News

In the latest headlines of the daily newspaper Vedomosti and later confirmed by ABN News, several developers have made claims of rapid expansion of hotel chains across Russia. The first statement came from Delta Capital Management, announcing the creation in Russia in the next ten years of 50 three star hotels under the Country Inn & Suites brand. A few days later, a similar announcement was made by the affiliate structure of Menatep in cooperation with Cyber Projects on the creation of several hotel chains to be operated by Marriott. Russia’s Sistema group is in talks with France’s ACCOR, which manages two four star Novotel hotels in Moscow, to develop construction of several economic class hotels in Moscow. The department for investment of the Moscow City government plans for the construction of 10 hotels in the 3 star category for total volume estimated around 70 million US. Finally, the Ukrainian National Reserve Bank has also made public its intention of developing several hotels in Russia.

The intentions of some investors to broaden the hotel supply spectrum are quite firm. One month does not go by that a press release stresses the shortage of mid-class hotel rooms in Russia and in Moscow. Moreover, the announcements are made without any supporting data as to the market conditions, namely supply and demand analysis in relation to the expansion schemes. The ruffle in the press creates the illusion that the three-star market is a completely untapped market, where there enough demand to rapidly turn the initial investment into a profitable venture. It is obvious to believe that much opportunity abounds in the hotel real estate development, which follows suite on the residential real and office space boom that has occurred during the last decade. Since the steady competition of the traditional commercial real estate realties has risen, the hotel business in this sense represents logical continuation of the investment and building programs in line with a steady increase in hotel demand nurtured from the normalisation of the Russian economy and growth consumer spending.

Russia is certainly a large country and there is more than enough space to absorb these new objects. But the geographical dimensions should not be the only argument in favour of these expansion schemes. Based on data provided by Goskomstat, the national statistics information bureau, occupancy for the existing supply in Russia did not reach the 40th percentile mark in 2002. In Moscow and St. Petersburg, occupancy is higher, but not at extremely high levels. Moscow hotels in general averaged 54% during the year. In contrast, St. Petersburg hotels traded lower at 49% in 2002. In terms of fill days, St. Petersburg enjoys approximately six weeks of high activity during the year from early May to mid-June with the rest of the year being fallow. Moscow is less affected by seasonality, but in general, the capital enjoys approximately 90 to 100 days of top activity, with corporate clients heavily influencing the average guest profile. For the actual performance of existing three star hotels, occupancy reaches above the 90^th percentile approximately two months in the year. But in low and mid season room occupancy of these hotels, even those, which are internationally affiliated hardly achieves the 50^th percentile level. This is also the case for mid-class hotel performance in Saint Petersburg and Sotchi.

Further, the problem of hotel demand can be viewed as the tip of the iceberg. The law of natural selection also applies to hotels. More competitive and well-conceived hotels will eventually impose themselves on the Russian market. Relics of the Soviet era suffering from physical and functional obsolescence will eventually yield to better-adapted hotels, which are in line with current demand. The improvement in the hotel supply will benefit the consumer but the expansion schemes have not undertaken any analysis in terms of the break-even point, which the operations of these hotels much achieve to become profitable. The announcement made by Delta Capital concerning the creation of several 80 to 120 rooms, costing $70 to $90 a night for an approximately $8 Mio investment per hotel unit cannot generate a satisfactory return for the projects. Feasibility projections are usually inflated in comparison to actual performance figures. Conversely, it is rare, despite all caution adopted by the most conservative feasibility experts, for actual performance levels match the financial forecast prior to the opening of the hotel.

Finally, going into a hotel venture like a headless chicken without assessing the market impact can seriously jeopardize the profitability of the project. In Moscow, unless the hotels are targeting business travellers, the hotel rack rates for mid-tier hotels (3 star hotels) will usually be over $150,00 for the hotel to break-even and cover all related variable and fixed charges. Compared to mid-tier hotels in Europe, and in consideration of the corresponding quality of accommodation, such rates are not very advantageous to budget-conscious visitors.

Even if we unquestioningly accept that there is strong demand for this rapid question, and that all of them will be positioned in the middle segment, then it these hotel units will have to be staffed accordingly. Unfortunately, finding qualified staff to work in mid-class hotels in Russia to achieve budgeted operational results is hard to come by. We base our assumptions on interviews with Russian operators such as Umaco and Bonita Group. Umaco currently operates one hotel in Moscow and two in Sotchi with ambitious plans to create the first national hotel chain with most of its properties located in Sochi and around Krasnodar region along the Black Sea. The Bonita Group, which currently operates two objects in Kazakhstan, plans to build 100 additional hotels across Russia and Kazakhstan cloning the Express by Holiday Inn product design specifications. Both have consolidated enough staff to operate the above objects, but are stalled in their effort by inadequate human resources to materialise their expansion plans in various cities. As the representatives of these companies mentioned to us, finding qualified managers to pilot the proposed hotels successfully such as General Managers, Sales Directors and Financial Controllers are hard to find and must often be recruited from abroad at high expatriate salaries.

In closing, Hotel Consulting Development Group suggests that it is wiser to start with one or two hotel projects in major cities such as Moscow and Saint Petersburg to test the market and establish a given hotel product brand, then proceed on moving into more remote parts of Russia, rather than making such ambitious statements. Apart from Moscow and Saint Petersburg, the Russian province still presents a serious challenge for mid-tier hotels due to the financial risk attributed to weak demand in terms of room night volume and spending power. Thus, each project requires serious investigation in so far as market dynamics, concept definition and feasibility study, concluding with a well-documented business plan before proceeding to the next development stage. The hotel market is still a risky venture for most, and as such it is judicious to proceed with great caution and capitalise on a few profitable projects, rather than walking on thin ice with ambitious, yet shallow plans.