Investors prefer to build hotels from the ground up rather than reconstruct old buildings. Urals hotels built during the Soviet-era have long become obsolete; they are tatter-worn and most certainly do not fit into any classification. Meanwhile, the demand for quality hotels in the region is on the rise. Accordingly, local and outside investors have begun to look at the hotel business as one of the most prospective investment tools; therefore, they are building new facilities and redeveloping old buildings.

According to the analytical report issued by ABARUS Market Research titled Development Trends in the Russian Hotel Industry, the Russian hotel industry as of today is valued at $1.7-$2 billion, with 20%-25% annual growth. At the same time, according to an evaluation released by DISCOVERY Research Group, the share of Moscow’s and St. Petersburg’s overall sector share is contracting. Indeed, whereas in 1999 hotels in Moscow and St. Petersburg generated more than 80% of the overall profit, in 2002 this figure had dipped to 70%, while today the two cities combined account for a bit less than 50%. Accordingly, the investment flow has been going to the regions of late, and specifically to large cities in the Urals, such as Perm, Yekaterinburg, Chelyabinsk and Tyumen.

Given that business travel to these areas has increased, local and outside investors prefer to put their money in new hotels and the redevelopment of old ones built under Soviets. Interest in hospitality business is based on the excellent prospects for this commercial real estate segment. According to data provided by Colliers International, today in Russia there are around 300-350 three-four-star hotels, which is a scanty amount.

Furthermore, today there are many hotels which have not been certified for stars. Although it is difficult for experts to cite the exact number of such hotels, according to various estimates there are several thousand, and they are located predominantly in the regions, including those with a similar level of economic development as the Urals. “Today unmet demand exceeds supply by 15%-20%, and to meet this demand around 200,000 hotel rooms must by built in the upcoming years,” says Marina Smirnova, deputy director of the valuation and consulting department at Colliers International.

Smirnova also believes that despite the long recoupment period (seven to eight years) for hotels vis-a-vis office or retail centers (four to five years), hotels will generate more profits in a decade. “This is mostly because commercial space lease contracts are signed for the long term, and a hotel room is ‘sold’ on a daily basis and quickly adapts to market changes.”

Hotel Consulting and Development Group shares this view, confirming that investment in regional lodging industry is more advantageous than in retail or office real estate. Shopping centers and offices are becoming more risky, as they are geared mostly on local demand, while the hotel industry is reliable because it mostlt leans on outside demand.

The Obsolete Hospitality Industry

Buying up Soviet-era hotels is one of the ways of developing the hotel real estate business. According to experts, on one hand this is a very profitable source of investment, given that redevelopment costs 60%-80% of the cost of new construction. Moreover, Soviet-era hotels are often located in cities centrally, where there are a lot of people.

In Perm, Soviet-style hotels, according to data provided by the local administrations, account for 61% of the overall accommodation space. The largest are Ural (Almaz Ural), Prikame, Dynamo, Tsentralnaya and Profsoyuznaya. In the Tyumen Region (including Khanty-Mansiisky and Yamalo-Nenetsky autonomous territories) there are 133 Soviet-era hotels, or 68%. Around 80%-85% of the rooms in Chelyabinsk are of the Soviet era. Specialists from Becar Commercial Property categorize these facilities as being low-cost hotels, which include Yuzhny Urals, Sapfir, Malakhit, Chelyabinsk, Sfera and Planeta.

The situation is a bit better with the hospitality industry in Yekaterinburg. Beginning in 2003 when the investment influx began, the number of hotels has increased by 50% (there are now 42 hotels in operation), and there are chains and international brands as well. There are also 19 additional accommodations, such as dormitories and hostels. Yekaterinburg is the Urals’ only city with a five-star hotel, the Atrium Palace Hotel.

On one hand, redevelopment is not widely popular with investors, despite the local government’s attemps to attract investors to redevelop Soviet-era hotels. One of the reasons for the lack of success is that investors today are concentrating on three-star and upscale hotels and short-term return on investment. Accordingly, redeveloping Soviet hotels to modern standard for the middle and upper classes is for the most part not possible.

Vyachaslav Frolov, owner of the Domashny Hotel, is convinced that investing in one- and two-star hotels is not profitable. “The city is expensive and work costs $1,500-$2,000/sqm, plus equipment and advertising. In the end, one square meter costs $2,000-$3,000, depending on the hotel,” says Frolov.

Natalia Lebedeva, director of the hospitality and services department at AVS Group (owner of the three-star AVS Hotel, the former Svetly resort), agrees with this view. “Despite the high demand for economy-class hotels, it is not profitable to build and reconstruct them, as expenses are $700-$1,000/sqm, and recoupment is five to six years.”

The other reason for the lack of interest in redevelopment is the labor-intensive process in which architects and designers have to toil in close quarters.

Experimental Hotels

At the beginning of 2004 Ermak investment company acquired the Polet Hotel, previously owned by Perm Airline (PA), for 14 million rubles. The hotel is a five-story building constructed in 1967, and most of the rooms required full refurbishment.

Ermak’s management team has admitted that investing in this facility is very risky. “The project may not be successful, if the passenger flow from the Perm airport does not increase,” says Konstantin Podvalny, first deputy director at Ermak. However, the project has been successful over the past three years, given that passengers have increased by 50% to the Bolshoi Savino airport. More than one million dollars have been invested in Polet, with refurbishing done to the rooms, conference halls and business rooms. Reconstruction lasted for one-and-a-half years and return on investment is slated for four years. Polet became the first hotel in Perm to receive a three-star rating.

According to Yekaterinburg city hall, Sverdlovsk Hotel (built in 1969, with 390 economy-class rooms) requires full redevelopment. Very soon 27.6 million rubles in charter capital will be raised, and the five-person board of directors for the company will have been approved. The charter capital will be divided into 2.76 million common shares at 10 rubles per nominal share. The city’s authorities hope to find an investor who has been involved in large-scale reconstruction previously.

The local authorities have tried to reconstruct the Tourist Hotel, which has been under construction for the past 25 years and still has not been completed. Several years ago the city’s administration and Uraltransgaz, having bought the building from the unions, decided to redesign it into a business complex. In July 2003 Turgaz, a subsidiary of Uraltransgaz, began reconstructing the building and finished work at the end of 2005; however, the facility still has not been delivered to the market. Meanwhile, the city’s hotels from the Soviet era belonging to private companies are being reconstructed at a faster pace.

In the past two to three years, following full reconstruction, the Grand Avenue Hotel opened (previously called the Eurasia Hotel), while the Yekaterinburg Central Hotel, an architectural monument from the twentieth century, was also reconstructed. Currently, the Iset, Bolshoi Urals and Uktus hotels, respectively, are undergoing reconstruction.

The same fate has befallen hotels in Chelyabinsk. Recently, the Hotel Group, uniting the Malakhit, Yuzhny Urals and Omsk hotels, was privatized and Dmitry Eremin, entrepreneur and city deputy, became the new owner. However, the buildings require complete reconstruction (around 90% of the rooms), and, according to unofficial data, Eremin tried to sell Hotel Group about a year ago, while the sales offer has been actively discussed among the city’s realtors.

However, now buyer has been found willing to acquire the troubled asset valued at $11 million by the owner. Additionally, Hotel Group has neither denied nor confirmed the information on the deal, while a large section of the three-star hotel is currently being leased out as offices.

Furthermore, just opposite this hotel, Boris Bidgof, a local businessman who joined the hotel business in 2002, has invested substantial funds into reconstruction of his Berezka and Slavyanka (owned by the Chelyabinsk Tractor Factor until the late 1990s) hotels

Today both hotels operate in adherence to international standards, with a room in Berezka now costing from 3,300 to 12,500 rubles, although same rooms cost 10-fold less in 2003, prior to reconstruction. The cost of a room in the Slavyanka is from 2,500 to 5,000 rubles, which is also significantly higher than the cost prior to full refurbishing. The most expensive deal on the local hospitality market was the purchase made by the Industrial Group, lead by Mark Leivikov, which bought the Victoria Hotel from Switzerland-based Euromin for $2.7-$3 million.

Guests of the Urals

Additionally, not only local entrepreneurs are interested in the Soviet-era hotels. At the end of last year in Perm there was an open house of the Amaks Premier hotel and entertainment complex following full reconstruction (former Tourist Hotel). This hotel has been part of the Amaks Grand Hotels chain, which owns 14 hotels in Russia’s regions, since 2004. The building was fully reconstructed in correspondence to the chain’s standards, with 139 rooms for up to 200 guests. There is a conference hall, negotiations room and a business center.

However, the majority of the international investors prefer to build new, modern hotels in the Urals. Indeed, London & Regional Properties is investing $500 million in the construction of 20 hotels in Russia’s regions, including Perm, Chelyabinsk and Yekaterinburg. In February this year, Asia and Intercontinental Hotels Group signed a franchise agreement on a Holiday Inn hotel in Chelyabinsk, set to open in September 2007. This will be the company’s eighth Holiday Inn hotel in Russia, and will include 24 rooms, a restaurant for up to 200 guests, fitness and aerobics halls, a beauty parlor, a pool, a sauna and a 200-seat conference hall. The main target group of guests to the hotel will be the upper class, international and Russian VIP’s, as well as Olympic team members.

Vadim Shumkov, deputy director of the strategic investment department for the Tyumen Region, has reported that the largest international hotel chains, such as Marriot, SAS Residor and Accor Group, have plans to build hotels in Tyumen in the near future. Shumkov noted that there are already plots selected for Marriot and SAS Residor (Park Inn brand) in the center of the city, while the selection process is underway for a plot on which to build the Accor Group hotel.