Strategy of Investing into Hotel Business in Ukrainian Environment

Hotel business is one of the main components of Ukrainian economy. Effective functioning of hospitality sector is an indicator of positive changes in national economy, important precondition of country’s international relationship intensification and integration into the world community.

The unique natural and climatic resources, historical and cultural heritage are obvious factors for the growth of Ukraine’s investment attractiveness and raise its rating in the international community.

With radical changes and emerging market economy, Ukraine requires complex development and formation of the hotel network as well as of the tourism and entertainment industries.

One of the main preconditions of hotel business development is creation of favourable investment climate and searching for resources to finance new hotels construction and renovation of the existing ones. Planned and complex development is impossible without considerable essential investments into this field.

Investments for January-March 2009

   Mastered Fixed Capital Investments
  actual prices inUAH    As % against:
    January-March, 2008    Total volume
   Total    25.2 Bln.     61    100
   Hotel business   122.3 Mln.     50    0,5

Source: State Statistics Committee of Ukraine, 2009

The key fact is that in the current world recession, investing into Ukrainian economy has not stopped and only for two months of the current year investments into hotel business made up 122.3 Mln. UAH.

Despite of investment attractiveness, Ukraine for the time being can not boast of significant hospitality development. Unfortunately, the current state of most hotels remains far from international standards. The list of additional services in domestic hotels is considerably smaller than in most European hotels which offer their clients more than 80 kinds of additional services. A little less than three quarters (71.6%) of all hotels have such services as restaurants, cafes and bars. About a third of hotels (31.5%) have parking and just over a half (57.4%) – sauna and laundry.

It’s widely known that hotel development is the most complicated and specific one among all segments of commercial real estate, regardless of the stage and level of market development. In addition, Ukraine has hospitality market of amateurs who sincerely think that hotel business is just hotel construction.

Owners entrust creation and project management to construction companies which know nothing in hotel business and just construct hotels without market research, business plan and during the whole construction time wastefully use owners’ money. International standards, regulations, innovation technologies are neglected, low-quality materials are used to imitate expensive and high quality ones and as a result the owner constantly invests into renovation and restoration. This is only one hundredth of problems which arise in the process of hotel business creation by local business partners. And moreover, they save on Services and Management. Not many owners know or want to know that under management of international operator, hotel net operating income is higher approximately by 10.5% percent than the profit under self-management. A management company provides high fulfillment, constant stream of corporate clients, bears advertising and promotion expenses, optimizes taxation, has international economy experience, etc.

Almost all local developers, investors, owners of the land plots are convinced that 5-star hotels are the most profitable, the most expensive and hence as they think the best. 3-4-stars hotels are built in the same way e.g. – 3-stars hotel for 37 rooms is decorated with 26 kinds of different materials, including marble, natural wood, stone, etc. The owners still do not know the term of its payback due to absence of business plan. One more example of Ukrainian mentality –  hotel owners appointed a person who has never worked in hotel industry and previously was delivery man and commerce manager, as the CEO.

Ukrainian mentality is very specific and unique in its own way. Choosing bridgehead for hotel business it is necessary to make marketing research. But often it’s not carried out due to cost cutting and misunderstanding of its necessity. In Ukraine the owners make marketing researches over coffee by themselves developing the concept, defining the target customers, stars number, etc. Sometimes marketing research is made by employees who are not competent in this field. So it was and still is the main problem why hotel industry of Ukraine is still undeveloped.

International hotel groups and management companies got interested in Ukrainian market in the early 90’s but nowadays only 4 hotels in Ukraine are managed by international operators: Radisson SAS Kiev, Radisson SAS Resort Alushta, Hyatt Regency Kiev, Rixos Hotel Prikarpatye in Truskavets.

As a rule, choosing wrong strategy of investing into hotel business of Ukraine turns into the headache for a foreign investor.

Foreign investor entering independently Ukrainian market takes the risk to lose the project, due to unawareness of the market specificity. Foreign investor has several strategies of investing into Ukrainian hotel business:

1. Local partner

First challenge is a local partner which most investors are seeking for. Those who work according to international standards as a rule suppose their partner to be reliable. According to the analysis made by Savills, only one project out of a hundred was realized together with a local Ukrainian partner, the share of which was less than 7%. This fact is connected with widely spread raiding in Ukraine. So having even small holding of shares local partner is ready to block the project for his own interest which is successfully going on in most cases.

2. Consulting

The choice of local advising partner is difficult as current consulting market in Ukraine is at the infant stage and only few companies are not intermediaries (see info below) and provide professional services according to international standards and are able to organize “turnkey“ business. Foreign companies working on Ukrainian market face unfair competition when employees arrange confidential information leak in favour of competitors, make decisions in their own interests.

3. Intermediaries

Working with intermediaries who solve certain questions, an investor risks to lose the project without having complex solution and overall project management. Without understanding specifics of project development and hotel business intermediaries misservice the investor and are ready to leave him at any project stage. Intermediaries cause corruption. They jack up the projects’ costs by acting in collusion with contractors while solving certain question, they are not interested in the standard project management, assisting in bad misvaluation with the purpose of earning fast money. Investor may be very “lucky” if an intermediary doesn’t work against him.

Another obstacle is confidential information leakage and exchanging with Ukrainian companies\intermediaries encouraged and often initiated by investors that creates unfair competition on Ukrainian market.

Investor who has chosen self-investment strategy will face difficulties at the stage of land plot selection. Nobody in Ukraine can be sure that acquired land plot or object for renovation will be his property. There is a number of examples when one land plot legally had several owners and to assert the rights investor should spend years trying to find where the legislation was broken. Consequently, the final legal decision may not be in favour of investor. Based on experience of foreign investors, applying to legal companies is unreasonable as lawyers make legal evaluation examining certain documents but not the range of events in the history of the land plot or property.

Even experienced foreign players can never start the project in Ukraine having faced  bureaucracy which can easily stop any promising project. Activities connected with adjustment of “red tape” involve a number of contacts with organizations controlling hotel business (sanitary-and-epidemiologic institution, fire prevention, tax administration, etc.). Distinctive peculiarity of Ukrainian hotel business is that in the spheres regulated by market mechanisms it is possible to find sufficient solution based on market regulations. But in the spheres controlled by administrative methods, it’s difficult to find any legislation. Obviously, that for foreign investor Ukrainian economy is unclear and inadequate system of relationships between business, state and consumer.

One of the ways to stop recession is investing in real sector of economy and one of its components is the sphere of hotel business. All problems can be solved, all obstacles can be overcome. The only need is to find right strategy, because “slow and steady wins the race”. And these «races» are chosen by investors who should take into consideration risks while choosing the strategy:

  • Do not start the project with local partner
  • While buying a land plot, property, investment project for making legal evaluation apply not to legal company but to consulting entity which will make legal due diligence and examine all events in the history of the land plot or property to exclude legal disputes
  • To make thoroughly legal due diligence of ownership documents, but it’s better to make the project from start-up
  • Do not work with intermediaries (commission agent, jobber) but with professional consulting company
  • While  realizing a project consider specifics of Ukrainian business and mentality

Slowly but irreversibly Ukrainian market will have to follow European standards, so with the lapse of time specificity of Ukrainian hotel sphere will be not so critical and foreign operators easily will make happy the tourists of all over the world by quality of services in Ukrainian hotels.

And it’s the right the time for investors, because hotel business is still a free niche developed by unskilled sites and objects’ owners and by unprofessional approach of investing in Ukraine.

Today this market is possible to win with “hands down”.