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Interstate Proceeds With Caution in India

It's easy to understand why Interstate Hotels and Resorts and other Western developers see a subcontinent-sized opportunity in India. Not many countries have 84,000 hotel rooms for 1.1 billion people, and 9% annual GDP growth.

The real mystery is why Interstate and other major hotel companies took so long to discover the country. While major Western hotel developers have been marketing in China for more than 20 years, few have been in India for long.

It's not because the economics are bad. The numbers have looked spectacular for some time. Room rates in some Indian cities are higher than in the U.S. and Europe, and revenue per available room (RevPAR) has skyrocketed.

Countrywide, average daily rates grew from $77 in 2002 to $224 in 2007. Occupancy climbed too, from 51.8% to a high of 72% in 2005 and only recently dipped back to 69.9%, according to Deloitte's Hotel Benchmark Survey. Nationwide, RevPAR has grown from $40 in 2002 to $157 in 2007 — a lot of money in a country where per capita GDP is roughly $1,000 a year.

Formulating a game plan

In Interstate's case, hesitancy to enter the market had to do with a desire for good advice about how to break in. “We have always thought about going into India, but did not want to do so without a partner with local expertise,” explains Leslie Ng, Interstate's chief investment officer.

For a strategic partner with local expertise to guide the venture, Interstate turned to the Bangalore subsidiary of JNB LLC, a U.S.-incorporated real estate developer. To further hedge its bets, the Arlington, Va. company recently formed a 50-50 venture with JHM Hotels, a major U.S. hotel developer. The joint venture's first project is a 124-room, five-star business hotel under construction in an upscale part of Vizag, a city on India's eastern coast and home to the country's largest port. The hotel's cost and brand have not been announced.

The two companies have made a $12.5 million investment in Duet India Hotels, a $166 million hotel development fund that closed in February, which plans to build 25 three- and four-star business hotels across India.

Emerging market pitfalls

As with most emerging markets, a few wrinkles make development in India difficult. First, the sorry state of Indian infrastructure makes it tough to find locations to build quality products. Lousy infrastructure shaves 1.5% to 2% off GDP growth every year, and the hotel business and other industries suffer.

Second, land ownership is fragmented. In China land belongs to the state and is leased up to 40 years. In India, a one-acre parcel for a 100-unit hotel might have as many as 12 owners, says Philip Johnston, hotel group head at Savills, global property advisory service in London.

Others argue lack of capital is the real culprit. Hotels are capital intensive and require a seven-year gestation period, he says. That's a tall order for many developers, says Abhishek Gupta, an analyst for Jones Lang LaSalle in Mumbai.

“I think from the hotel operator's point of view, it's a very good time to get in and get the flags on the map,” Johnston says. Research firm Lodging Econometrics estimates there are more than 47,000 rooms in the pipeline.

Ng sees the biggest challenge as finding people to manage hotels after they're built. “There is such an anticipated boom of inventory coming on line that there is going to be a shortage of talented hospitality professionals,” Ng predicts.

Hotel property investors, however, may want to tread carefully. Sales prices have doubled and tripled in some places in recent years, and some analysts say prices are reaching a peak.

Bennett Voyles is a veteran commercial real estate reporter and National Real Estate Investor's Paris correspondent. For questions or comments, e-mail [email protected].

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