For the first time in history, the People’s Republic of China’s Gross Domestic Product exceeded the GDP of America, as measured by purchasing power, in 2014. According to the International Monetary Fund, China’s purchasing power GDP hit $19.4 trillion last year versus $17.9 trillion in the U.S.
The Chinese hotel industry has a long way runway. Today, it is $33 billion in revenue, roughly one-quarter of the U.S. market size. Domestic travel continues to grow in double-digits. Based on a conservative projection of the proposed hotel pipeline, China will pass the U.S. to become the largest hotel market by number of rooms by 2025.
Today, almost 40 percent of Chinese hotels are privately owned, up from 25 percent a decade ago. However, the Chinese hotel industry is barely profitable. Unfortunately, the short term prognosis doesn’t look much better. According to our internal analysis, in stark contrast to its U.S. counterpart, the industry will be structurally unprofitable in the coming years.
Recent data suggests that greater scrutiny regarding government consumption has resulted in less 5-star hotel travel and a significant reduction in banqueting spending across China. There is also some evidence that despite historically low interest rates, Chinese banks are restructuring their portfolios, increasing equity requirements and enforcing more traditional loan re-payment terms. Therefore, owners are experiencing a sense of urgency and many projects are being slowed down or entirely reconceived.
Is there a deeper explanation for the declining performance of full service hotels in China? What can be done, both in the short term and long term, to improve the performance of Chinese hotels, especially in the full service segments?
In certain cases, oversupply is an issue tied to the waves of urbanization occurring in China. But this has been going on in China for over a decade is nothing new. In the long run, demand growth will catch up even in markets like Chengdu. What is the bigger area of concern are the capital related brand standards requirements being imposed by the hotel chains?
The big hotel management companies who are not investing any capital into hotels in China (Hilton, Starwood and Marriott do not own a single property in China and very few if any in all of Asia) are enjoying a free ride at the owners’ expense.
The resulting impact on the hotels operational cost structure is a combination of unproductive capital investments and higher fixed costs resulting in lower profit margins. The challenges in staffing and developing hotel operations teams and service culture in China have been exacerbated by government requirements to build international 5 star hotels and a “bigger is better” mindset.
In contrast, more experienced hotel owners in the U.S. market have been busy downsizing their hotel rooms, outsourcing their restaurants and reducing their operational footprint. Despite, union labor costs and a less productive work force than their Chinese counterparts, U.S. hotels are far more profitable.
As an Asian based hospitality company, we are in constant dialogue with Chinese hotel owners, both public and private. According to our analysis, Chinese 5-star hotels are in their big last supply wave with declining pipeline as traditional luxury hotels have not generated internal rates of return. However, hotels in china can be very profitable and generate attractive returns on capital, despite rising labor costs and ongoing challenges with recruiting, training and retention.
We believe the Chinese hotel industry will be reshaped by the following:
1. The downsizing of traditional 5-star projects and the rise of 50-150 room lifestyle/boutique hotels in mixed use projects with residential, office, restaurants, gyms and other amenities;
2. The explosive growth of residential brands tied to a technology platform that provides new service related value propositions for the business traveler;
3. The development of global restaurant, entertainment and nightlife brands that deliver both Chinese and international brand experiences;
4. The emergence of 3rd party management companies accompanied by the growth of franchising with thousands of Chinese entrepreneurs capitalizing on continuing growth in domestic travel and a low cost of capital
At CACHET Hospitality Group, we believe that Chinese hotel owners, whether public or private, should build hotels to generate a standalone return on invested capital. We use analytical models to inform the appropriate size and features of each hotel given market conditions. Upfront feasibility and analysis should be an input into hotel programming and design. Capital budgets should be transparent and hotel management companies should also be held accountable for cost overruns. In summary, objective analysis, rather than the ego of government officials or the onerous brand standards of the chains should rule the day.