Why Are More Luxury Hotels Being Built Inside Complexes?

The number of foreign visitors to Japan is on a rise, and the Japanese tourism industry is about to grow bigger and bigger. There is a roadblock, however: Only a limited number of luxury hotels are available in the country. This is a result of profitability issues in hotels that are developed alone.

April 03, 2018

Number of luxury hotels serves as an indicator of a city’s power

It’s final–the 2019 G20 Summit will be held in Osaka. Fukuoka City was also in the running to host the summit, but lost to Osaka. Some media outlets, such as Nishinippon Shinbun, report that Fukuoka City lost because of a “shortage of hotels,” and it is apparent that the number of luxury hotels available serves as one of the metrics by which to measure a city’s urban function. Meanwhile, toward more growth in the Japanese tourism industry, many experts have pointed out that Japan lacks luxury hotels, which attract wealthy tourists from abroad, in comparison to other countries. But why are there so few luxury hotels available in Japan, when the number of foreign visitors to Japan is on the rise, and the Japanese tourism industry is about to grow even more?

Yasokazu Terada, vice manager of the JLL Japan Hotels & Hospitality Department, which has invited a number of foreign hoteliers to open a hotel in Japan, says, “The demand for accommodations is highly volatile week-to-week and month-to-month, and the demand grows and shrinks according to the day-to-day lodging prices. It’s not easy to talk about a shortage of hotel rooms.” Having said that, he explains the significant shift in recent hotel demand, “In the past five years, the number of foreign tourists to Japan has increased rapidly, but their primary reason for coming to Japan is leisure. Tokyo’s lodgings are used for business purposes, and people on business trips tend to use single rooms. On the other hand, foreign tourists coming for the purpose of leisure stay in hotels as a group, for consecutive nights, and have a lot of luggage. They need bigger guest rooms. It would be more accurate to say that there aren’t enough large guest rooms, rather than to say there aren’t enough luxury hotels. In other words, supply is not meeting demand in this regard.”

Profitability-oriented “accommodation-only” hotels are the mainstream

Nevertheless, there are quite a few hotel development projects happening in Japan. If you take a walk in Ginza—one of the biggest commercial areas in Japan—and other districts in central Tokyo, you will see hotels being constructed here and there. However, most of these new hotels are “accommodation-only” hotels. The hotels themselves don’t have restaurants or cafés, and are equipped with automated check-in and check-out systems. They are solely focused on functioning as lodgings. A good example of this type of hotel is business hotels. Hotels that are for single guests rather than travelers are the only ones growing in number. Terada points out the main reason for that: “Decisions made when a hotel is seen as a real estate enterprise.”

“In order to embody the concept of a luxury hotel that provides a full range of services, you need to develop a number of auxiliary facilities that are not necessarily profitable—a restaurant, banquet facility, fitness center, and a spa. Providing red-carpet service, too, requires more staff, and naturally, you have to have more office spaces that do not make any profit. As a result, in comparison to other developments like commercial facilities, offices, or residential facilities, profitability per floor area is smaller. This is not just the case in Tokyo—in local cities, luxury hotels are even less profitable.”

Therefore, it is quite natural for private hotel development projects to revolve around “accommodation-only” hotels that are expected to make profit.

Luxury hotels are built in complex buildings

For the government, which aims to host more international conferences, like the G20 Summit, developing luxury hotels is a pressing task. Standalone hotels are likely to stall during development because of the issue of profitability, but developing “built-in” luxury hotels as part of large-scale redevelopment projects is becoming more popular. Pullman Tokyo Tamachi, which is scheduled to open its doors in fall 2018, will be located inside the “msb Tamachi” mixed-use building that is being developed as part of the “TGMM Shibaura Project” (tentative name), a large-scale complex redevelopment project. Hotel Okura Tokyo’s main building is being renovated, and the work is planned to be completed by 2019. The new hotel building will have office space in its upper floors (the 8th to 25th floors; a total floor area of roughly 64,000 m2). Scheduled to open in spring 2020, Four Seasons Hotels & Resorts has announced its intention to open a hotel in the upper floors (the 3rd floor and the 34th to 39th floors; a total floor area of roughly 25,578 m2) of Building B of the “OH-1 Project” (tentative name). All of these hotels are being developed alongside offices, residences, and commercial facilities. In terms of the share of floor space, too, the buildings will not be used mainly as hotels.

The main reason for developing more of these “built-in” hotels is that developers can benefit from the relaxed rules regarding floor area ratio. “The government expects more luxury hotels to be developed in order to enhance the city’s convenience and brand value, but developing a hotel alone is not profitable enough. Hence, the authorities relax the floor area ratio to encourage hotel development,” says Terada. Standalone hotels also follow this trend. Palace Hotel Tokyo reduced the number of its guest rooms when it was revamped in 2012, and Tokyo Garden Terrace Kioicho, which was built as part of the redevelopment of the former site of Grand Prince Hotel Akasaka, also use half of its total floor area of about 227,000 m2 as office space. While Hotel Okura will have more guest rooms after its renovations, it is being developed as a mixed-use building with offices and residential spaces, as well.

Advantages to owners, hotel operators, and the government

Many projects to develop new luxury hotels are undertaken under a management contract. Under a management contract, hotel operators provide their expertise in running a hotel, and the more hotels they open, the higher they can set their fees. Developers who invite hoteliers to open hotels in their projects are able to enhance convenience and promote their brands in urban development market, while the government develops the city’s infrastructure—all three of them enjoy different advantages. In addition, Terada notes, “More developers are starting to think that signing a management contract can better pursue upside risks than earning income from rent under a traditional lease agreement, and it’s become easier for hotels to find a partner.” Hoteliers are watching closely for an opportunity to open a hotel in Tokyo, Osaka, Kyoto, Fukuoka, and other major cities.

While hoteliers are still eager to open new locations in Japan, many developers prefer hotel brands that are opening its first location in Japan yet to create a buzz as the key feature of their redevelopment projects. Terada explains: “There are a number of hotel brands that haven’t opened a hotel in Japan—mid-range hotel chains as well as big-name brands. When you include Japanese hotel operators in the count, you will get more options.” He also mentions some points to be careful.

“Foreign luxury hoteliers, in particular, have locations all over the world, and have undertaken a large number of contracts. However, developers often don’t have much experience in hotel development or negotiations for signing a management contract. If a hotelier and a developer attempt to sign a management contract through direct communication, it can end up in an unfair agreement that is more favorable to the hotelier.”

Government expectations are likely to encourage the inviting of luxury hotels even more, but a go-between who is armed with a deep understanding of both Japanese business customs and foreign hoteliers’ business expansion strategies will be essential.