Hotelier Sant Singh Chatwal is building his “Dream” in a place with the unlikely name of the Backwaters, a complex of lagoons and lakes linked by countless canals forming a large part of the Indian state of Kerala.

Until recently, the Backwaters were pretty much just that, and the state's picturesque but sleepy port of Kochi (Cochin) on the western coast of India was best known to the outside world as a backpacker's destination.

In 2009, Chatwal's New York-based company, Hampshire Hotels & Resorts LLC, which owns about 2,500 rooms in Manhattan plus properties in London and Bangkok, will open Dream Chochin, a 200-room luxury hotel on a Backwaters location not far from downtown Kochi, the first of seven properties the company plans for India.

The Kochi property will be the first luxury hotel to open in the area in more than a decade, offering such amenities as a three-story glass atrium lobby with water views and a variety of restaurants, again overlooking the omnipresent creeks and other waterscapes of the Backwaters location.

The property targets not only international travelers, Chatwal says, but also travelers from other parts of India, and local residents who will use its meeting space and other facilities.

Chatwal has no doubt that there's now a market for this kind of property in a second-tier Indian city in India. “Like most major markets in India now, Kochi is now underserved in terms of hotel rooms while demand is only growing,” he says.

While land costs are high, construction costs are lower than in the U.S., as are labor costs, Chatwal says. “Average room rates rival many major U.S. markets and in some cases supersede them, which offers the potential for returns of 20% more than their U.S. counterparts.”

The growth of the Indian economy as a whole might be a factor in developing a hotel in a place like Kochi, but local market conditions are equally as important, Chatwal explains.

Though not known to the world as a tech center like Bangalore, Kochi's ITsector has nevertheless been growing rapidly in recent years. The National Association of Software and Service Cos., India's software trade organization, now ranks Kochi as the nation's second-most attractive city for IT-based services.

Redefining ‘emerging’

Hampshire Hotels & Resorts is part of the rush to develop hotels in emerging markets worldwide, particularly in India and China, and not just standard international hotel fare in usual-suspect major cities in these countries, such as Beijing or Delhi.

Hoteliers see the potential in drilling deep into these markets, and they're responding with ambitious growth plans for the two nations through direct investment, joint ventures with Chinese and Indian real estate companies, franchise agreements or a combination thereof.

Indeed, Hilton International — which merged last year with Hilton Hotel Corp. before being swallowed by Blackstone this year — has partnered with RREEF to develop various brands of hotels in China in the coming years.

The company will open its first Hilton Garden Hotel in Sakat, India next year. Ten more properties, including Hilton Garden Inns, Homewood Suites and Hiltons, are under way via a joint venture with Indian developer DLF.

InterContinental Hotel Group is on track to open 125 new Holiday Inn Express properties in China by the end of next year, adding to the Crowne Plaza and Holiday Inn brands it operates there.

Meanwhile, Best Western International is partnering with the Indian company Cabana Hotel Management Pvt. Ltd. to open more than 100 hotels in India over the next 10 years.

Paris-based Accor signed a deal this year to partner with Dubai-based Emaar, which has experience in India, to develop 100 of the company's Hotel Formule 1 budget brand. Accor already has a joint venture with InterGlobe to develop Ibis hotels in India.

The French hotel giant opened its first Ibis — an economy brand — in China in 2005, and now has a goal of perhaps as many as 40 in the next two years. That total is about the same as the number of mid-market and upper-upscale offerings (Novotel and Sofitel, respectively) that the company also wants to develop in that country.

“An emerging market is a place where the political and economic climate fosters new demand for hotels, not just among foreign travelers, but locally as well,” says Kapila K. Anand, KPMG's national industry director of real estate and hospitality advisory services.

“In terms of the opportunities to develop new hotels, India and China still blow everywhere else away,” adds Anand, “though the competition is only going to increase and both countries still pose complicated puzzles for developers.”

The old international hotel paradigm is disappearing, says Miguel Rivera, a senior vice president at Jones Lang LaSalle Hotels. “The model used to be to saturate the developed world with your brands, and place luxury or upper-upscale properties for business travelers in the gateway cities of developing countries,” Rivera says. “Now there is more aggressive targeting of secondary cities in emerging markets, not just with full-service properties but mid-scale brands as well.”

Big rewards, big risks

For all their opportunities, however, the behemoth emerging markets of China and India also are known for the difficulties they pose. Some of the broader problems, such as dealing with the uncertain attitudes of official China on matters of the sanctity of contracts, or India's famed red tape, are well known.

Their respective legal structures, which include the details of land ownership and other property issues, plus their tax structures, are also complicating factors, especially in India, where such structures have a highly localized flavor.

Connections are usually the way to navigate the shoals of such a complicated development environment, typically through local corporate partners.

“Development in India, not unlike anywhere else in the world, is based largely on relationships,” says Chatwal of Hampshire Hotels & Resorts, whose connections to the Indian subcontinent run deeper than most hoteliers. Chatwal was born there, immigrating to the U.S. in the 1980s to make his fortune in the restaurant and hotel business.

“My personal ties to home have benefited us in both the development partner and local architect of record,” he adds. “Our development partner [in Kochi] possessed prime, undeveloped real estate, and understands the ebb and flow of the local politics of development. This has minimized the hurdles that would face the unfamiliar foreign investor.”

Other issues, particularly involving infrastructure, are of special concern to hoteliers who want to expand in China and India. “It's not enough just to have a big population and middle class. You have to estimate where and how they'll be traveling,” says Anand. “Travel infrastructure is a critical component in a property's success, but it's also less predictable than you'd think.”

Some cities in China, Anand says, are currently hobbled by inadequate air travel infrastructure — especially obsolete or rundown airports. “Some of those markets are huge, but without a high-quality airport to sustain them,” she adds. “In the case of China, however, investment in infrastructure is massive, so if a hotel [operator] times it right, it can take advantage of new infrastructure. Nearly 50 airports will come on line in the country within the next five years,” adds Anand.

As for India, the infrastructure question is even murkier. India doesn't spend as much on infrastructure as China does, and its planning is far less centralized.

“We have a client who says it's going to put up 40 to 100 hotels in secondary markets in India, but what you'd have to predict very closely is which highways will expand and where to match your hotel product,” Anand says. “India's an enormous puzzle in that regard, and some hotels are going to be misplaced.”

Undaunted by obstacles

Nevertheless, hoteliers insist the markets are worth the trouble. Tom Keltner, CEO of the Americas and global brands for Hilton Corp., echoes Chatwal in explaining that hotel development can profit from relatively low costs, except for land.

“In India, good sites tend to be quite expensive, but that's balanced out by construction costs and labor costs, which tend to be lower, and therefore the margins are better than in the U.S.,” Keltner says. “We're expecting internal rates of return in the high teens in India. That compares well with other markets, including the developed world.”

Christian Karaoglanian, chief development officer with Accor, notes that margins are higher in emerging markets, but only if a company establishes a strong presence. “You won't make your money on a single property,” he notes. “But with 50 or 100, you'll get efficiencies inback-office, labor and so on. Land is expensive in China and especially India, with its real estate boom, but the labor arbitrage is where you'll see a higher ROI,” adds Karaoglanian.

Of course, that's if your brands catch on with local consumers, who in coming years also will have non-Western brands from which to choose. “Will the people in emerging markets care about the international brands, or will local brands do the trick?” says Rivera of Jones Lang LaSalle Hotels. “It's still an open question.”

Emerging demographic

Whatever the uncertainties, the demographics of China and India are compelling for hoteliers. The new hotel development paradigm in both countries hangs on their burgeoning middle classes, which for decades were inhibited from growing due to government policies.

“In China and India, the new middle classes will change a lot of things because those countries have never had a large middle class before,” says Anand. “That includes patterns of travel. The middle class will pump up demand for hotel rooms.”

To be in the middle class in China or India isn't quite what it would be in the United States, western Europe or Japan. China's gross domestic product per capita in 2006 was $7,700, while India's was $3,800, according to the CIA World Fact Book. (By comparison, the per capital GDP in the U.S. is $44,000).

Nevertheless, according to separate 2006 reports by the McKinsey Global Institute, both the Chinese and Indian populations will have considerable money to burn in the future. By 2025, McKinsey predicts, China's urban households will command a total of about $2.6 trillion in spending power annually, or roughly the same as Japanese households do now.

As for India, McKinsey predicts that the country's middle class may total as many as 583 million people with $1.5 trillion to spend annually by 2025.

Building a critical mass

“We will concentrate our resources in countries where we can develop large numbers of hotels, and India and China have room for most of our brands, especially our middle-market brands,” says Karaoglanian of Accor, which has ambitious plans for both countries.

Karaoglanian adds that the next frontier for hoteliers in those countries is serving the “missing” middle markets. “In India, the opportunity is especially enticing, because there are only about 110,000 rooms in the entire country — a ridiculously small number, fewer than in New York City,” he says.

“Both India and China represent opportunities to expand our mid-market brands,” says Keltner of Hilton. “But you can't do just a few hotels in each of those countries. You need to have a concentrated effort to make your investment pay. For example, we have partnered to develop 25 Hilton Gardens in China.”

In India, the company is focusing on expanding its Hilton and Hilton Garden Inn brands throughout the country, including numerous secondary markets. Keltner points out that often more amenities are expected from mid-market properties in emerging markets than in the developed world.

In the U.S., for instance, a Hilton Garden Inn might offer limited restaurant service, since its immediate vicinity would probably be thick with places to eat. In India, in order to be competitive a Hilton Garden Inn offers more robust food service, perhaps two restaurants at each property, one local cuisine and the other Western cuisine.

It would also feature more meeting space than most examples of the brand in the developed world to host small events or large weddings.

“The demand for these kinds of amenities is increasing, and often existing properties aren't up to meet it,” Keltner says. “Our new properties are going to meet that demand.”

Dees Stribling is a Chicago-based writer.