The most popular way to attract collective investment to create your country hotel.
The method is fairly new, it has been used in Russia for a couple of years, so the practice is not very big yet, but we at Basinn Hotel Development are at the cutting edge of creating such projects, so we can share our experience and tell you about certain tricks of this method and pitfalls.
My name is Anton Basin,
What are the prerequisites? Why is there such a boom in financing out-of-town hotels with the help of collective investments in Russia right now?
First, the yields of other commercial real estate sectors have declined. At the end of 2022, according to Forbes, yields in the residential sector fell to 3-7% per annum. Offices and retail are called in forbes the depression of the year, as rates fell by 10-15% and warehouse space, too.
Secondit is obvious to everyone that tourism is really developing in Russia because of various factors, which we will now discuss.
Factors that influenced the increase in demand for domestic vacations:
As a consequence, the total domestic tourist flow in Russia increased by 7%, although usually it grew by 4-5%;
Third, there is a mortgage with state support* at a rate of 6.7% per annum. Up to 12 000 000 ₽ can get from the state on the mortgage, provided that this money can be spent on:.
This attracts not only those who want to build their own house, but also those who are willing to build a house in order to give it to the management company, which will be engaged in its renting out to the final guests to make this house profitable;
*Mortgage – a type of mortgage lending in which banks lend to borrowers of certain categories at a reduced rate, and the difference to the actual rate is compensated by the state.
Fourth, the demand for the type of out-of-town hotel accommodation has changed. In the last 2 years, since the pandemic first, we are constantly talking about it and seeing this trend.
The idea is that detached cottages and semi-detached modules are now the favorites, more than 60-70% of the total load from the total flow falls on these options of accommodation. Since the family audience is the largest for country hotels (not resort hotels), the biggest demand is for detached cottages of different formats.
Rooms in the buildings are also in demand, just for the most part, for a certain audience. Cottages are more often in demand among family visitors, companies and couples in love, and rooms in the buildings are more in demand among the MICE segment and the corporate segment. If it is a SPA-hotel, couples are also accommodated in the buildings.
All these prerequisites led to the creation of a new tourist product. We call it a holiday village;
Holiday village -it is a countryside vacation, in fact such a country hotel or dacha for short-term rent in which there is no hotel infrastructure. At the most there can be a reception, a bathhouse, children’s playgrounds, a minimum of water infrastructure, beaches. But there is not and can not be any capital-intensive infrastructure. For example, a restaurant, SPA-center – there is no such thing, only a cottage.
Why do they come there, what is the guest’s vacation scenario?
Guests just come to rest and sleep, they grill meats and socialize a lot. Socializing takes up most of their time, whether it’s family or company, that’s why they come.
There is a way to attract collective investment in such an out-of-town vacation, it is called SELL & LEASE BACK. We can translate this expression as sell, in this case a house, and get it back for management. This method is suitable for developers, not for the final investors who buy these houses. I want to tell you about how to create such a facility from a development point of view.
**Housing Construction – individual housing construction
Here it must be said that HML is not intended for commercial activitiesso be careful!
After you sell such a house to an investor, you get it back in management and operate it: rent it out, clean it, maintain it, and so on. At the end you share the profits with your investor.
So what kind of profitability can we talk about here?
For end investors here the possible yield is 15-20% per annum. This is the normal average yield on real estate, now a few years, this yield will be quite real while the market is not yet saturated with such projects.
But the profitability of the developer can be much more than 30-50% on the invested capital, and for only one first year.
How is a developer’s profitability formed?.
It is formed on the difference between the cost of acquiring the land, the cost of construction and the cost at which the developer sold to the final investor of the house;
This is a relationship where one of the parties to the transaction (the developer or investor) always gets a higher yield at the expense of the fact that the other receives a lower yield.
Let’s look at an example of a slider, where 5 years is the payback period for the investor, and for the developer in this case, the income will be 30% per annum.
If we increase the payback period of the project for the final investor to 7 years, then the developer will significantly increase income from project management, up to about 50% (very relative figures).
To summarize, the more expensive the developer sold the house to the investor and convinced him that this return is possible, the more the developer will have a return on the management of the house. But the developer must keep his word and return this yield to the investor. If there is fraud, it beats on reputational risks. So here you need to be careful and attentive;
This format of attracting collective investment works in the holiday village, when, except for houses, you and I have nothing;
But what do we do when we want to create a facility with hotel infrastructure?
We understand that a hotel business unit will be in demand on our site: a restaurant, a SPA, a bathhouse. In addition to this infrastructure, which brings income, we have another infrastructure, which does not bring income, we call it a tour product. For example, a conference hall, children’s playground, landscaping. As a tourist product I consider even those elements that work for zero or in deficit, that is, they are kind of paid for, in contrast to the playground and landscaping, but they are not in themselves a profitable business. The tour product is the reason to come to our hotel!
How do you fund infrastructure that does not directly generate revenue?
1. Home sales.
We sell homes and from the proceeds, from the sale of those homes, we fund that infrastructure. It’s not always enough money, for example, we, we got 50% of the proceeds from the sale of the homes. That’s not always enough to cover the cost of the infrastructure. We need to consider what kind of infrastructure we have, if we put 1 restaurant, then 50% is enough. However, when we put something more: a restaurant, bathhouse complex, thermal complex, this money may not be enough.
2. Infrastructure construction loan.
We take a loan for building the infrastructure and we pay the loan or part of it by selling the houses. So we remain in ownership of the infrastructure, but not ownership of the houses because we have investors in those houses, and essentially you and I got, for free or at a very large discount, those business units due to the fact that we sold the houses, and we earned on them.
What is the problem with this method?
If you imagine the whole hotel as a single organism that has an infrastructure: restaurant, bathhouse, room stock and so on. When the facilities leave the hotel because the houses were sold into someone else’s ownership, and you cannot control them, these new owners can do whatever they want with these houses. Investors can say that we do not want to work with you, or they can say that they will rent out the houses themselves, or will live there, they can say in general we want to tear down the house and plant cucumbers there.
I mean you have no control over this property and what will happen to the houses in 2,3, 5,10 years, we don’t know and there is a risk that you and I will not have this room stock in our management, so you and I will not have guests! There will be no guests, then there will be no consumers of our business units (restaurant, baths, SPA), and we are the owners of this business unit. This becomes a long-term problem.
How can we solve this problem?
Part of the houses, better to keep in order to reduce the risks described above. Ideally, keep as many houses as will allow these business units to exist at zero. At least for zero sustainability of the entire business.
3. Sell a portion of the infrastructure in proportion to each house. For example, a house builds 10,000,000 and we sell it for 20,000,000 because you still put a portion of the cost of the infrastructure with the house.
4. Residency model.
It’s a scheme where you sell everything: you sell the houses separately, each of the investors for a separate house is a resident. For each business unit, you invite a resident separately, so you sell a restaurant, you sell a spa, you sell a bathhouse separately to each resident.
The residency model is also divided into 2 options.
– You just lease the land to the resident, and the resident builds the facility with his own money.
– You create a resident SPV – this is a legal entity of a special purpose vehicle. In which you and the operator have a share, and you lease this land to this SPV company. This is a more secure scheme for the resident, because in this scheme, the resident does not build on his land. It turns out that not only do you get the rent from the lease of the land, but you also participate in the business itself, but you’re not involved in operational matters. You invited a restaurateur or bath attendant, and he is engaged in the business, but you just participate in it, as an investor. You financed part of the construction or financed the entire construction.
– You fully financed the construction of the building, for example, the restaurant. The operator comes in and maybe in SPV format or on their own already does the renovation and supplies the furniture equipment to that restaurant and does the catering, but the building itself is rented from you.
what other problems and pitfalls does this whole scheme have?
As I said, in the beginning it’s very convenient to sell such houses on residential land. Because residential land can be divided into 5-6 acres, and recreational land up to 5-6 acres cannot be divided, so this is an ideal scheme.
The ideal land ownership scheme for such investments is when there is a piece of residential property, there is a piece of land for recreation, they are adjacent and, accordingly, you sell off the pieces of residential property, and on the recreational land you create all the infrastructure.
What are the common pros of all other methods?
The ability to apply when the property cannot legally be singled out for sale
Common cons of other methods?
Other financing methods
That’s how it is accepted, so you can finance your project with bonds.
Plusives you can redeem bonds at the end of term, no need to wait for project to spin out, you can earn, and redeem bonds at the end. No collateral or security required. You will need a public credit history in order to raise money on the stock exchange in the future, but you will have to be very careful in maintaining it.
of disadvantages, I will name disclosure of information and it is impossible to do it quickly, there is a certain period of consideration.
This is the advantage of a closed mutual fund you can trade these units on the stock exchange, respectively taxation is super comfortable, there are no taxes inside, but only after selling the unit.There are taxes, and the disadvantages are that there are a lot of participants in the scheme, respectively, it is all expensive, and that is why this approach is suitable for investments of over 1 billion rubles.
We create the final product and understand what financing methods you can use for a different hotel, we’ve all been through this many times.
For creating a hotel concept, we have been doing it for 15 years, I should say, we have eaten the dog and we do almost only country hotels.
