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Optimistic Outlook For Malaysia’s Industrial Property Sector

Bar chart showing Malaysia’s property transaction volume in 2017 (in number of units). In 2017, Malaysia property transactions in number of units were as follows: Residential 194,684 units, Commercial 22,162 units, Industrial 5,725 units, Agriculture 70,290 units, and Development Land and Others 18,963 units.

Demand for Malaysian industrial real estate could rise further driven by a resilient manufacturing sector and ASEAN’s growing e-commerce market.

Accounting for just 1.8% of Malaysian property transaction volume and 8.3% of transaction value, industrial properties contribute the least to Malaysia’s property transactions by volume and value according to data from Malaysia’s National Valuation and Property Services Department’s (JPPH) Property Market Report 2017.

Bar chart showing Malaysia’s property transaction volume in 2017 (in number of units). In 2017, Malaysia property transactions in number of units were as follows: Residential 194,684 units, Commercial 22,162 units, Industrial 5,725 units, Agriculture 70,290 units, and Development Land and Others 18,963 units.

Bar chart showing Malaysia’s property transaction value in 2017 (in millions of Malaysian Ringgit). In 2017, Malaysia property transactions by value were as follows: Residential RM 68,467, Commercial RM 25,439, Industrial RM 11,642, Agriculture RM 13,501, and Development Land and Others RM 20,794.

However, with Malaysia’s residential and commercial property sectors facing oversupply issues, the country’s industrial property sector may offer better prospects; Malaysia’s manufacturing sector is resilient (contributing 23% to GDP in 2017 and accounting for 15% of 2017 FDI inflows) which suggests industrial properties for manufacturing and warehousing could offer investment potential, and the country’s ecommerce market is booming which could open opportunities for industrial real estate in areas such as logistics and warehousing. In particular, larger storage space near ports and airports, and smaller warehouses located close to urban areas could see an uptick in demand, as distributors look to establish fulfillment centers close to their customer base in an effort to shorten parcel delivery times to online shoppers.

An example of this is when real estate private equity and advisory firm Area Management Sdn Bhd announced its plan to set up an inner city distribution hub in Kuala Lumpur. The warehouse which will have 1.2 million sq ft of warehouse space will be located in Hulu Kelang, in the town of Ampang, just about 10 minutes away from KLCC.

Such investments in industrial property could be just the beginning. ASEAN’s e-commerce market is booming, yet with e-commerce accounting for just 2% of the region’s total retail sales, (this is lower than the average worldwide which saw 10.2% of total retail sales coming from online sales in 2017 according to eMarketer). Singapore has the highest e-commerce penetration with 5.4% f total retail sales being made online, followed by Malaysia at 2.7% according to a report by Maybank Kim Eng Research suggesting ample room for growth. Research by Google and Temasek forecasts the region’s e-commerce sales to grow at a CAGR of 32% from US$ 5.5 billion in 2015 to reach US$ 88 billion in 2025, when they will make up 6% of total retail sales in the region. Management consulting firm A.T. Kearney expects Malaysia’s e-commerce market to grow 23% annually until 2021 according to a 2017 report.

Furthermore, as intra-ASEAN trade grows and consumption increases stimulated by rising incomes among ASEAN’s 600 million plus population (larger than that of North America and the European Union), logistics demand in the region is poised to grow. Malaysia’s strategic geographical location, and its strong infrastructure network puts it in prime position to emerge as a logistics hub for the ASEAN region. Malaysia’s infrastructure is second only to Singapore among ASEAN countries according to a report by the World Economic Forum.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

A number of multinationals looking to capitalize on Southeast Asia’s emerging markets have already spotted Malaysia’s logistics potential. Swedish furniture company IKEA has selected Malaysia to be its ASEAN logistics hub and the company will be investing nearly a billion Malaysian ringgit to establish a regional distribution and supply chain in the country in what would be among its 10 biggest regional distribution centers globally. E-retailer Zalora has invested RM 20 million building a regional e-fulfillment hub in Malaysia and Chinese e-commerce giant Alibaba (NYSE:BABA) has selected Malaysia’s commercial capital Kuala Lumpur as one of the company’s five global hubs with the others being Hangzhou, Dubai, Liege and Moscow. French automaker Groupe PSA has selected Malaysia to be its ASEAN hub and Chinese tech giant Tencent (HKG:0700) has selected Malaysia as its ASEAN data center hub.

West Malaysia – Central Region

Selangor, Malaysia’s most prosperous state and the top contributor to Malaysia’s GDP (accounting for 22.7% of Malaysia’s GDP), dominates Malaysia’s industrial property market, boasting about 35% (or 39,139 units) of Malaysia’s industrial properties. Selangor is followed by southern region state Johor (16,117 units) and northern region state Penang (9,057 units).

Boasting logistics hubs such as Port Klang (Malaysia’s busiest container port), Shah Alam, and the upcoming KLIA Aeropolis, the state of Selangor, Malaysia’s richest state, shows potential to be developed into a regional logistics gateway to the ASEAN region thereby supporting ASEAN international trade. For instance, Swedish furniture retailer IKEA set up a new regional distribution and supply chain center in Pulau Indah Industrial Park in Port Klang, which will serve IKEA stores throughout the ASEAN region.

Port Klang is Malaysia’s busiest port and the world’s 11th busiest port according to the World Shipping Council. Although the formation of a new global shipping alliance, the Ocean Alliance, in April 2017 saw a number of carriers shifting from Malaysian ports to Singapore ports, resulting in a 10% drop in Port Klang’s container throughput, and with the rise of competing ports in the region such as Ho Chi Minh City and Jakarta further eating into Port Klang’s share of transshipment volumes (which account for over 60% of Port Klang’s volume according to data from the Port Klang Authority), Port Klang, ASEAN’s second biggest port, is still expected to remain as a secondary transshipment hub, second only to Singapore.

Thus, the current limited supply and higher prices of industrial land in Port Klang townships such as Pulau Indah is likely to persist. Last year, a land transaction in Pulau Indah topped the list of Malaysia’s highest industrial real estate transactions by value when a 274,413 sqm vacant plot in Pulau Indah Industrial Park sold for RM 112 million according to data from the National Property Information Centre (NAPIC).

With Malaysia’s first Digital Free Trade Zone being set up in KLIA Aeropolis, Port Klang has been identified as a potential location for another new Digital Free Trade Zone, industrial real estate demand in Port Klang as well as the surrounding area could see further increases.

Companies moving in to capitalize on the opportunity include Sime Darby (KLSE:SIME) and Japan’s Mitsui (TYO:8031) which have announced a partnership that would see the development of industrial facilities on 39 acres of land at Bandar Bukit Raja in Klang (about 20 kilometers away from Port Klang) with an estimated gross development value of RM 530 million.

Selangor is among the fastest growing states in Malaysia, with much of that growth driven manufacturing, services and agriculture (this compares with Kuala Lumpur where growth is driven by services).

Bar chart Malaysia’s economic growth by state in 2017. Sabah was Malaysia’s fastest growing state with a growth rate of 8.2%. Sabah was followed by Melaka (8.1%), Pahang (7.8%), Federal Territory of Kuala Lumpur (7.4%), Selangor (7.1%), Johor (6.2%), Labuan (6.1%), Terengganu (5.9%), Perak (5.5%), Penang (5.3%), Kelantan (5.0%), Kedah (5.0%), Negeri Sembilan (4.9%), Sarawak (4.7%), and Perlis (2.3%). Malaysia as a whole registered a GDP growth rate of 5.9% in 2017.

Shah Alam, the state capital of Selangor, is a popular manufacturing hub, located about 20 kilometers away from Malaysia’s biggest container port, Port Klang, 50 kilometers away from Kuala Lumpur International Airport and about 30 kilometers away from Malaysia’s vibrant city center Kuala Lumpur. This makes Shah Alam an attractive location for manufacturing, warehousing and distribution activities, and the city already boasts a number of high profile occupants including German logistics company DHL which maintains a supply chain logistics hub in Shah Alam,

Yet, as Malaysia’s burgeoning e-commerce market continues to grow, Shah Alam could see rising industrial real estate demand as its advantage of being strategically located close to Selangor’s key airport (KLIA), sea port (Port Klang) and being located within Malaysia’s Klang Valley (one of Malaysia’s most advanced retail markets) lure multinationals and e-commerce companies looking to establish warehousing, e-fulfillment and distribution facilities to tap into ASEAN’s growing army of online shoppers.

Suggestive of this potential, Singapore-based property developer Aspen (Group) Holdings Limited (SGX:1F3), has diversified into logistics, having acquired a 71 acre industrial land in Shah Alam which will be developed into an integrated logistics, warehousing and e-commerce hub.

FM Global Logistics (M) Sdn Bhd, a subsidiary of Malaysian freight services provider Freight Management Holdings Bhd (KLSE:FREIGHT) is developing an e-commerce fulfillment hub in Shah Alam.

Axis Real Estate Investment Trust (REIT) has acquired two parcels of industrial land in Shah Alam, for RM87 million.

Meanwhile DRB-HICOM (KLSE:DRBHCOM) has disposed of its non-industrial real estate assets in an effort to focus on industrial property development.

Fashion e-retailer Zalora selected Shah Alam to establish its e-fulfillment hub, fancying the industrial city’s merits of being close to the airport, the seaport and close to Kuala Lumpur where it has a large customer base.

Volvo, the Sweden-based subsidiary of China’s emerging automotive giant Geely (HKG:0175) announced that it is looking at making Shah Alam its export hub to serve the ASEAN market.

Malaysia’s KL International Airport is a 45 minute drive away from Malaysia’s leading container port, Port Klang, a 45 minute flight away from Singapore, a one and a half hour flight away from Bankok, Jakarta and Ho Chi Minh City.

Malaysian airport operator Malaysia Airports Holdings Berhad (KLSE:AIRPORT) is developing an air logistics hub, named KLIA Aeropolis, in a 404.7 hectare site surrounding the Kuala Lumpur International Airport. The airport city project is expected to attract RM 7 billion in foreign and domestic investments.

Having selected Kuala Lumpur to be its global hub along with five other cities, namely Hangzhou, Dubai, Liege and Moscow, Cainiao Network, the logistics arm of Chinese ecommerce giant Alibaba, is constructing the company’s first regional e-fulfillment hub outside China – a new distribution center in KLIA Aeropolis near the KL International Airport, as part of a wider agreement to build a Digital Free Trade Zone (DFTZ) which aims to facilitate SMEs to engage in cross-border trade. The DFTZ is scheduled to begin operations in 2020.

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Vietnam’s Industrial Real Estate Sector Holds Potential For Growth

Pie chart showing 2017 Foreign Direct Investment (FDI) into Vietnam by industry (% share). In 2017, 44.2% of FDI into Vietnam went into the Manufacturing and processing Sector, 23.3% into Power production and distribution, 8.5% into Real estate and 24% into other sectors.

With labor costs rising and regulatory requirements increasing in China (the current Factory of the World), Vietnam is rising as a manufacturing hub and is poised to continue doing soas the country’s advantages of being geographically located close to China and relatively lower production costs entice multinationals as well as Chinese manufacturing companies to relocate production facilities to Vietnam enabling them to serve the enormous and lucrative domestic Chinese market while reducing costs. In 2017, Vietnam’s manufacturing output rose 14.4% and 44% of FDI investment into Vietnam were channeled towards the manufacturing and processing sector according to data from the Vietnam Foreign Investment Agency (FIA).

Pie chart showing 2017 Foreign Direct Investment (FDI) into Vietnam by industry (% share). In 2017, 44.2% of FDI into Vietnam went into the Manufacturing and processing Sector, 23.3% into Power production and distribution, 8.5% into Real estate and 24% into other sectors.

The trend is likely to continue. China’s labor force is dwindling, (the country’s working age population, defined as those between 16-59 fell by 5.5 million last year to 901.99 million according to the National Bureau of Statistics), wages are rising (according to a study by Euromonitor, manufacturing wages in China have risen steadily over the past decade and are now on par with high-income economies such as Portugal and Greece), and changing policies (such as the government’s effort to move to high end manufacturing) have made regulations more stringent and subsidy programs reduced.

However, with China boasting top-notch infrastructure, a large talent pool, and extensive sourcing options among other reasons, the Middle Kingdom still retains its appeal as a manufacturing base for multinational and Chinese manufacturing companies; the trend is not of abandoning China altogether but either of moving production towards China’s interior where wages are lower, or of supplementing Chinese production facilities with outsourced facilities (particularly for labor-intensive, low-end manufacturing operations such as product assembly) from lower-cost countries such as Vietnam, a production model known as China+1.

For China, the world’s largest exporter, exports account for about 19% of the country’s economy. The United States is the single largest export destination of Chinese-made products absorbing about 20% of Chinese exports in 2017, and Asian countries such as Hong Kong, South Korea, Japan, Vietnam and India collectively account for about 45% of China’s exports. Unsurprisingly, the vast majority of China’s factories are strategically located in the coast, in areas such as Shanghai, Shenzhen, Ningbo, Qingdao, Guangzhou, and Tianjin where the majority of China’s key ports are located such as the Port of Shanghai, Port of Shenzhen, Port of Ningbo, Port of Qingdao, Port of Guangzhou and Port of Tianjin which are among the world’s busiest and largest ports. Much of China’s export products are transported via sea through these ports which are the origin points of key shipping routes such as the Pacific route, one of the world’s busiest shipping routes, which goes through the Pacific Ocean.

Thus, relocating to inner provinces may make sense for some manufacturers such as those with substantial domestic sales or for those with major exports to countries such as Central Asia or Europe as goods can be transported via a growing rail system which is part of China’s ambitious “Silk Road” logistics network. Chongqing for instance, an inland Chinese province which is gaining prominence as a hub for railroad shipments across Central Asia and Europe, has lured the likes of Hewlett Packard which shifted production to Chongqing as part of China’s Go West initiative and transports products such as motherboards and laptops to Europe via the China-Duisburg rail line which connects China to Germany. The railway line which originates in China, crosses Kazakhstan, Russia, Belarus and Poland before finally entering Germany, a distance of over 10,000 kilometers taking about 16 days to complete, considerably less than the 3 months or so transport time for container ships. Add in the lower transport cost, and the rail option beings to look very favorable for companies such as HP. Duisburg-China traffic has reportedly quadrupled since the service was established in 2011.

For others however, such as Intel, the Chine+1 production model whereby some production facilities are relocated to another country to supplement existing Chinese manufacturing bases may make more sense. Vietnam’s close proximity to China (port city Hai Phong in northern Vietnam is about 865 km away from Shenzhen, considerably closer than Vientiane which is 1,200km away, Bangkok which is 1,700km away, Jakarta which is 3,300km away, and Kuala Lumpur which is 3,025km away) low wages, relatively young population (the median age is 30), and improving infrastructure (including ports enabling access to Vietnam’s East Seam, one of the major shipping routes in the world), make it an attractive option for manufacturers migrating away from China. According to the World Economic Forum’s latest Global Competitiveness Index, Vietnam ranked 79th out of 137 nations in terms of infrastructure, ahead of Southeast Asian peers Philippines, Laos and Cambodia.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

This opens an opportunity for Vietnamese industrial real estate in the years to come. Vietnam’s industrial real estate market is at a nascent stage of development, and as Vietnam continues to grow its position as a new industrial powerhouse, the market holds considerably potential to expand as well. In 1986, just 335 hectares of land in Vietnam were dedicated to industrial parks. By 2018, this had grown to 80,000 ha a CAGR of over 18%.

Northern Vietnam in prime position to benefit from China+1 production model

Considered to be the ‘Number 1 option’ for manufacturers looking to move away from China, Northern Vietnam is poised to be among the biggest beneficiaries of the China+1 production model, which should drive demand for industrial property in the area. The China+ 1 model has been noted to be a major reason for Vietnam’s growing presence in global electronics supply chains with manufacturers such as LG, Samsung, and Nokia to name a few, maintaining substantial manufacturing operations in northern Vietnamese provinces such as Haiphong. This explains why manufacturers of computers, electronic and optical products account for the largest occupiers of industrial property in northern Vietnam according to JLL.

Pie chart showing Northern Vietnam industrial property, key occupiers by sector (%). By sector, the biggest occupiers of industrial property in Northern Vietnam were Computer, Electronic and Optical Products 25%, Machinery and Equipment 15%, Fabricated Metal Products except Machinery and Equipment 12%, Rubber and Plastic Products 7%, Chemicals and Chemical Products 6%, Other 35%.

According to CBRE Vietnam, rents in the northern region of Vietnam are expected to increase by 2% in 2018 and 1.5% in 2019 and 2020 while the vacancy rate is expected to drop to 19% in 2020 from 22% in 2018.

The North key economic zon (NKEZ) comprises seven cities/provinces; Hanoi, Hai Phong, Bac Ninh, Hai Duong, Hung Yen, Vinh Phuc, Quang Ninh. Of the seven provinces, Hai Phong and Bac Ninh boast the highest number of industrial parks in the country; according to JLL, as of March 2018, these two provinces accounted for 46% of total industrial land in Northern Vietnam and given their geographically advantageous location of being close to Vietnam’s seaports, these two cities are likely to continue seeing greater supply of industrial land.

Vietnamese city Hai Phong (located in northern Vietnam, 865 km away from China’s manufacturing hub of Shenzhen and about 100km away from Vietnam’s capital Hanoi) is increasingly emerging as a manufacturing and logistics hub with its increasing number of industrial zones (such as the VSIP Hai Phong Industrial Zone, the Nomura-Hai Phong Industrial Zone, and the Trang Due Industrial Zone), growing presence in Vietnam’s port system, and its direct rail line, the Kunming-Hai Phong railway, which connects Vietnam with China, with a transport time of about 9 hours.

Such economic merits have helped the city notch a 14.01% GDP growth rate in 2017, the highest since 1994, and twice the national average of 6.81%. During the first six months of 2018, exports turnover reached US$ 9.3 billion, a 25.34% increase compared to the same period in 2017. With numerous infrastructure developments taking place, from highways and bridges to port expansion projects, the city is actively working to increase grows its appeal as an alternative for manufacturers looking to shift production to Southeast Asia, potentially benefiting Hai Phong’s industrial property market.

Haiphong, already known for its existing port (which however is not a deep water port) is set to further strengthen its position as a rising logistics hub with its new Lach Huyen International Gateway Port (also known as the Hai Phong International Gateway Port) which was opened in May 2018; the new deep water port can handle around 300,000 20-foot equivalent units (TEUs) currently, and capacity is expected to expand going forward enabling the port to handle between 2 million TEUs and 3 million TEUs by 2019. Haiphong’s existing port handled 4.10 million TEUs in 2016 according to data from the World Shipping Council. Coupled with the new port’s capacity, Haiphong will be able to handle about 5 million TEUs, placing Haiphong on the same level as Vietnam’s leading port Ho Chi Minh City in south Vietnam which handled 5.99 million TEUs in 2016 according to data from the World Shipping Council.

Southern Vietnam

With its relatively well-developed infrastructure and favorable investment policies such as tax breaks, industrial property in southern Vietnam (the area surrounding Ho Chi Minh City which includes popular investment provinces such as Binh Duong, Long An and Dong Nai) have long been Vietnam’s industrial growth engine and remain as favored destinations for investors in Vietnam. Companies maintaining manufacturing operations in Southern Vietnam include Samsung, and Intel.

Companies adopting a China+1 production model may find southern Vietnam to be less appealing compared to northern Vietnam, particularly for time-sensitive manufacturing operations that require speedy transport of components between Vietnam and China.

Others however find value the area’s merits such as close proximity to Ho Chi Minh City, which boasts Vietnam’s largest commercial port – the port of Ho Chi Minh City, and Vietnam’s highest-earning consumer base (according to a 2017 report by VietnamWorks, employees in HCMC earn the highest average salaries in Vietnam at about 38% higher than the national average). This explains why a fair proportion of industrial occupiers in Southern Vietnam are in consumer-related businesses such as apparel, textiles and food processing.

Pie chart showing Southern Vietnam industrial property, key occupiers by sector (%) as follows: Machinery and Equipment 15%, Textile and Apparel 11%, Fabricated Metal Products (except Machinery and Equipment) 9%, Rubber and Plastic Products 9%, Chemicals and Chemical Products 8%, Food Processing 7% and Other 41%.

Yet, there is still potential for expansion. Southern Vietnam is general the preferred “launch market” for consumer products companies and as the country’s middle class population expands, demand for warehousing, distribution centers and manufacturing facilities should grow thereby driving industrial property demand. Already enjoying strong occupancy rates (occupancy rates in HCMC, Dong Nai and Bunh Duong Binh Phuoc stood at 77%, 85%, 88% and 85% as of June 2018 according to JLL) strong economic growth and continued growth in manufacturing activity is expected to continue driving industrial property demand with JLL forecasting industrial property in southern Vietnam to enjoy higher occupancy and rental growth over the next few years.

This year, US private equity investment firm Warburg Pincus formed a JV with Vietnam’s state-owned Investment & Industrial Development Corp (known as Becamex IDC, one of the largest industrial real estate developers in Vietnam owned by the government of Binh Duong province in Southern Vietnam) to develop industrial properties in Vietnam. The JV, known as BW Industrial Development JSC, was seeded with eight industrial property development projects across five cities in the North and South of Vietnam, including Binh Duong, Dong Nai, Hai Phong, Hai Duong and Bac Ninh. Warburg Pincus owns 70% of the JV.

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India Hotel Market: Long Term Growth And Opportunity

Bar chart showing India hotel transaction volume (in Indian Rupees millions), 2001-2017. In 2017, hotel transaction volume in India reached Indian Rupees 9,709 million, a four year low.

India’s hotel market is a growth market, and the country’s tourism and hospitality industry which contributed about 9.6% to India’s GDP in 2016, has emerged as a key growth driver of India’s service sector and thereby the Indian economy.

India’s hotel industry as a whole has been going through a relatively rough patch over the past few years with distressed loans from the sector jumping 63% over the past three years as a result of overinvestment, cost overruns, and high interest rates among other reasons, which have restricted capital flow into the industry and reduced hotel real estate transactions in the past few years.

 

Bar chart showing India hotel transaction volume (in Indian Rupees millions), 2001-2017. In 2017, hotel transaction volume in India reached Indian Rupees 9,709 million, a four year low.

However, there are numerous fundamental reasons to be optimistic on the industry’s long term prospects, particularly in the mid-scale and budget segment which have not been affected by the financial woes plaguing the luxury and upscale hotel segment. The Development Cost Per Key declines considerably the lower the hotel class, and coupled with robust demand from India’s growing wave of middle class domestic travelers, India’s mid-scale and budget hotel segments have been doing brisk business, a boon to their bottom lines.

Line chart showing the Average Development Cost Per Key in India (in India Rupees millions) by hotel positioning. The Average Development Cost Per Key in India for hotels in the Luxury, Upper Midscale, Upscale, Upper Mid Market, Mid Market, Budget, and Economy categories are INR 22.3 million, INR 14 million, INR 9.8 million, INR 7.2 million, INR 5.6 million, INR 3.5 million, and INR 1.7 million respectively.

India’s expanding population of middle class travelers have also helped boost Indian hotel occupancy rates which have been on an uptrend over the past few years, rising to 66% in 2017, the highest since 2007-2008, according to a report by hospitality consulting firm Horwath HTL.

Bar chart showing all-India hotel occupancy rates, FY 2013 - FY 2017 (E). Occupancy rates have been rising in India; during FY 2013, FY 2014, FY 2015, FY 2016 and FY 2017 (E) hotel occupancy rates were 58%, 59%, 61%, 64% and 66% respectively.

The momentum is expected to continue. However, with hotel demand exceeding supply (according to data from Hotelivate, Indian hotel demand is growing at around 12% while new supply is growing by up to 6% annually) and with hotel rooms per capita in India standing at just 18 per 100,000 people, considerably lower than China where there are 307 hotel rooms per 100,000 people, there is ample potential for expansion in India’s hotel sector driven by a growing middle class, rising disposable incomes, a growing fleet of low cost airlines and government measures to boost the country’s tourism industry such as the UDAN Regional Connectivity Scheme, and incentives such as the five year tax holiday offered for 2, 3 and 4 star category hotels located around UNESCO World Heritage sites (except Delhi and Mumbai) and the establishment of Special Tourism Zones. Further encouraging measures may be expected in the country’s upcoming Tourism Policy as the Indian government works towards its target of attracting 20 million Foreign Tourist Arrivals by 2020 and thereby addressing the country’s imbalance of outbound tourists being four times more than inbound tourists.

India is expected to be one of the fastest growing tourism economies over the next decade and the country is forecast to emerge as the world’s 3rd biggest tourism economy by 2028 according to a 2018 report by the World Travel and Tourism Council. According to forecasts by CARE Ratings, India’s hotel industry is expected to see an increase of 11-13% CAGR in room revenues during FY2017-FY2021. The Indian hotel market is projected to reach US$ 13 billion by 2020 according to a paper by FICCI-Yes Bank titled ‘Tourism Infrastructure Investments: Leveraging Partnerships for Exponential Growth’.

Unsurprisingly, global hotel operators are increasingly keen on expanding into India to grab a slice of the growing pie. International hotel brands already account for about half of India’s 123,000 branded hotel rooms, a dramatic increase in market share since 2002 when international hotel brands accounted for less than 20% of the 25,000 branded hotel rooms in India. By 2020, international hotel brands are expected to account for about 76% of India’s branded hotel room supply according to Patu Keswani, chairman and managing director, Lemon Tree Hotels.

Land scarcity and high development costs in Delhi and Mumbai are likely to encourage upscale hotel developers to focus on Tier II and Tier III markets

For several years after the global financial crisis in 2008, India’s luxury hotel sector struggled with an oversupply of hotel inventory and poor demand leading to lower occupancy and Revenue Per Available Room (RevPAR).

However, the tide may be turning as signs of a demand recovery and a limited supply pipeline push up occupancy levels, particularly in India’s top two hotel markets, Delhi and Mumbai where occupancy rates reached 75% and 70% respectively during 2016-2017, thanks to increasing business and leisure travellers, and a muted hotel room supply.

During the year ended March 2017, new hotel rooms in Delhi increased by just 1.1% compared to a CAGR of 5.3% over the past decade. The situation is the same in Mumbai where new hotel rooms increased 3.4% in 2016-2017, compared to a 5.3% growth over the past decade.

Bar chart showing the number of hotel rooms in Mumbai and Delhi during 2007-2008 and 2016-2017. During the CY 2007-2008, Mumbai and Delhi had 8,454 and 9,019 rooms respectively. By FY 2016-2017, Mumbai and Delhi had 13,494 and 14,296 hotel rooms, reflecting a CAGR of 5.3% in hotel room growth during the decade.

Yet, while rising demand in India’s top cities of Mumbai and Delhi may lure hotel developers, problems such as land scarcity, and zoning laws among other reasons are likely to continue restricting new hotel room supply going forward. While the difficulties may not hinder the expansion plans of some luxury hotel operators such as Jumeirah (which is planning to launch an upscale business hotel in Mumbai), other hotel operators may go down the acquisition route instead, which could drive up acquisition demand for existing hotel assets in these two cities, as high development costs may compel players looking to ride the tourist boom in Delhi and Mumbai to pay a premium for brownfield and existing hotel assets rather than developing new hotels.

With much of India’s luxury hotel room inventory concentrated in NCR, Mumbai and Bengaluru, developers are also likely to explore untapped opportunities in Tier II and Tier III cities such as Jaipur, Goa and Ahmedabad where occupancy rates and RevPAR have shown strong growth. According to JLL India’s 2017 report, Goa remained India’s most expensive hotel market for the second consecutive year, while Ahmedabad enjoyed the strongest RevPAR of 21% followed by Jaipur at 12.2%.

Marriott, currently India’s largest hotel by room inventory, appears to have spotted the potential; the hotel group has plans to expand its current Indian hotel portfolio of around 120 with the addition of 50 new hotels, which will add another 12,000 rooms to its current tally of more than 22,000 rooms in India. In addition to Tier I cities, the company is looking at opportunities in Tier II cities such as Ahmedabad, Jaipur and Kerala.

Ashmi Holdings, which manages the Bristol Hotel, an upscale business hotel in the business city of Gurgaon, (recently renamed Gurugram), has plans to lunch upscale, midmarket and budget hotels in Tier III and Tier IV cities with a target of 1,000 keys by 2020.

Significant upside potential in the midscale and budget hotel segment

India has welcomed rising numbers of foreign tourists, with Foreign Tourist Arrivals exceeding 10 million last year, and the number is expected to grow in the coming years as the government rolls out favorable measures as part of its effort to double Foreign Tourist Arrivals to 20 million by 2020.

However, the country’s tourism and hospitality sector is largely driven by domestic travelers and domestic hotel demand has historically been higher than inbound demand as domestic travelers account for a larger share of India’s travelers.

During the period 1991-2016, domestic visits to all Indian states grew at a CAGR of 13.03%, far outpacing foreign visits which increased at a CAGR of 8.25% during the same period according to data from India’s Ministry of Tourism driven by rising domestic travel among India’s swelling numbers of travel-hungry middle class citizens – a relatively price-sensitive and value conscious demographic who opt for hotels in the mid-scale and budget categories.

This trend is likely to continue as India’s middle class rise grows and their disposable incomes increase, which should increase their propensity to travel as well as their travel spend which currently accounts for about 88% of the tourism sector’s contribution to India’s GDP.

The opportunity in India’s midrange hotel sector has attracted the likes of companies such as Lemon Tree Hotels (NSE:LEMONTREE) and Royal Orchid Hotels (NSE:ROHLTD) which expanded their midscale offerings, thereby driving up the country’s midscale room inventory over the past several years; in 2002, some 6,000 of the 26,000 branded hotel rooms in India – less than 25% percent – were mid-market hotel rooms. By 2017, mid-market hotel rooms jumped nine-fold to 53,200, accounting for 43% of the total branded hotel rooms in the country which increased five-fold to 125,000 according to data from hospitality consulting firm Horwath HTL.

Apeejay Surendra, plans to expand its ‘Zone by the Park’ midscale hotel brand in Tier II and Tier III towns, positioning the hotel as a price and design conscious offering.

Goldman Sachs-backed hotel investment firm SAMHI Hotels Ltd plans has plans to acquire hotel assets around the country, mostly in Tier I and Tier II cities.