Small Hotel Draws Big Trouble

MTHad he known how hard it was to build a small hotel, he never would have started to begin with, Igor Lavrik said.
Igor Lavrik wanted to bring small, affordable hotels to the heart of Moscow. After three years, his first project on a vacant lot has not risen beyond the ground floor, stymied by inquiries from City Hall, federal authorities and even a State Duma deputy.

"The idea seemed like a good one -- entering the completely undeveloped mid-range hotel market. But if in 2002 I had known what I know now, I never would have started this project," said Lavrik, a 44-year-old entrepreneur.

While modest hotels with as few as 10 beds constitute a significant percentage of room supply in European capitals such as Paris and London, they hardly exist in Moscow. Especially in the center of the city, visitors are unlikely to find a decent room for less than $100 per night.

Lavrik decided to address this gaping hole in the market back in 2002. As the general director of a developer called Stabilnaya Liniya, Lavrik came up with a plan to create a chain of small, three-star hotels in central Moscow, each with fewer than 50 rooms.

But three years later, he is still struggling to get his first project -- a 28-room hotel at the intersection of Bolshaya Nikitskaya Ulitsa and Gazetny Pereulok -- off the ground.

"For 20 years, there was nothing but dumpsters on this site. But suddenly after we began construction, Duma deputies, law enforcement bodies and bureaucrats from various federal services became so interested in the project that we were forced to stop any construction," Lavrik said.

Lavrik's plan to construct a copy of the historic building that once stood on the spot -- the right wing of the 18th-century Menshikov House -- was part of the problem. Because federal and city authorities are locked in a battle over who is responsible for protecting Moscow's historic buildings, developers like Lavrik often find themselves caught in between. The federal service charged with cultural heritage protection ordered Lavrik to stop building earlier this year on the grounds that it -- and not the city -- was authorized to grant permission.

A spokesman for the service confirmed the order but could not provide details.

"It's not even about corruption; it's about bureaucracy. Corruption is when you can have things done after paying off the right person. But bureaucracy is when an official promises to deliver, but then nothing happens for years," Lavrik said.

Duma Deputy Alexander Lebedev, a prominent businessman who ran for mayor in 2003, waded into the debate last month, filing an official complaint with City Hall claiming that the project violated preservation laws.

Complaints also came from neighbors, who said the construction was causing damage to their building, which Lavrik denied.

In addition, city utilities raised their rates for gas, electricity and heating, Lavrik said. "Even though upon its completion the hotel will be owned by the city and we will only manage it, they are charging two to 2 1/2 times more for utilities. When we try to protest, they simply answer that they don't have enough capacity for us."

The site's central location also means that Lavrik, as the developer, is obliged to make significant investments to relocate infrastructure on the site.

Darrell Stanaford, the director at real estate consultant Noble Gibbons, in association with CB Richard Ellis, said that Lavrik's woes were by no means limited to the hotel business.

"There is an absolute lack of coordination and cooperation between different branches within City Hall. The absence of a unified process is hampering all real estate developments across the city -- big or small," he said, adding that smaller projects without lobbying heft were most vulnerable to bureaucratic inefficiencies.

The construction site, even though it covers a mere 500 square meters, is crossed by 12 different electric cables, water pipes, telephone lines, a telegraph line and a dedicated gas pipeline leading to the eternal flame at the Tomb of the Unknown Soldier outside the Kremlin wall. The cost of diverting the various lines is more than $1 million, Lavrik said.

It is the uncertainty over extra costs that makes the construction of three-star hotels in the city center unprofitable, he said. Although City Hall has presented ambitious plans to develop Moscow's mid-range hotels, developers are finding elite residential or upmarket hotels far more lucrative investments.

High costs mean that only developers with significant means at their disposal can afford building in the city, said Stephane Meyrat, a senior consultant at Hotel Consulting & Development Group. Furthermore, there is no history of small, family-type hotels in Moscow.

"The culture of the Soviet time and the economic planning of that era stressed large concrete hotels with very formal restaurants and a few bars and cafes for tourists," Meyrat said.

And while hundreds of restaurants and cafes have appeared in Moscow since the fall of communism, much higher development costs for hotels mean that mostly upmarket, business-class hotels have sprung up in the past 15 years.

It did not have to be that way, however. In St. Petersburg and in the Black Sea resort town of Sochi, dozens of family-run hotels have opened recently, thanks to support from local authorities who have eliminated red tape.

Budapest could serve as a good example for Moscow, Meyrat said. The Hungarian capital instituted a policy of cheap land leases, uncomplicated privatization schemes and tax incentives to encourage the proliferation of panziok, or three-star, half-board hotels.

While in West European cities the price of land normally accounts for no more than 10 percent to 15 percent of a hotel project's cost, in Moscow that figure can be as much as 50 percent, said Marina Usenko, vice president at Jones Lang LaSalle Hotels.

"If you are building a five-star property, you can raise your room rates accordingly in order to get your money back faster, but it is impossible if you have a three-star hotel," she said.

Lavrik planned to open his first hotel on Dec. 31, 2004. But after numerous delays the opening date was pushed back by a year, and now, Lavrik said, it is "indefinite."

Originally, Lavrik expected to charge $100 per night and to recoup his investment in five to six years. But because of the delays he has raised the room rate to $150 -- with the most optimistic payback time frame at seven years. The total investment into the project has ballooned by 80 percent -- from an original $2.5 million to $4.5 million.

Lavrik remained skeptical that he would ever complete his original plan to build 10 small hotels scattered around central Moscow. But he said he was determined to complete his first project. "It's a matter of principle," he said.