The investment landscape on the commercial real estate market has been reshaped over the year. In addition to the growing number of investment transactions, falling yields and influx of foreign capital, the investment market expanded. Hospitality properties rushed into the selling spree in Russia along with retail and office centres.

It’s no secret that hotels have the longest payback period of any segment of the commercial real estate market. Hotel development calls for serious investments at the initial stage, long-term loans and extensive payback periods. But the lack of competition and high occupancy rates at quality hotels all over Russia make this sector one of the most attractive instruments for foreign investors.
The hospitality market is roughly estimated by various consultancies at $2.0-2.5 billion. The total national room stock nears 200,000 rooms with a total of 350,000 beds. “For all that, the regional hospitality market is very far from saturation; a tangible deficit of high-quality hotel rooms exists in all regions and competition is much slacker here than in other segments. These factors in their totality have a considerable effect on investment flows into hotel properties, which makes the accommodation business one of the most promising in terms of development and investments,” comments Alexander Gusakov, president of Heliopark Group. City Hotel Development shares this view: “The investment spree can be explained by high returns on investments in the lodging industry. In the first half of 2006 five-star hotels in Moscow outperformed European hotels in terms of yield, although the hospitality sector started out later than office or retail real estate. The average annual occupancy rates at upscale hotels are close to a maximum from the perspectives of European hospitality sector, namely over 70%,” affirms CEO Damir Kaftaranov.

A hot market
Moscow, St. Petersburg and Sochi are Russia’s leaders in development of the accommodation business. The lodging industry is also rapidly evolving in the Kaliningrad, Tomsk and Volgograd regions as well as in the cities of Chelyabinsk and Yekaterinburg, Krasnoyarsk and Novosibirsk. In short, these large cities facing an acute shortage of hotels coupled with a steady tourist flow, including business tourists, which is stimulating vigorous develop of hotel facilities. According to Heliopark Group, around 5 million tourists are projected to visit St. Petersburg annually by 2010 and therefore demand for quality three-star and upscale hotels will rise sharply. Currently 311 hotels categorized as three star or above are operating in Russia’s northern capital, and 22 hotels with the total of 1,700 rooms are under construction. Altogether 125 projects that will add roughly 10,750 new hotel rooms to the city’s stock are now at the planning or construction stage. In Yekaterinburg the accommodation demand across all categories is only being 50% satisfied. Krasnodar and the surrounding region are actively being positioned as the business and tourism leader in the South Federal District. The occupancy rate at hotels in Sochi exceeds 90% while hotels in Anapa and Gelendjik are 100% filled during the “high season”. The room stock of in Nizhny Novgorod’s 78 hotels totals 2,979 rooms.
Yet foreign investors are primarily interested in the Moscow market, since the demand is still high here and this market collects 40% of all hospitality-related revenues. According to recent data, 183 hotels with a total stock of 42,000 rooms are operating in the capital; and 18 new hotels were were opened from 2000 to 2005. Only 6000-8000 rooms comply with the international standards for high-quality hotels. “The supply of quality hospitality services is still in lacking in Moscow, which causes a steady rise in average prices in all segments as well as continued high average annual occupancy rates (65-80%). The current situation is further exacerbated by the city’s policy of demolishing and reconstructing hotels built during the Soviet era. New hotels entering the market in 2006 (for example, Holiday Inn Sokolniki, Holiday Inn Sushchevsky, Savoy, Peter I) did not fill the deficit,” explains Olga Arkhangelskaya, head of real estate consulting at Ernst & Young.
In her opinion, the main advantage of the Moscow hospitality market as compared to Western hospitality markets is its higher rate of return, which, coupled with decreasing macroeconomic and political risks (reflected, among other things, in the positive assessment by international rating agencies of Russia’s economic development outlook), creates a favorable setting for greater foreign investment. “Furthermore, given the clear shortage of quality supply any well thought-out hospitality project managed by a renowned transnational operator is destined to be a success, which is confirmed, among other things, by very high average per room rates at Moscow three-star hotels, which often exceed $200 per night (for example, in the four hotels of the Holiday Inn chain),” note Ernst & Young’s experts.
The market’s shortcomings prove the attractiveness of the market for investors: the remaining transparency issues and the need to capitalize on good connections with the city administration do not hinder major foreign investors who are staking out their share of the Moscow market or the Russian market in general.

Who’s investing?
The interest of investors in the hospitality segment is steadily rising despite the longer payback periods in this segment. “Properly managed 3- and 4-star properties show a yield of at least 14-15% in regions, although, on the average, the payback period on hotel projects spans 7-10 years after their delivery. This means that hotels cannot compete with office or warehouse projects in terms of the return on investments,” says Alexander Gusakov. In addition, experts at Heliopark Group say that the yield in hotel segment has dropped in recent three years. “While the yield could reach 20% per year in the recent past (for example, our Heliopark Country hotel paid for itself within 4 years) present-day investors agree to enter a project even if the rate of return is only 10%,” says Mr. Gusakov.
Yet market analysts point out that the hospitality sector has greater potential for growth, especially in regions with excellent recreational opportunities. Therefore, many investors are so much willing to invest in regional hotel projects — primarily in St. Petersburg as Russia’s second capital. In 2006 a record number of investment deals involving Russian hotels were closed. Thus UK-based London & Regional Properties bought an unfinished 280-room hotel on Vasilyevsky Island from St. Petersburg-based LenSpetsSMU. The amount of this transaction came to around $30-35 million. After construction on this property is finished the hotel will be managed by the L&RP’s Finnish chain Holiday Club.
Norway-based Wenaas Group made two more acquisitions in St. Petersburg: first the Norwegians bought out Pulkovskaya Hotel from Kempinski for $70 million and in November they added the Pribaltiiskaya Hotel to their portfolio for $100 million.
Experts mention the following large investment deals in the Moscow hotel market: the 160-million-euro refinancing of Ritz-Carlton Moscow and the sale of city’s stakes in municipal hotels (for example, Ukraine Hotel was sold; Intourist took over the Cosmos Hotel; and a 69% stake in the Baltschug Kempinski Hotel was sold).
In addition, Heliopark Group completed two notable transactions last year: in the first case this operator acted as buyer when it took over Bad Hotel Zum Hirsch in Baden-Baden, Germany. Thus the company became the first Russian hotel chain to enter the international property market. In the second case the company acted as seller: “Having sold Heliopark Country Hotel to London&Regional Properties, Heliopark Group became the first Russian company to close a sale and lease back deal on the Russian hotel market, since we’ll be commissioned with asset management of the sold hotel over the next 20 years,” the company’s president explained.
There were less than 10 investment deals in the Russian hotel segment last year — not very impressive for such a huge country. However this is a tremendous breakthrough for a developing market that began to draw the attention of major developers just two or three years ago. This dynamic points to high growth rates that can not only be observed in the hotel business but also on the Russian commercial real estate market as a whole.