Bad news for hospitality industry
There is so much interest on the “Ill-health” of the real estate industry, that almost everyday I get a couple of queries from the print media, for “bytes” on some story they might be doing.
Knowing some of the compulsions of the media, I am sure that the story in entirety is not always published. I thought a good idea to carrry my answers on my blog, without any pulls & pressures.
Here was my e-mail reply to a Journalist from a leading business daily.
A large number of developers have opted to to sell off their hotel projects, land assets or other commercial projects in order to raise funds. The list includes the realty biggies like the DLF, Unitech, Parsvnath as well as other smaller developers.
Most developers, during this liquidity crunch, would like to either defer development, or encash the land / Project assets which are locked in, and seek further infusion of funds. To our assessment, projects which would not generate positive cash flows, during the construction phase would be the first to be exited. Hence, residential projects would still move forward, depending on the projected demand and consumer interest in the particular locality / vicinity. Hospitality projects announced by developers, either as part of their larger development, or stand-alone, would be sacrificed as it is capital intensive, and would not deliver cash flows for the construction and development. Also, most of these assets would have been capitalized based on an inflated revenue assumption earlier. Those assumptions are no longer relevant.
Let us not forget that the valuations and investments into Hospitality projects are based on the revenue flow & cash flows projected over a 5-7 years window. Those numbers are being furiously re-calibrated downwards from the assumptions pre-2008.
However, in the ongoing economic slowdown, do you think there are enough buyers who would be interested in buying out these assets. Further, even if there are buyers will the developers get correct valuation? (is it not possible that the properties get grossly undervalued) – Like in any market, there would be buyers for deals at the correct OR distress valuation. A fair valuation would take into account three important factors – Cost of land, cost incurred towards approvals, projected cash flow. Developers who entered into the projects between the last qtr 07 to Jun 08 would be the most seriously hit. Their valuation would be eroded by more than 30% over the business plan numbers. Hospitality projects, part of larger townships, instead of standalone acquisitions, would still fetch reasonable returns to the developers. (since the land would have been acquired at a better average price. On a realistic basis, most acquisitions during these times would get acquired at a value lower than the expectations of the developers / Land owners. Let us also not forget that the reason for putting these assets on block is liquidity. Hence, the investor / Liquidity provider would build in a safety net for their IRRs in the transaction, which would bring down the valuation lower than the expectation of the developers.
Also, besides the developer and the investor, there is the third partner in the hospitality project, namely, the Operator OR hotel brand. The valuation is dependent on their outlook, projections, character of the product and the strength of the brand.
Most operators are re-calibrating the average Tariff per room nites & occupancy rates downwards, which would negatively affect the valuations expected by the developers.
Do you think that putting assets on sale is the right strategy for a developer to tide over the present crisis? If not, then what should they do to improve their finances?
Though there can’t be one thumb assumption for all projects, it would be a wise strategy to sell out assets and not incur the cost of money towards the same. The strategy followed / to be followed by each developer would be unique, depending on the projects awaiting funding for completion, and the cash flows from existing projects. There are indications that even residential projects are on the block, wherein the developers are willing to guarantee an IRR or safety net on the top line realization in excess of 25%.
I do not think that developers under liquidity squeeze should equate the sales of these assets akin to selling of family silver. They should view it as sell off of surplus availability, or sales of non strategic assets.