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Hotel REIT India Prospects?

Friday, April 5, 2019, 16:14 Hrs  [IST]

After the first REIT IPO for commercial real estate in India took off successfully, over-subscribing by 2.6 times, there is a curiosity in the various sub-segments of the Real Estate sector, including hospitality, about the feasibility of dedicated REIT for different asset classes. While Hotel REIT as an investment vehicle is quite popular in many developed markets, experts in the hospitality industry in India feel that the hotels as asset class in India is still not matured to evoke interest in retail investors because of the current regulatory framework as well as the inability of the hotel assets to deliver a guaranteed fixed returns to the investors.
P Krishna Kumar tries to understand the sentiment about Hotel REIT in the Indian scenario….

Real Estate Investment Trust (REIT) is a type of investment vehicle that pools investors’ funds to purchase real estate assets, which can ultimately be traded in the stock exchanges once, get listed. REIT as an investment fund although quite established and popular in developed markets, it is something new to India. The first draft guidelines for REIT was prepared in 2008 by SEBI (Securities and Exchange Board of India) and it took more than a decade and many amendments before first REIT got formed in the Real Estate sector. In the last few years, several amendments were made to make REITs an attractive investment option. Last among them, according to experts in the financial sector, made REIT make major headway, was the decision to reduce the minimum investment limit from INR 2 lakh to INR 50,000 in March this year.

Although there were apprehensions and speculations about how REIT would be received by Indian retail investors, the overwhelming response to the first REIT IPO concluded recently by Embassy Office Parks’ put to rest all such apprehensions. The Embassy Office Parks REIT IPO, backed by global private equity firm Blackstone Group LP and Bengaluru-based developer Embassy Property Developments, aimed to raise INR 4,750 crore by issuing shares at INR 299-300 apiece. If the reports are anything to rely upon, the IPO was subscribed 2.15 times by institutional investors and 3.10 times by non-institutional investors. Reports indicated that the market was taken by surprise by the response evoked by the first REIT IPO when the overall investment market was gruelling under uncertain investment climate for some time with many firms put on hold their IPOs.

While in the commercial real estate REITs, the major chunk of the funding goes to fund more fixed revenue generating infrastructure facilities like offices, retail spaces, etc., the hotels and other spaces get only minor attention. Even in the Embassy Office Parks REIT IPO also, the portfolio has a pretty large commitment for the Grade A office parks and city centre office buildings to the tune of 32.7msf.

Internationally, there are dedicated REIT for hotel asset development with a varying degree of success and failures. In the US market, hotel REIT operates its hotel portfolio under diversified collection of franchise agreements, cross the country. There are big and small listed funds which operate in the market. Hotel REITs is said to have delivered better results to investors than many other real estate securities during the boom period in the US. Equally significantly, it was the hotel stocks that fell the sharpest when the financial market fell after 2008.

Assessing all these scenarios, what is the scope and prospects of dedicated REIT for a hotel in the Indian scenario? Many hotel industry conferences in the past discussed the issue of Hotel REITs inconclusively because of lack of clarity on many aspects related to the framework. Now, with the first commercial real estate REIT coming off, it’s appropriate to ignite a new round of discussion on the topic.

Prospects of Hotel REIT:
The industry watchers feel that the hotel industry in India is not yet ready for REIT funding due to factors both regulatory and also inherent in the business. REIT as an investment model is also new to the retail investors in the country and has to develop a certain level of confidence in it. The “Indian Hospitality Sector is currently not ready for a pure play hotel REIT listing given the subdued yield the sector is delivering which is not likely to provide adequate returns to investors. However, mixed-used REITS like the one listed by Embassy which also includes Hotels are likely to find favour going forward as the mix of real estate asset classes and a reasonable blended of return on investment could find favour in this differentiated real estate investment product,” said Mandeep S Lamba, President – South Asia, HVS Anarock India. “All eyes are on the first listed REIT and how it gets valued by the stock market in the next couple of days. This could well be the instrument that unlocks the much-needed capital for the stressed real estate sector,” he added.

Expressing similar sentiments, Jehangir Homi Aibara, Director, Aibara & Mahajan Advisory LLP said that although REITs would be a big boon for hotel assets given their lack of liquidity, it will take time for investors to develop confidence. “Given the il-liquidity of hotel assets REITs would be a major benefit for asset owning companies. It may take retail investors some time to understand investing directly in hotel REITs in contrast to the more cash flow stable commercial counterparts,” he observed.

Saurabh Gupta, Managing Partner – Investment Advisory & Asset Management, Hotelivate was quite straight-forward in his observation. He feels hotels as an asset class is not matured to evoke investments under REITs. “REIT is a form of raising equity from the market. Any asset that produces income can make sense for REIT. As of now REIT laws seek a very high degree of fix income safety for investors. A hotel as an asset class cannot guarantee a fixed income on a regular basis. As rates vary on an everyday basis, guaranteeing a fixed income to investors is challenging. As of now, there is no possibility for a dedicated REIT and it is not matured right now because of the fixed income clause. “

“Maybe a long ways to for hotel REIT as the secondary market in India not yet matured and huge mismatch of expectation due to valuation disparity. I feel both the sellers and buyers need to be practical while valuing the hotel asset. Till such time the secondary market will not develop and therefore, very difficult for REIT to succeed,” said Ashwin Mehta, Managing Director, Pankti Management Consultancy.

But Shwetank Singh, Vice President – Development & Asset Management, InterGlobe Hotels is not giving hope. He sees the prospects of a Hotel REIT get listed sooner than later. “Since REITs need to ensure that 90 percent of net distributable cash is distributed as dividend, it would necessarily need to have a portfolio of highly profitable hotels, which doesn’t need to retain cash on the Balance Sheet for future CAPEX, to come together and go for a listing and distribute returns for the investors through a REIT. We see the Indian markets are opening up and REITs like Embassy getting huge investor confidence, and we believe that REIT structure for Hotels may soon become a reality.”

How would REIT change the relationships??
Will REIT bring any change in the current owner-management relationships, strategies in terms of pricing, etc. in the short and long term? What kind of efficiencies that the ownership model will bring to the table? Although it is too early, experts do not see much of a change in the owner-brand relationships or other strategies with the advent of REITs. But at the same time, people believe that it would demand more professionalism and accountability because returns are quite key under REIT model.

Responding to it, Gupta from Hotelivate remarked that REIT is not concerned about “running of hotels” but about “returns”. However, REIT can reduce the debt exposure of a hotel asset in the initial ramp-up stage, and therefore ease the pressure on the GMs in the initial years. Generally, the GMs are under tremendous pressure in the initial years to ensure cash flow to service the debt, he said. “The core of any business is to make the profit. It is the same for hotels. Even owners who set up hotels to show off their wealth, after a couple of years realise this fact and look for revenues out of it. Therefore, REIT doesn’t change anything.”

Ownership involvement would become a lot more professionalised and we could see cash flows driving decision making in comparison to single owner whims, said Aibara commenting on the efficiencies. “Institutional ownership will certainly demand higher levels of accountability.”

Giving an account of the international practices under REIT, Singh from InterGlobe Hotels observed that it will be a “motivator for both owners and operators” to work under REIT. “In overseas markets, they generally keep the Prop Co and Op Co model wherein the business is separate from the asset, whereas in India, it’s usually the same company or various SPV’s running their individual operations. So, we can look forward to some structural changes that Hotel owners might be doing to make their ownership and operations in a separate company to have an advantageous model with the emergence of the REITs. Hotel Management Companies would be looking up to the challenge to deliver higher profitability, so that not only is the business more profitable, it is able to generate a higher return to the Prop Co, which would ultimately be distributing the returns to the Owners / REIT investors.”

Impampact on Valuations:
With REIT taking shape, industry-watchers foresee more prudent valuation decisions shaping up in the hospitality sector. The valuations of hotel assets will be more based on the cash flows rather than assumptions and gut feelings.

Reacting on the impact of Valuations, Gaurav Sharma, Vice President - Investments, SAMHI Hotels Private Limited, said, “Entry of REITs may lead to increase in valuations for core assets in the short term, due to increase in demand from institutional investors/aggregators looking to assimilate REIT-able portfolios. This would be limited by the availability of transact-able high- quality core hotel assets. However, over medium and long-term hotel REITS will push valuation closer to the income potential of the assets. As REITS allow more participation of public capital (characteristically targets a more conservative return than private equity and same is reflected in higher trading multiples applied to the valuation of publicly listed companies) this access to a larger pool of public capital would decrease yield expectations of stable hotel assets (in comparison to Private Equity).”

“I do not see much impact on Valuations as in a long-term REIT will function in its normal way, i.e., on a yield basis. In the short term, some large player may be on a buying spree to create a portfolio which can be encashed via REIT. However, valuations for the hotels which are performing will improve as they will get higher multiples of earnings,” informs Mehta of Pankti Management Consultancy.

Commenting on Valuations, Aibara expects valuations start becoming more cash flow driven than replacement cost driven. I see REITs playing a big role in helping mature the Indian hotel transaction market where present buyer-seller mismatch is high.

Predictions on first Hotel REIT in India:
As of now, the overall sentiment is to wait and watch, and in the meantime ride piggy-back on the larger real estate REIT as a sub-segment. No one is ready to bet on how soon India will see a dedicated Hospitality REIT. “Most of the existing large hotel asset portfolios are nearly all listed on the equity markets. Given the investment that it takes to build such a large hotel portfolio, and the time a hotel takes for ramping up and being highly profitable, a hotel REIT may be some time away,” feels Singh.

“It’s beyond our imagination. Currently, SEBI norms maintain that 80% of the market value of a REIT should be derived via existing income producing assets like offices/ retail stores. Only 20% of the value is towards a host of infrastructure amenities including hotels. Hence, at present, this is like a small side door for equity infusion in hospitality. Over time, we expect SEBI to relax these norms and that will assist hotels to raise equity from REITs on their own merit; just like how they do in developed nations like Singapore, United States, and others,” commented Gupta.

But Sharma from SAMHI has a different take on the prospects especially in the wake of positive developments in the Indian industry. “Professionally managed institutional investors like Blackstone and SAMHI possess high-quality portfolios of hotel assets in the country. Further, consolidation has also been gaining momentum, with ongoing transactions like Brookfield Leela and acquisition of Keys portfolio by Lemon Tree Hotels on the anvil. The increasing institutional ownership indicates Hotel REITs, which offer an attractive exit mechanism to financial investors, may not be too far from the horizon.”

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