Three weeks ago the Shangri-La Group opened a Kerry Hotel in Shanghai. Local media raved about its facilities (even a micro-brewery, it seems) but the glitzy launch may mask a more serious problem. There are already plenty of empty hotel rooms in many Chinese cities, yet many more are in the planning or construction phase. Is China heading for a hotel crash?
The surge in new capacity shows no sign of losing steam. Shangri-La reportedly plans to double its presence in China over the next three years, and almost every international hotel operator is talking about doing likewise. Local media has estimated that $60 billion could be spent on hotel construction over the next five years, with 7,500 new hotels going up in the same period. That’s in spite of widespread concerns that the industry is already suffering from chronic overcapacity.
China’s economy has been growing quickly, of course, but hotel room numbers have been growing even faster – at an estimated 20% annually in recent years. So it’s not surprising that average revenue per room peaked nationally in 2005, and that occupancy rates in many cities are on the decline.
What’s odder is that hotel investment only seems to be accelerating.
The situation is most apparent in the political and financial capitals – Beijing and Shanghai. Both cities have seen heavy hotel investment: one in anticipation of the 2008 Olympics and the other in advance of the 2010 World Expo. Beijing saw its number of luxury hotel rooms double in three years, only to see average occupancy fall to 47% after the Olympiad ended. Shanghai hotels expanded just as quickly before the Expo, and there too occupancy dropped to 45% (for five star accomodation) a few months after the Expo had concluded, according to the Global Times.
Compare that to occupancy in Singapore at 86% so far this year, and something similar for Hong Kong and Sydney in the last quarter of 2010, and it becomes clear that hotels in China’s two leading cities are suffering from too many empty rooms.
Shanghai’s hoteliers have tried to brush off concerns by pointing to the new Disneyland being built in the city. But whether this will be enough to fill the estimated 60 new five-star hotels due to open just this year is more than questionable. “We all know that there’s oversupply, but no one can stop it,” hotel executive Ma Junsong told Oriental Outlook magazine. “Disneyland has not been built yet, and the new hotel capacity is already more than the demand brought about by more than one [theme park].” Disneyland won’t be completed before 2015, in any case.
Instead, the prognosis is grim, according to insiders.
“Newly-opened hotels have a 90% probability of failure in Shanghai,” hotel manager Huang Tiemin told an industry conference recently. He said too that many existing hotels in the city face double-digit falls in lodging ratios and room rates this year.
So why are so many new rooms being added? The answer, as with so many things in China, lies in rising land prices.
Top international hotel groups typically don’t own the properties they run in China (a business practice commonly employed elsewhere too). Instead they manage them for a percentage of revenues, and local developers take the remaining profits (or loss).
A coalition of interests is driving the growth.
“Real estate developers only approach management groups after they have already decided to build a hotel,” developer Zhong Jinhua explained to Oriental Outlook. “[They] care more about property appreciation than a hotel’s intrinsic profit potential.” Additionally, high-end hotels, even if they’re loss-making operations, can pull up the value of nearby residential developments.
It’s a lucrative business for the hotel operators too: estimated to be worth at least $1.5 billion in China each year. Even so, competition to win management contracts among the international chains has seen hotelier fees fall from around 3% of revenues 15 years ago to 1.5% today. “On the whole, international hotel management groups still make large profits,” says hotel executive Li Cong, “because the number of hotels they manage has greatly increased.”
The race to grab more management business is driving room growth too. Take three of the management operators: Intercontinental Hotels Group (the largest hotel operator in the world) has 132 hotels in China and 149 more under construction; Hilton has 47 more under construction, and plans to open more than 100 in the next five years; and Starwood Hotels has 62 – and will soon open 87 more.
That leads to situations on the ground in China that can differ from industry norms.
“Normally multinational operators run one hotel under one brand in each city, in case they compete with each other,” hotel consultant Zhao Huanyan told the Global Times. “But in China you can see several hotels of the same brand in one city.” In Beijing, for example, there are two Ritz-Carlton hotels (a cause of some consternation to guests arriving by taxi at the wrong one).
As land prices in first-tier cities continue to rise, the hotel management companies are following their property developer partners into second and third-tier locations too. Whether local demand is going to support premium priced brands doesn’t always seem to be a concern. “Local governors often see luxury hotels as a matter of promoting the ‘public image’ and ‘investment environment’,” writes Oriental Outlook, “even though they know the industry suffers from oversupply.”
The developers and multinational brands seem to have been happy enough with the industry’s growth. But surplus capacity is biting into profits (revenue per available room in Beijing dropped from Rmb589 in 2007 to Rmb399 last October). Insiders predict a swathe of staff cuts may result.
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