Jabalpur to Tawang: Why hotel projects are exploding in Tier-2 and Tier-3 Indian cities

Anand Gulati, a pharmaceuticals representative for a leading multinational firm, has spent more than half his life travelling across Uttar Pradesh and Uttarakhand—two of the territories he covers. Bad roads, poor connectivity, non-existent hotels—the 43-year-old has seen it all. But things are changing, and he couldn’t be happier. “Gorakhpur has a Radisson; Aligarh has a Lemon Tree hotel. Bharat is meeting India,” he grins. Gulati recently attended the wedding of a client’s daughter in Aligarh. The wedding took place at the Lemon Tree Hotel. “The boy’s family wanted a hotel wedding and not one in a baraat ghar [marriage hall],” he says. Lemon Tree, which opened in 2021, is only the second branded hotel in Aligarh besides Ramada by Wyndham.

Aligarh or Gorakhpur aren’t the only locations seeing the advent of branded hotels. Latent demand, industrialisation and domestic travellers eager to explore more of India are leading to hotel chains making a beeline for the country’s Tier II and III cities. At the forefront are companies such as Lemon Tree Hotels, which will open 38 new hotels over the next couple of years in cities such as Hubli, Jabalpur and Bharuch. “One big learning from Covid-19 is that smaller cities and towns are the most resilient. They have bounced back much faster and much stronger than the big cities,” says Vikramjit Singh, President of Lemon Tree Hotels, which now runs 87 hotels across the country and had posted revenues of Rs 416.27 crore in 2021-22.

He cites two reasons for expanding into Tier IV cities such as Chirang in Assam or Chandausi in Uttar Pradesh. First, these cities have no supply, and being the only branded hotel in a market ensures that Lemon Tree gets a disproportionate share of the demand. The other and more important reason is something he refers to as the network effect. “The minute I open a hotel in a city, people in that city learn about Lemon Tree as a company and as a brand. As a result, the business that starts coming to my other hotels from that city is phenomenal.”

Such word-of-mouth, free marketing is needed in bagfuls as India’s hospitality industry goes all guns blazing to capture the hinterlands. Consider this: in calendar year 2022, a total of 250 new properties were signed on as hotels under management, of which 200 are in Tier II and III cities. “Of the 20,000 new keys under management, nearly 17,000 keys are in Tier II and III cities,” says Harmeet Bedi, Senior Director, Hotels and Hospitality Group, India, JLL, a real estate consultancy.

Small is in

So, right, there’s demand for hotels in small towns. But what’s spurring the demand? These may not have large corporate offices, but they do have a “huge SME and MSME base”, explains Singh, adding that there is also demand to host weddings and small conferences. “Most of these towns are trading towns, so you have people coming in for a couple of nights,” he says.

This demand has not escaped the notice of IHCL, India’s largest hospitality company by market capitalisation, which is a part of the salt-to-software Tata group. “With a strong pipeline of 70 hotels, we will enter new destinations and scale our brands,” says Suma Venkatesh, Executive Vice President-Real Estate & Development at IHCL, which had a market capitalisation of Rs 45,133.22 crore as of March 21, 2023. The chain has planned Taj hotels in cities like Patna, Raipur and Gandhinagar; IHCL SeleQtions for cities such as Bhubaneswar, Rajkot and Munnar; Vivanta hotels in places such as Haridwar, Tawang and Manipal; and Ginger Hotels in cities like Srinagar, Coimbatore and Agra.

Meanwhile, Bengaluru-headquartered Royal Orchid & Regenta Hotels plans to expand to 100 hotels over the next year from the current 82—and it has Tier II and IV locations on its radar. The hotel chain, which says it is likely to post a turnover of Rs 300 crore in FY23, is looking at places such as Phagwara, Gulbarga and Ambala. Chairman & MD Chander K. Baljee says that 26 million Indians used to travel abroad for holidays, but that has been hit due to factors like visa delays, high cost of air travel and rising cost of accommodation abroad. “[Now,] they are looking at exploring the country and looking for newer destinations,” he says. The chain recently opened a hotel in Dharamsala, with another one planned in McLeodganj. Also on the cards is a resort in Maharashtra’s Guhagar—known for its beaches and Alphonso mangoes—and another in the coastal town of Digha in West Bengal. A quick check on hotel booking website Booking.com reveals that there are nine properties in Guhagar, but none are branded. Similarly, Digha has over 60 properties but hotel chains seem to be absent. Both are untapped markets.

Unlike Lemon Tree, which prefers greenfield projects, Baljee says his chain prefers brownfield projects that can be turned around quickly. Besides the pure management model, where the company runs the hotel for a management fee, Royal Orchid has franchisees and also a revenue-share model where a fixed percentage of the revenue is given to the owner of the hotel. “Then profit or loss is to our account. It’s like a flexi-lease,” explains Baljee.

Another sector that hotel chains are concentrating on is the pilgrimage circuit. “We have seen a lot of demand from the domestic traveller for pilgrimage centres. People who were earlier okay with not staying in hotels now want to stay in hotels,” says S.P. Jain, Chairman and MD of Pride Hotels Group, which operates 51 hotels in 14 states. Pride is already present in Dwarka, Somnath and Ranakpur, and will soon be present in Rishikesh, Rudraprayag and Varanasi. “Occupancy in these hotels is around 75-80 per cent. On religious days, they are sold out,” says Jain.

First movers

Of course, it’s not as if there were no branded hotels in smaller cities and towns earlier. Sarovar Hotels & Resorts, for instance, considers itself a pioneer in venturing into locations beyond metros. “Tier II and III are not new to Sarovar,” says Managing Director Ajay K. Bakaya. He adds that with the advent of the internet and social media, people in smaller towns have big aspirations. “So, there is enough demand to justify good branded hotels in these places.”

To fulfil this demand, Bakaya has 50 hotels under different stages of development. “Over the next five years, I am looking at a net gain of 10 hotels a year, so around 750 rooms a year,” he says. Sarovar, which currently manages over 95 hotels in 60 destinations in India and overseas, is a part of Paris-based Groupe du Louvre, which has a portfolio of 2,500 hotels in 52 countries. By the end of the year, Sarovar will have 15 new hotels in destinations such as Sonipat, Ayodhya, Dalhousie, Saharanpur and Aurangabad. It typically enters into a 15-year management contract and charges a management fee of 6.5 per cent of gross revenue.

International chains, too, have begun to target Tier II and III cities. Take Radisson, for instance. According to Zubin Saxena, Managing Director and Senior Area Vice President-South Asia, Radisson Hotel Group, his chain has over 150 hotels in operation and development across 60-plus locations in India. “Nearly half of our portfolio is concentrated in Tier II and III markets, where we have benefitted from being the first movers. Towns like Gorakhpur, Ranchi, Guwahati, Nagpur, and Bhopal had Radisson Hotels well ahead of time, integrating us into their cultural fabric with local roads named after the brand,” he says.

The Challenges

Running hotels in small towns and cities, however, is no cakewalk. Trained manpower is a concern. Lemon Tree’s Singh says it’s less of an issue for a chain like his because it regularly rotates the management. Sarovar’s Bakaya, however, feels that connectivity is a bigger challenge. “The success of a hotel depends on ease of access. Very often you have a city with a sizeable population but very difficult to get to,” he says. The biggest challenge, though, is the cost of land. “Smaller cities don’t necessarily mean cheaper land. Your cost of development is almost the same. So, cost ends up being similar but you are not getting the room rents of a larger city,” says Bakaya.

For instance, for a luxury hotel, the cost is Rs 1 crore upwards for a room verses Rs 40 lakh for an economy level room, and you can get twice the number of rooms in economy in the same land area. The focus therefore, Bakaya says, should be on smaller properties in the 4- and 3-star categories, adding that Sarovar doesn’t look at anything smaller than 50 rooms.

Jain of Pride says the biggest factor in making a hotel profitable is to control costs. He adds that it takes lesser time to become profitable in a Tier II or III city than in a metro or a semi-metro one. That’s because manpower costs are reasonably low in these cities, power costs can also be lower, while raw material costs are also lower. “Our hotels in Jaipur, Puri and Indore started making profits from the second year, after breaking even in the first year itself,” says Jain. Comparatively, a metro takes two to three years to break even. Add to that, room rates in Tier II locations have gone up. “Earlier they were half the amount of semi-metros but now they are hardly 10-15 per cent lower,” says Jain. Pride, which expects to clock a turnover of Rs 300 crore this year, plans to have 100 hotels under management by 2030.

Another interesting aspect is that when it comes to managed hotels in Tier III and IV locations, Indian hotel owners prefer tying up with home-grown brands. “Indian owners draw comfort in the fact that the country’s top domestic hotel operators own a sizable number of hotels in their portfolios and are not only pure-play management companies like some international hotel operators,” says Mandeep S. Lamba, President (South Asia) of hospitality consultancy HVS Anarock. Agrees Lemon Tree’s Singh. “Lemon Tree [with 5,000-plus rooms] is the third-largest owner of hotel rooms in India. So, that gives a lot of confidence to the hotel owners because they feel that we understand the pain of a hotel owner better than someone who doesn’t own any assets,” he says. Lamba says that other factors that work in home-grown chains’ favour are getting access to the highest decision-making level in the operating company’s hierarchy and greater flexibility in product configuration.

Meanwhile, the hospitality sector is continuing to witness strong year-on-year growth. The year ended with a 90 per cent y-o-y growth in RevPAR (revenue per available room) for calendar year 2022 over 2021, as per JLL’s latest ‘Hotel Momentum India’ report. As connectivity improves and demand for hotels in small-town India grows, this is only likely to rise. And as this happens, Gulati can continue to look forward to a comfortable stay when he travels to small-town India on business.

@smitabw