It was only six months ago when Russia’s economy hit peak performance, fuelled by high commodity prices, namely oil and gas. Over the last decade, Russia’s political and economical stability endured.
There seemed to be no limits to the country’s potential, exploding on the world stage with major infrastructure projects and a booming purchasing power. In turn, Russia became an attractive playground for foreign investors, in search of a slice of this enormous pie. Today however, as raw product prices deteriorate and Russia struggles to cope with the global financial crisis, investments are being reassessed.Katerina Udalova - UMACO, Managing Director Katerina Hotels Naturally, the crisis affects everybody, but we think it will affect resort hotels more than it will affect city hotels. People will still conduct business and they will still need to travel. The fact that we have a financing structure, a development and management sub-organisation is a big plus. In the future we see ourselves as a pure management company, not property owners and not developers. Our core business is hotel management. As we say: We don’t forecast the future – we create it!What future for Russian hotel market?Ever since the term BRIC was introduced in 2001, all eyes turned to Russia – the new kid on the block. Following turbulent years during the USSR’s collapse and the economical crisis of 1998, Russia proclaimed its intention to become an economic superpower and to play a greater role in world affairs. Indeed this happened. In 1997, Russia became a member of the G8, and now, the country is ready to enter the World Trade Organisation (WTO).Vladimir Putin came to power in 2000, and introduced major reforms. This continued after he was re-elected in 2004, and again in 2008, when Putin’s nominee Dmitry Medvedev moved into office. Much of Russia’s recent success can certainly be attributed to political and economical stability, and driven by a dependency on gas and oil exports – fuel and energy constituted 69.5% of total Russian exports in the first nine months of 2008. Russia’s economy mirrored the soaring commodity prices, with GDP experiencing an incredible increase.The International Monetary Fund estimated that in 2007, Russia’s GDP reached US$1.29 trillion, representing an 8.1% GDP growth rate compared to 2006 and boosting the country’s ranking just outside the top ten.Russia’s appeal for investments has also increased significantly over recent years. According to the Organis ation for Economic Co- Operation and Development (OECD), Russia was the third largest recipient of foreign direct investments (FDI) among the developing economies in 2007, after China and Hong Kong. In 2007, FDI increased by 60% compared to 2006, reaching US$52 billion. The global financial crisis however has instigated major concerns, with performances seriously altered all-round. We are now seeing a GDP growth rate for 2009 of around 3%.This crisis has brought back bad memories from 1998. As commodity prices continue to fall and industrial production decreases, confidence in Russia’s economy is diminishing. This year’s conflict with Georgia also prompted an exodus of foreign capital, and since then, things have continued to look bleak. In the first nine months of 2008, FDI decreased by 2.3% compared to the corresponding period in 2007.For 2009, The World Bank ranked Russia 120th out of 181 countries for ease of doing business. No doubt that cutting through red tape is the biggest challenge, particularly with regards to construction permits. For instance, 54 required steps to build a warehouse take an average of 704 days in Russia, in comparison to 13 steps and 137 days in France.The business environment in Russia could be characterised by strengthening state control, a slightly increasing transparency in procedures and a developing tax legislation. The business environment has indeed improved with the ameliorations in the financial system and in infrastructure.Investments in transportation until 2030 will reach four trillion euro. Russian Railways are planned to include high-speed trains (up to 350 km/h) linking Moscow with St. Petersburg and Sochi. Meanwhile, Russia’s major airports are all undergoing a much needed modernisation programme. This has been especially essential as Russian airports witness a major increase in passenger numbers. In August 2008, Moscow’s Domodedovo International Airport was the fastest developing airport in Europe.Overall, international arrivals to Russia in 2007 grew by 2%, reaching 22.9 million visitors. 9.7% of total arrivals were leisureorientated visitors, while 14.2% business visitors – hence the primary market for hotels. The remainder are considered private travellers, visiting relatives and friends (VRF). Leisure arrivals have experienced a concerning downward trend, with a decrease of over 8% in 2007. A major increase in accommodation and service prices is partially responsible for this decline. Some leisure source markets have shown a significant increase, such as Spain (+47%), Australia (+34%), Austria (+22%), the Netherlands (+16%), Canada (+13%) and Israel (+15%).Russia’s tourism potential has yet to be fully exploited due to hurdles, such as complicated visa application procedures and a lack of marketing and promotional campaigns in international markets. Where European countries spend an average of seven euros to attract one foreign tourist who will spend an average 1,000 euros, Russia spends only 0.69 euro cents. The importance of tourism is however rising and the government is adopting various initiatives to boost its impact. A new hotel classification system for example was recently introduced, consequently unifying accommodation quality standards and bringing them to an international level. Huge sums have also been injected into infrastructure developments, as well as marketing various regional destinations.A new challenging playground Accommodation undersupply, short payback periods and high average daily rates make the Russian hotel market a very lucrative business. Now, as economic difficulties cast a shadow over most parts of the world, the question remains, is this the right time to invest in Russia? Russia is currently suffering from a lack of hotel accommodation. According to the Federal State Statistics Service, in 2007 there were 5,917 accommodation establishments, 4,369 of which (187,000 rooms) are classified as hotels. Russia at the moment has 1.5 hotel rooms per 1,000 inhabitants, far behind North America’s and Europe’s 14 and eight rooms, respectively. Supply is also not heavenly spread across the country. Approximately 40% of all hotels are situated in the Central Federal District, with 3.4 rooms per 1,000 inhabitants in Moscow and the Volga Federal District.Furthermore, internationally branded hotels still have a relatively low penetration rate. Less than 10% of Russia’s hotels are actually managed by operators and around 40 hotels are internationally branded. Of these, only 10 are outside the main cities of Moscow and St Petersburg. “This illustrates the sheer raw potential for further growth and why we are so excited about the opportunities this market presents to us,” Mike Collini, Hilton Vice President Development for Northern Europe told HTR.A promising market for developersImproved accessibility from key feeder markets such as Western Europe and the US, combined with increased wealth and mobility of domestic travellers are all key factors for the growth in Russia’s tourism and hotel industry. Hotel supply is still very low however, and not growing at sufficient levels to meet domestic and international demand. In light of this, Hilton is one of many hotel brands who have identified Russia as a key market, with major plans for development. “We believe that Russia represents some of the greatest potential for hotel growth in the world today and we are certainly entering at a pivotal time in its economic development. Over the next ten years, we anticipate that we could see more than 70 Hilton Family hotels across key Russian cities and regional centres,” continued Collini.According to Collini, there is significant investment demand for both management and franchise business models, providing Russian corporations with the option of developing and operating hotels themselves. Catering for both the international and domestic markets, Hilton envisages that its new properties may also be part of mixed-use development schemes, very much linked to the overall strong domestic economic growth.“We will achieve this growth target by working with local developers and hotel owners, through a combination of management and franchise agreements, to rapidly grow our portfolio of brands. We are therefore looking to work with partners who understand the local market,” said Collini.Russia’s hospitality industry has indeed become an attractive prospect for real estate investors over the last six years, particularly as office and retail markets were saturated. Accommodation supply has in turn grown steadily. From 2002 to 2007, the number of hotels increased by 38%, i.e. an average annual growth of 6.7%.“Despite the prevailing economic situation, which will present challenges to all operators in Russia and worldwide, we remain cautiously optimistic about the Russian hospitality industry. Supply is still relatively limited and the Russian economy is still in catch up phase, with a lot of potential for development rates in excess of the more developed economies, so we believe that despite the shortterm challenges, our outlook particularly for the medium and long-term is still positive and the sector is still very attractive for existing and new operators in the industry,” explains Daniel Xuereb, Managing Director of International Hotel Investments (Benelux), owning company of Corinthia Nevsky Palace St Petersburg.To work with local development companies is not always an easy task, as remarks David Home, Director of Development, Russia and CIS countries for Wyndham International. “We’ve found that many local developers do not have the hotel development experience that exists in other countries and, as such, the development process needs to involve a lot of education about the industry as well as brand standards”.Accor’s Director of Operations for Russia and CIS, Alexis Delaroff is also optimistic: “We are one of the few companies that really believe in the Russian market. We have introduced contracts based on variable leases, contracts where Accor is a minority shareholder, without saying that on specific projects we can also look at some guarantees,” he said.Prime capital cityThe centre for most hotel developments is surely Moscow, with a 10%-15% annual increase in foreign arrivals. In 2008, there were originally 28 hotel projects planned in Moscow. Of these, 21 should be realised. Currently, Moscow offers only 75,000 beds, which is way too few for the expected increase. Moscow’s government has identified the problem of hotel supply de.cit, and it has adopted the Moscow Master Plan for Hotel Development. This initiative highlights the need of 556 hotels totalling 186,473 beds by 2010. And although the pace of hotel constructions has been rather slow, particularly in the midscale segment, many international operators have already signalled their interests to enter the market. Occupancy Rate (OR) reached 73.1% for the first 10 months of 2008, while ADR reached €288, an increase of 8.6% compared to the corresponding period in 2007 – an attractive prospect by any standards and much higher than other more mature European tourism destinations. In Paris for instance, ADR reached €169, in London €160 and in Berlin €106. Overall, Moscow achieved a very attractive RevPAR of €210.Regional growthAs competition on Moscow and St. Petersburg hotel markets becomes increasingly intense, especially in the upscale category, hotel developers, local and international, are turning to regional markets. These markets offer hotel investors potential activity from an increase in business travellers, as well as leisure tourism.“The Novosibirsk region, for example, has great potential for leisure and adventure tourism,” Economic Cooperation and Tourism Commit-tee of the region, Piotr Nechaev points out. Hotel supply in regional cities is still very limited. In fact, visitors are struggling to find a decent accommodation.There are only 10 hotels operated under international brands outside Moscow and St. Petersburg: Hilton Garden Inn in Perm, Holiday Inn in Chelyabinsk and Samara, Renaissance in Samara, Park Inn in Voronezh, Izhevsk and Yekaterinburg, two Radisson SAS in Sochi and one in Rostov-on-Don. The remaining hotel supply is left-over from the Soviet era, with low service standards and high prices due to lack of competition. With 11 cities of over a million people, economic growth and an improving standard of living, the potential is vast. “Due to the lack of quality hotel guestroom supply, pretty much all the regions have very strong potential for development,” remarks Arild Hovland, Senior Vice President Business Development Rezidor which currently stands at 27hotels and over 7,300-guestrooms open or under development.Nizhny Novgorod is one of the favourite regional cities for investors. The city currently lacks approximately 4,500 rooms, in all categories. This gap will be partly filled by such projects as Novotel and Ibis opening in 2009 and Kempinski Plaza, planned for 2011. IHG is also introducing its brands Crowne Plaza and Staybridge Suites.Other cities with enormous potential include Yekaterinburg, Rostov-on-Don, Sochi, Kazan, and Novosibirsk, the third-largest city in Russia.Identifying hurdlesWhen opening a hotel in a regional city, operators should count on a lower OR compared to the capital. In addition, foreigners are often forced to create partnership with local companies to be able to navigate through multiple bureaucratic obstacles.However, regional administration is often very interested in cooperation with investors. In some regions, where tourism development has been prioritised, local authorities have implemented incentive programmes to encourage investors. Tax reliefs and subsidies to cover a part of the interest costs on loans taken for project development are also available.Bureaucracy and a complicated legal and tax environment are other challenges investors can expect to face, of course other than the current global economic turmoil."If opening a hotel was so easy, Russia would not have such a small number of new hotels on its vast territory. So yes, indeed, opening and running a hotel in Russia remains challenging,” stated Delaroff. “This is due to the fact that such contracts as Management Agreement are not typical in Russia and require a lot of teaching and confidence to be run properly. Bureaucracy and complicated legal and tax environment are also factors that are slowing the process. When comparing to 1997, things of course are improving. But improving does not mean perfect.”Then there are some challenges, transformed into opportunities. These are what investors should capitalise on, i.e. once high construction costs and cost of land.Local brandsTimes have changed since the one state-owned hotel chain, Intourist (managing 450 properties across the USSR). Now, the domestic market is dominated by such brands as Heliopark, Azimut and Intourist. Among the lesserknown chains include Alrosa Hotels, Amaks Grand Hotels and Maxima Hotels – mostly represented throughout Russia’s regional territories.Although all of these companies have some ground to catch up on international brands known to the rest of the world, progress is being made. Over 800 independent and chain hotels in Russia and other CIS countries have united under the Best Eurasian Hotels marketing brand (formerly Best Eastern Hotels), in order to be present in the various global travel distribution systems (GDS), online booking sites, and travel exhibitions.Many owning companies have also announced their expansion plans. Their strategy is to purchase old Soviet style properties and upgrade them to 3and 4-star hotels. Umaco, owner of Katerina City in Moscow and Katerina Alpik Krasnaya Polyana in Sochi is one of these brands who is planning to finance future hotels partly with own means. Within the next 10 years, the group plans to develop three brands: Katerina City, Katerina Infra and Katerina Inn.With the rise of local brands and the growing interest of international chains, Russia promises to be the world’s next playground for hotel investors. And although the current economic crisis has hindered the pace of development (as it has in the rest of the world), new opportunities have emerged, suggesting that the right time to enter the race might be now. Sochi – a year round destinationEven before Sochi was announced as host of the 2014 Winter Olympic Games, the Russian Government adopted a €9 billion initiative to develop the city as a mountain and climatic health resort. This has in turn stimulated additional investment and boosted the region’s economy. In 2007, investments into the region increased by 26%, reaching €6.5 billion. Krasnodar is one of the most dynamic regions in Russia, enjoying one of the fastest GRP growth rate. In terms of infrastructure, the region now boasts 3 international airports, 8 seaports, and Southern Russia’s largest railway hub. Recent infrastructure projects include significant improvements and construction of new roads, extensions to Sochi airport, to be completed early 2009, as well as relocation of railway lines and stations, thus creating additional space for numerous hotels and resorts. In addition, a new sea cargo port, currently under construction and to be completed in time for the Olympics, will be converted into a cruise passenger port, able to handle 150-200 cruise liners per year and a marina.A need for new hotelsCurrently, there are 18 resort zones in the Krasnodar region, with a total 485 accommodation establishments, including 219 hotels (as of end 2007). Of these hotels, there are 38 4- and 5-star hotels. There are only 2 internationally branded hotels, both operated by Radisson SAS – Lazurnaya and Lazurnaya Peak Hotel. However, other international groups, such as Starwood, Accor and IHG have expressed interest for this destination. Indeed, Krasnodar offers enormous potential for prospective hotel developers, as current accommodation supply is of low quality standards, whilst demand is increasing. The 2014 Winter Olympic Games will also certainly ensure a boost in hotel demand, in preparation, during and even post the event, as it will cement the destination’s position not only on the Russian market, but also globally.Tourism development strategy in RussiaHTR interviewed Ms Nadezhda Nazina, Director of the Tourism Department of The Ministry of Sport, Tourism and Youth Affairs of the Russian Federation and Mr Evgeniy Pisarevsky, Deputy Director of the Russian Federal Tourism AgencyHTR: What role does tourism play in Russia’s economy? Nadezhda Nazina: Tourism, being an export oriented industry, performs better than other sectors during an unstable world market. According to WTO, tourism revenues reached 6.7% of GDP in 2007. The industry employs directly or indirectly 5.7% of total employed population in Russia.HTR: What are Russia’s tourism development objectives? Evgeniy Pisarevsky: Tourism development objectives are outlined in the official document called The Russian Tourism Development Strategy 2015. What Russia’s tourism industry needs most of all is comprehensive legislation that would regulate the activities of all tourism sectors. This legislation should clearly differentiate the powers of the public institutions and responsibilities of the administration on a federal, regional and local level. That is what concerns the normative basis. If we speak about numbers, our objective by 2015 is 36 million international arrivals and 14,000 hotels, compared to 25 million international arrivals and 6,700 hotels forecasted for the end of 2008. Meanwhile, tourism exports should reach 43 billion.HTR: How do you see the development of Russia’s hospitality industry and what incentives does the State offer in order to attract investments into this sector? NN: It is true that the hotel sector is the foundation for tourist product development. Today, we need to solve the problem of the undersupply in the midscale category. Federal special pur pose programmes, such as ‘Russian South’ and ‘Far East and Transbaikal socio-economic development’ support the development of the hospitality industry, among other sectors. Development of tourist and recreational special economical zones is another tool to promote the hotel sector, especially in regional areas. In these zones, the State finances infrastructure, engineering networks and energy supply, with the purpose to create favourable conditions for the development of the tourism and hospitality industry.HTR: Can international visitors expect easier and more flexible entry visa procedures? EP: Certainly, this has been one of our priorities. We are in the process of simplifying visa procedures for EU citizens for certain categories of visitors, and in fact, in dialogue with the EU to entirely wave visa requirements. The list of visa-free countries is continually expanding. Recently we signed an agreement for visa-free movements with Brazil and will soon implement this with Argentina. HTR interviewed Colette Ambiehl, Senior Consultant at MKG Hospitality’s Cyprus office that specialises in market studies for Central and Eastern Europe, as well as the Middle East.HTR: What are the most remarkable transformations that you have noticed in the Russian hotel market over the last few years? We have seen that most international hotel operators are either already present in Russia or willing to open hotels there. Accommodation supply in Russia is continually increasing, in terms of number, quality, as well as variety. In the past, hotel groups were coming to Russia with their upscale brands, now we hear more and more about midscale hotels in Moscow and in the regional Russia. At the same time we have noticed an increase in professionalism and quality-of-service from Russian-based hotel chains. Expansion into the regions is another noticeable trend, with enormous potential for development for international and domestic brands.HTR: How will the Russian hospitality industry react to the current financial crisis? At the moment there is a slowdown in hotel activity. The winter promises to be difficult for hotels, as companies are beginning to cut down on expenses and travelling less. Occupancy in Moscow’s midscale and upscale hotels in November 2008 was 70.6%, versus 74.9% in November 2007. However, Moscow is still an expensive destination. ADR in midand upscale hotels reached €294 in November compared to €279 during the same period in 2007. As room supply still reveals a strong deficit, we do not expect a significant decrease in room rates.HTR: How will Russian overall economy be affected by this crisis? Russian economy heavily relies on exporting primary commodities. These feed the economy when prices are high, but during crisis situations like what we are experiencing today, Russia has few tools to fall back on. We can say that the country has put all of its eggs into the same basket. Economic diversification is needed and tourism is one of the sectors that could become a goldmine for the country during difficult periods and indeed in the year ahead. Tourism and hospitality is still very much in its infancy in Russia and proposes enormous potential. It is surprising to see that a country with such rich cultural and historical heritage, as well as natural beauty has no tourist offices abroad to promote its offerings. Of course the next few months will be difficult, but we believe that in the mid- to long-term future, with improvements in infrastructure and in hospitality supply, as well as additional marketing and promotions, Russia can become a very popular destination. What about the crisis?There is no doubt that the financial crisis is influencing Russia’s economy. HTR has gathered opinions from highprofiled international developers on how it will affect the country’s hospitality industry. Russia’s size and tourism potential, as well as its critical undersupply of hotels makes confidence a number one priority.Mike Collini - Hilton Hotels Corporation, Vice President Development Northern Europe This is without a doubt a challenging time for the industry and we must respond to this by operating in a leaner and more efficient way. The hotel industry has proven to be a cyclical one and the longer term outlook is more positive. We are not alone in this situation and hotel companies are looking at all areas of the business – from hotel, area and regional level, where we can proactively introduce a range of strategies and initiatives to sustain and improve our performance. Demand for hotels in many markets like Russia continues to outstrip supply.Marcel Lindt - Orco Property Group, Acquisition Manager The financial crisis has certainly had a major impact on Russia’s hospitality market. Many developments that were well on the way have been stopped, whilst others that were planned have been put on ice for now. For us, this means that a number of projects where we were in advanced discussion to operate a hotel were put on hold or discussions have simply slowed down because securing financing became a higher priority than selecting an operator. However, we believe that by signing a good and experienced operator to manage the hotel, securing financing should become easier.Arild Hovland - Rezidor, Senior Vice President Business Development As with all industries, naturally we have seen a softening of development demand but less to do with the crisis but rather the restriction of the credit markets and excessive borrowing rates. Ironically, the crisis actually provides quite incredible opportunities in our sector. Now the cost of land, even prime sites has dropped significantly and huge savings can be made on construction which more than offsets the cost of debt finance. The fundamentals of undersupply (or even zero supply) of quality bed stock in pretty much all major Russian cities remain the same, crisis or no crisis.Frank Fiskers - Scandic Hotels, President and CEO The downturn in business conditions, which is affecting the whole of Europe right now, will of course take its toll on the hotel industry. In Russia, the negative impact from the recession is partially counteracted by the underlying structural growth in the hotel industry. Even though the development might be somewhat haltered for a while, there is long-term growth predicted for both corporate and leisure travel in Russia, which will benefit the hotel industry in the long run.
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