Hotel Boom In India’s Small Cities Won’t Sustain Unless Infrastructure Keeps Pace

India’s tier 2 and tier 3 cities have been driving all sorts of business growth in the last couple of years, be it e-commerce, retail or the development of India’s hospitality industry. With a saturation in India’s metros and bigger cities, everyone including hoteliers have spent the last two years looking towards India’s smaller cities for more profitability

Jones Lang Lasalle’s (JLL’s) Hotel Investment Trends Report 2024 showed that hotel investments in India in the first half of the year touched a remarkable $93 million. This number is expected to grow to $413 million by the end of the year. The report further reveals that 19,440 deals were signed in all, with the majority 83% in tier 2 and 3 cities. These included management contracts, revenue shares, and franchises. These numbers, from the first half of 2024, have already surpassed those of the entire year of 2023 when 13,600 deals had been signed. Another JLL report found that in Q1 2024 alone, 36 new hotel properties opened, with a majority of them in tier 2 and 3 cities.

At a time when the post-pandemic pent-up demand for consumption seems to be waning for various reasons, hotels in India seem to not be affected. The 2024 Indian Hospitality Trends & Opportunities Report found that in the financial year 2023-24, India’s branded and organised hotels closed with a nationwide occupancy of 67.5%, the highest in a decade. The average daily rate was Rs 8,055, a record high.

All signs point towards the continued growth in the hospitality sector in India, fuelled by Tier 2 and 3 cities. While experts warn that there could be market corrections if infrastructure growth doesn't keep up, hoteliers are optimistic that smaller cities, with lower real estate prices and other localised factors, will continue to drive profitability.

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A Significant Boom

A senior hospitality professional told The Core on the condition of anonymity that both national and international chains of budget and mid-range hotels are focusing on tier 2 and 3 cities. This trend, he believes, is likely to continue for the next few years. “Taj Vivanta and Holiday Inn are opening up in cities like Bhubaneshwar and Amritsar. Hilton properties have been announced in Lucknow and Jaipur. Varanasi and Indore are coming up in a big way,” he said.

Several factors have influenced this growth, the most important being increased road and airline connectivity. Hari Sukumar, senior vice president at Jaypee Hotels in Agra, has witnessed this first-hand. “There are now good branded hotels in the city. Mathura is expanding, and Aligarh and Gwalior are getting traction too. Connectivity through the expressway has benefited these areas. Greater Noida has become a hub too because of accessibility,” he said.

India’s tier 2 and tier 3 cities have seen economic growth and a rise in disposable incomes. This has been favourable for hotel chains as well. Zubin Saxena, senior vice president and regional head, of Hilton South Asia agrees and is geared up for this new phase in India’s hospitality industry. “I see vast potential lies in tier 2 and 3 cities, where leisure demand, social aspirations, and the revival of domestic travel converge to create untapped opportunities, such as Lucknow, Kochi, and Jaipur where we have announced multiple signings of our brands across portfolio — luxury, full service, and focused service.

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Behind The Business

Hoteliers told The Core that a majority of their business in these cities comes from destination weddings, MICE (Meetings, Incentives, Conferences, and Exhibitions), and local food service. However, Sukumar said that it was nearly impossible to discuss hotel signings and openings without destination weddings. “We have done Rs 350-400 crore wedding business 2023-24. We’ve seen exponential growth of about 80% in 2023-24 in Agra and surrounding areas,” he said.

The dependence of hotels in the region in tier 2 and 3 cities on travel agents and foreign tourists has also reduced significantly since the pandemic. “There has been an increase in ARR (Average Room Rate) and hotels now can command their price,” he said.

While names like Varanasi, Nashik, Nagpur, Ambala, Mysuru, and Gwalior, come up often through these conversations, Chaitanya Adgaonkar, co-founder of Centro Hotel in Pune, puts in perspective the growth story of Indian hospitality with numbers. “There are only six tier 1 cities in the country, but together the tier 2 and 3 make up about 180. That gives you a sense of the opportunity there is,” he said. “Tier 2 and 3 cities were not considered growth drivers by major hotel chains. That has changed after the pandemic. This is where the next growth spurt is going to come from. With real estate prices going up in Tier 1 cities, it is becoming unviable to run a hotel with a decent profit margin,” he said.

Aishwarya Adgaonkar, co-founder of Centro Hotel in Pune said that people moving back to their hometowns during the pandemic had also helped change the outlook towards India’s smaller cities. “Plus, with government initiatives and increased connectivity, the tier 2 and 3 city markets are primed for growth,” she said.

Travel providers like SOTC are expanding their footprints outside of India’s tier 1 cities. In September, the tourism company announced a retail centre in Karnal, Haryana, followed by Mysuru. Thomas Cook India opened an outlet in Chromepet, Chennai to “leverage the high-growth market of the city and its surrounding catchments”.

Occupancy rates in tier 2 and 3 city hotels are significant, too. Sukumar reports a 75-80% occupancy at the 341-room Jaypee Palace Hotel, Agra. Adgaonkars’ Centro Hotel with 31 rooms has 100% occupancy except during festivals.

“With this growth, several sub-brands of international hotel chains will make an appearance in the Indian hospitality landscape. They are common in Europe and the US. These are budget and mid-scale brands that will be required for tier 2 and 3 city expansion,” said a senior hospitality professional.

What Next?

Several factors including macroeconomic trends, government incentives and just post-pandemic revenge tourism have played a role in this shift of focus towards smaller Indian cities. Now that the revenge spending that followed the pandemic is receding, and many sectors including automobiles and air travel have been witnessing a steady decline.

Will the hospitality industry, after a spate of expansion, witness its pitfalls too? Sukumar said that a market correction is inevitable. “I don’t see it sustaining for more than three to four years unless there is a huge revamp of infrastructure and connectivity. We will probably go back to depending on foreign travel for business,” he said.

Adgaonkar, on the other hand, believes that the hospitality industry may be able to weather this storm. “Even though macroeconomic indicators are slowing down, minor corrections in real estate prices will help drive the growth. The capital that goes into the land and building are major expenses for hotels after all,” he said. Adgaonkar thinks that some areas and properties may not succeed, but it will be because of localised factors, not macroeconomics. “For example, Nagpur is built around electronics, and Pune is around IT. So, even though the IT sector is slowing down, other industries may not. It balances out,” he said.

Adgaonkar is putting money where his belief is. He has plans for further expansion to two new locations — Nashik and Nagpur. “Nagpur is showing great energy with corporate offices and an IIT (Indian Institute of Technology) coming up. It’s right up there after Mumbai and Pune with air traffic,” he said.

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