between value derived from discounting future cash flows and replacement cost will continue to reduce.
- Portfolio deals are an utopian preference of PE funds due to deal size and effort factor. Short supply of such deals is expected to put the focus back on to large asset-level investments.
- At some stage, banks squatting with high levels of non-performing assets will get empowered and bring more hotels to the market for disposition.
- Banks or Interim Resolution Professionals (IRP) might assume control of some assets and appoint professional Asset Management teams to manage hotel operations till such time that hotel assets assume a new ownership.
Particularly, we expect the new insolvency and bankruptcy act to severely challenge the status quo – debtors will no longer be able to delay the inevitable. Current activities related to beleaguered companies would create a workable template even for nonperforming assets in the hotel sector. And for the potential seller of a hotel asset, this waiting game could turn dangerous.
Finally, hotel transactions are very complex; they require an in-depth understanding of the real estate dynamics, underlying business, and the cash flows it can generate. We, at Hotelivate, are working with institutional investors, private buyers as well as sellers, and are jointly discovering the ‘value buys’ for our clients. The excitement around hotel investments is palpable. It’s game on!
