For most investors in investor cycle 2.0, the investment strategy has changed to investing only in operating assets or almost ready assets which takes away all the development risk and allows speed to market with income generating assets.

POST THE GFC in 2008 which led to a global slowdown followed
by a much reduced India GDP growth during the second term of the Manmohan Singh
UPA government, hotels which had seen new peaks never seen or imagined before,
started their descending journey hit by a triple whammy of global recessionary
trends, rapid slowdown of the Indian economy and the largest ever increase in
supply of rooms in most key cities. Living in ‘the good times’, hotel companies
started believing that this was the new normal and were ill prepared to handle
the almost tsunami like impact that hit them in the aftermath of the GFC and
the India slowdown.

While hotels were witnessing what was perhaps the best
performing years for the industry in post independent India from 2005 to 2008,
fresh investment from domestic and off shore investors started pouring in
fuelled also by the 100% FDI permissible in the hospitality sector through the
RBI’s automatic route making it the easy for foreign investors to enter the
Indian Real Estate sector through investments in hotels. (A JLL mapping of FDI in hospitality over the last ten years shows an
inflow of about Rs 5500 crores or just over a billion USD given the varied
value of the rupee over that period). Newspapers, periodicals and research
reports were screaming on the extremely inadequate room inventory in the
country and how we required over a 1,00,000 additional rooms over the next five
years to meet the surging demand. PE investors started taking bets in start-up
platforms with a typical investment horizon of 5 years somehow overlooking that
in India the average time taken to complete a hotel in the mid to upscale
category is about 3 to 4 years from the date of acquisition of land.

What followed in the years from 2009 onwards is the bloom to
gloom story of the Indian lodging industry which has witnessed perhaps its
longest down cycle ever, having seen seven consecutive years of slow down and
even today  is nowhere close to the
occupancy and ADR’s it was achieving in 2007 & 2008. Several new hotel
announcements made during ‘the good times’ never went further from the
announcement stages and a much larger number got into severe financial stress
as promoters felt the heat in their primary businesses which stopped them from
being able to bring capital into their extended interests of hospitality. Many
of the hotels that opened during the down-cycle have been deeply stressed on
account of the operating performance being unable to service the level of debts
raised for these properties. In summary, the Indian lodging sector witnessed
its best operating performance years from 2005 to 2009 along with its largest
draw of investments into the sector followed by its longest down cycle lasting
seven years and its most severe capital stress on account of mounting
unserviceable debts and incomplete projects.

So where do we stand now and where do we go from here?
Thankfully, after seven long years, the industry is beginning to show signs of
revival in its operating performances and most crystal gazers believe that the
worst is now behind us signalling the beginning of an up cycle. While there was
practically negligible interest from off shore investors in the Indian
hospitality story over the past five years having witnessed the performance of
the industry and the fact that almost all of the PE investors who entered the
market in the peak period have been unable to make any meaningful exit even though
they are much beyond their ‘use by’ date, (JLL estimates puts this figure at
about 500 crores or roughly 1% of FDI inflows) we are now at the threshold of
investment cycle 2.0 with investor sentiment once again showing buoyancy and
renewed interest in the sector. With India emerging as the fastest growing
economy in the world and the global belief that the new Modi government is
taking steps in the right direction, India, once again is becoming an
investment destination hard to ignore. One of the reasons that fresh
investments into the industry were far and few although the ideal expectation
would be to see several transactions take place in a severely stressed
financial environment, as mentioned earlier, was the gap between seller and
buyer valuations of the assets. However, with the passage of time and a better
understanding of ground realities, buyer and seller expectations are beginning
to get more aligned. On the seller’s part, he has started to understand that
hotel assets will not trade purely on real estate values and the perceived
escalations while Buyers have come to terms that there are very few deals based
purely on business valuations. In the current market place what we are likely
to witness is an increasing number of transactions being done on a Replacement
cost basis which determines the cost of building a similar asset at present
rates and adjusts for the depreciation of the asset based on its age.

For most investors in investor cycle 2.0, the investment
strategy has changed to investing only in operating assets or almost ready
assets which takes away all the development risk and allows speed to market
with income generating assets. Going forward, we are likely to see the hotel
transactions market opening up in India through change in ownership of
operating assets. Several investors from investor cycle 1.0 have realised the
complexities of the hospitality business, its long term play with regards to
ROI’s and its capital intensive nature and are looking to exit. The lessons
from investor cycle 1.0 will now bring more seasoned investors in investor
cycle 2.0 with far more patient capital and a better understanding of
hospitality investment. Most PE investors today are keen to enter the market
just when it is turning around which gives them the opportunity to see an
upside in the performance over a 4 to 5 year period riding on the up cycle that
we are now hoping to see with most of the new inventory in key cities being
absorbed and very little new inventory in the pipeline along with the economy
growing at close to 8% and large amounts of FDI being announced in various
infrastructure and manufacturing projects across the country. The stage seems
to be set for an acquisition model which provides most PE investors the horizon
to enter now at a reasonable cost and exit at a higher valuation within 5
years. With REITS also looking to become a reality (Infrastructure Investment
Trusts as they are called for Hospitality Investments), we should be seeing our
first hospitality REIT being listed within the next 24 months which would be
the beginning of an exciting new opportunity and a trend carefully watched for
its performance. What India lacks as of now is large hotel portfolios  available for acquisition as is the case in
more developed markets and which is the preferred route for large institutional
investors to get a significant presence in the country.  The likes of Lemon Tree & SAMHI will
eventually provide that opportunity.

We are once again seeing a few rays of the morning sun after
what seemed like a never ending night and are hoping that this time, global
sentiment towards India remains in the positive and upward trajectory that it
currently seems to be in and domestic events ultimately bring the much promised
and awaited ‘acchhe din’ to the country.