The Chinese hotel industry is a rising star in the global hospitality industry.

The development of hotels in China is a reflection of the economic growth structure of the country - significant investment into infrastructure and fixed assets. Many city planners and government officers believe hotel developments will help elevate the profile of an area and attract further investment. Hotels are not viewed as a supporting amenity to be developed once an area matures.

China's market is a main focus for major global hospitality players and offers a great deal of future growth potential. But a comparison of hotel performance levels in China to regional and global benchmarks indicates that China's performance is underachieving, even in the two major markets of Beijing and Shanghai.

Data from the China Hotel Industry Study also shows that hotel profitability declined considerably between 2006 and 2009. One of the reasons is the supply of hotels. Growth in the supply of hotels has cut into performance levels, kept occupancy relatively low and has placed pressure on room rates, which has eaten into profits.

After a tough year in 2009, the Chinese hotel industry rebounded last year. Shanghai led the way with the 2010 World Expo proving to be a major boost to the city's hotel fortunes.

The latest data from STR Global show that hotel performance across China in the first four months of this year has improved, with an increase in revenue per available room (RevPAR) of 7.7 percent in the 12 months to April as compared to the same period in 2010.

Most within the hospitality industry believe China is still loaded with attractive growth potential, with all of the major global players banking on China and many expecting to double their current stock of hotel rooms in the next five years.

The budget hotel sector has also made headway in the country, with a significant growth in supply expected to be the standard over the short term.

But despite the overabundance of hotel rooms, China continues to push forward with considerable growth in developing hotels. STR Global places the current hotel pipeline in China at 460 hotels, representing more than 150,000 rooms. While this may not amount to half the activity of development in the hotel market across the country, it still accounts for about 43 percent of total projects and 57 percent of the number of rooms in the pipeline in the Asia-Pacific.

It is no wonder all of the major hotel management companies (and plenty of smaller regional and domestic ones) are clamoring for a piece of the pie.

So if oversupply is a concern in many markets, then why do developers continue to build hotels?

Much of it is due to the way planning works in China and the reliance from local governments on land transfer fees for revenue. Many hotel projects do not make a lot of commercial sense in China. But if you look at the bigger picture, it is easy to see why hotels are still being built.

Typically a hotel development is just one part of a larger mixed-use project. If the mixed-use project includes a residential component, then the developer will be more than prepared to risk losses in a hotel in return for potential profits from the residential component. The developer is happy, the local government is happy and the hotel management companies are happy. Consumers should also be happy given the dampening effect oversupply has on room rates.

One current thought within the industry is that the growth potential in China is so high that it doesn't matter if there is an oversupply of hotels because high demand will result in a stable market.

This view is largely held by many respected analysts forecasting massive growth in China's middle-class as well as by economists expecting years of strong economic growth. Growth in hotel demand over the last 10 years certainly has demonstrated that China can make up for its massive growth in supply.

What has not been demonstrated is the Chinese hotel industry's ability to absorb the unending growth in supply and provide a return on investments for hotel developments.

With no end in sight to supply in hotel markets across China, an unhealthy performance outlook is likely to continue with profit levels not justifying investment costs. Should there prove to be a few more bumps along the way with the global economy, or the Chinese economy, the situation may prove to be a major disaster for the industry in the long term.

The author is director of Horwath HTL, a global hotel, tourism and leisure consulting firm.