Amid the rouble: the Russian market

In 2013, before the Euromaidan protests began in Kiev, there were few places in Europe quite as promising to hotel operators and developers as Russia and the Commonwealth of Independent States (CIS). With the Sochi Winter Olympics around the corner, the FIFA World Cup slightly further away in 2018, and untapped growth from Moscow to Tbilisi, everyone seemed to have big plans for the region.

Then, on a bitterly cold night in Kiev, everything changed. Just after 10.30pm on 29 November last year, thousands of protesters gathered on Maidan Nezalezhnosti, an old Stalinist square ironically built to prevent political protests. Ukraine's pro-Russia president Viktor Yanukovych had rejected a European Union trade pact, to the dismay of pro-European liberals and Ukrainian fascists alike. As the days passed, the rally turned into a determined street movement in which more than 100 participants lost their lives.

Almost 18 months later and it's hard to believe how much things have changed. Yanukovych is now long gone; Crimea, a region for decades split between Russian, Ukrainian and Tatar communities, has been entirely annexed; and Ukraine's eastern regions are locked in a deadly and intractable battle between Russian-backed separatists and the Ukrainian Army. Any hopes vested in February's Minsk II cease-fire look shattered as fighting sets in once again across eastern Ukraine.

Few would deny that what is happening in Ukraine and Russia constitutes a crisis. The death toll in the former has now exceeded 6,000, according to the UN's Human Rights Office, and more than one million people have been displaced. For business, though - and specifically for the region's hospitality market - things remain rather more complex.

Surprising strength

Despite the political situation and other economic problems in Russia, pipeline growth in the region remains remarkably strong. According to recent research by KPMG that draws on the pipeline of international hotel chains, 194 hotels with a total room stock of nearly 37,300 units are set to open in the region by 2020.

The development pipeline in Russia is, unsurprisingly, the most impressive. Hotel chains, including major groups such as Marriott International and Hilton Worldwide, are expected to open 5,200 guest rooms across the country in 2015. Research by Jones Lang LaSalle last year suggests the pipeline for Moscow alone is set to be between 10,000 and 15,000 new rooms over the next five years.

But if overall investor appetite has remained strong, there are signs that project timelines have suffered. In March last year, following the annexation of Crimea, the EU, US and a number of other countries and international bodies began a sanctions regime targeting Russian businesses, officials and prominent individuals. At around the same time, oil prices across the world started tumbling, causing the rouble to collapse and international investors to sell off Russian assets. Although hotels are yet to be fully cancelled, these commercial risks have meant a number of agreements being put on hold until the economic landscape becomes clearer.

"The political and economic situation is certainly going to affect when the pipeline is delivered," says David Jenkins, executive vice-president, Russia and the CIS, at Jones Lang LaSalle. "Hotels that are already being built [and] have made payments and commitments are obviously going ahead without delay. But with hotels that are yet to sign agreements, we're seeing pauses. As for hotels that are on paper at the moment, they're likely to remain on paper. If you're building a hotel now in Russia, at least 70% of your cost is influenced by foreign exchange. You don't know day by day what that exchange rate is, so how can you predict what your development profit is going to be, or your internal rate of return of that project when it opens in two or three years' time? So as an investor, building a hotel is very difficult."

This is certainly the view of executives at IHG. In 2014, the company's fee income in Russia and the CIS fell by €3 million as collapsing oil prices and a devalued rouble hit the hospitality market. It continues to operate assets across the country, but has recently announced plans to slow down on any new openings.

"Growth will be slower than we expected, and slower than in the rest of Europe," Angela Brav, CEO Europe, said at the International Hotel Investment Forum in Berlin earlier this year. "We'll still be signing, but hotels will be in the pipeline perhaps a bit longer."

As well as affecting development timelines, the economic and political backdrop in Russia and Ukraine is also affecting current hotel performance. Prior to the first quarter of last year, revenue per available room (revpar) in Russia was steadily growing. But from the second quarter onwards, it started to drop as the sanctions kicked in and the impact of oil prices was felt. According to the most recent data from STR Global, revpar in Russia decreased by 13.6% in February this year, with ADR down by 6% and occupancy down by 8.1% to 49.9%.

Business travel slows

The main source of this decline has, of course, been a drop in guests - predominantly corporate Western businessmen - visiting the country. According to the Russian Federal Tourism Agency, the flow of tourists in Moscow and St Petersburg fell by 10% in 2014, with a further drop of between 10% and 15% forecast for this year. This may come as something of a surprise. The decline of the rouble has made the hotel market cheap in Russia, particularly for those coming in with pounds or dollars. But with geopolitical issues as they stand, the usual benefit of increased occupancy that comes with lower rates is not being seen.

"We've been crying out for a bit more value in the Russian market for so long," Jenkins says. "Now, all of a sudden, we actually have more value through the exchange rate, but it's not stimulating demand because people have such a bad image of Russia at the moment."

While the wider picture is negative, some hotels have actually benefitted from this fall in occupancy. In Moscow, the luxury and high-end hotel segment has seen a 10% growth in revpar this year, predominantly from international travellers now able to upgrade with no additional cost. Other hotels have been looking at different source markets to help supplement occupancy - in some cases China and Asia, in others Russia's domestic market.

"St Petersburg in particular has seen a boost through domestic tourism," Jenkins says. "There are limitations on many officials, so many Russians are no longer allowed to travel abroad. At the same time as the rouble's value is as low as it is, your traditional European weekend city breaks that Russians would like to go on have became much more expensive. So in response, we've seen a lot of people turning inward, looking at their own classic European city, which is St Petersburg. I think this is a quite a positive step for the local hospitality market. Whether it continues when things stabilise is another question."

While Russia has lost out on international tourists, Ukraine has seen a major decline in Russian visitors, one of its key source markets. In the first quarter of 2014, as the conflict was beginning to emerge, occupancy in Kiev dropped by 31.7% to 26.9%, according to STR Global. Despite a small rebound this year, occupancy in the Ukrainian capital remains low at 33.5%, far behind the 52.9% figure posted in the first quarter of 2012.

"Until Russian business comes back or is replaced by European business, it's going to be a tough market," Jenkins says. "Even prior to Maidan, it was never the most successful area. It always had lots of potential but was never really capitalised on, mostly because of mismanagement. The country stopped the visa regime for Europeans and Americans, but without a unified system in place to attract tourists they never saw much growth. You can't just stop a visa - you have to go out there, like Turkey has done, and actually attract people.

"I don't think the market is dead - it's still got potential. I think if somebody wants to build, they should focus on the branded economy segment or branded mid-market because there are plenty of luxury and upscale hotels."

Writing in this magazine back in April 2013, industry journalist Ross Davies described Russia and the CIS as "Europe's most fertile region for ambitious operators". While it seems hard to muster the same level of breathless optimism two years later, opportunities remain, even if recent events have proven that, for now at least, making any concrete predictions about the future of the market would be foolhardy.