Hotel Management Contracts Evolutionary Tendancies
Content
HOTELS Hotel Management Contracts: Evolutionary Tendencies Given that statistically, the majority of agreements covering the management of a hotel will outlive most marriages, it is essential that the relationship between hotel owners and their respective management companies is governed through a fair and equitable agreement. John Podaras outlines the evolution in hotel ownership in the Middle East and the trends in management contract terms. Internationally, the nature of hotel owners has changed and metamorphosed from the inn keepers, caravansaries and guest house keepers of antiquity, to the 19th century “hôtelier” to the management companies, franchisors, asset funds, portfolio owners and all the stages in between to be found in the market today. Hotel Leases The management of hotels is equally diverse; traditional owner-managers have given way to hotel leases for example. Leases initially evolved from typical property asset leasing arrangements with a flat rent al fee with indexation built in. This arrangement offers the owner the security of a fixed inc ome for the dur at ion of the lease period, with the lessor earning increased revenues during strong hotel market conditions, and bearing all of the financ i al ri sk in tim e s of we ak hot el market performance. Over time, hotel lease rentals have included a variable component in addition to the fixed fee element, based on gross revenues or gross operating profit. Ho t el l eases are r el at ivel y r are i n t he Mi ddl e East, although they do exist for the mid market and budget end of hotels. Franchise Agreements The significanc e of the hot el br and has br ought wi th it an increased use of franchise agreements (sometimes called license agreements). A hotel franchise brings a number of advantages to the owner, including access to the brand’s sales and marketing network and booking engines, enhanced position to solicit debt and equity financ i ng t hr ough t he assoc i at ion wi th a recogni sabl e brand and still have a measure of self-determination and operational independence of their property. Many hotel owners choose to manage their own property or use an independent management company to do so under a franchise arrangement in the belief that
this arrangement will be more responsive to their needs, limit their costs and generate more gross revenue. Established brands benefit f rom f ranc hi se arrangements as they are a well established method of expanding a brand’s presence for a minimum of investment, as well as being a lucrative source of revenue. Franchise agreements also tend to be standardised and thus less complex to negotiate and administer than their management contract equivalents. Franchise agreements however are rare in the Middle East with many operators preferring management contracts to ensure their brand standards are being met. Condominium Hotels A further complication in the owner/manager relationship arises with the advent of the condominium hotel where rooms or suites are sold and then placed back into a le ing pool f or t he ope rat or t o ma nage. Another variant is the Sukouk Al-Intifa’a which is an Islamic property bond enabling Moslems of any nationality to obtain fractional ownership of a residential suite in specific de vel opme nt s suc h as t he Zam Zam Tower in Makkah. In these cases the company must be structured in such a way that there is one corporate entity with which the operator will have a management agreement. Management Contracts As the Middle East hotel market matures and expands, owners are be er i nf or me d a nd t hei r h ot el s mo r e specialised. The growing market has seen a change in ownership structure from the high net worth individual towards organisations with a keen eye for investments and fiel di ng a stabl e of asset m a nagers. The vast majority of branded hotels in the Middle East therefore are managed under the auspices of a management contract. With over 100 points needing to be addressed within a typical management contract,
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Hotels negotiations can be lengthy and convoluted. The tone and tenor of the process however, if not the relationship itself, depends on the 10 or so key terms that comprise the initial Memorandum of Understanding (also known as the Le er of Int ent ).
although some operators believe that equity participation strengthens their right to manage the property undisturbed.
Fees
Initial contract terms vary from as li le as 10 years to more than 75 with the option to renew for one or two further periods which tend to be half the duration of the initial period. Hotel operators favour longer contract terms as this provides more safeguard for the initial investment in taking on the property, a situation that benefits the own er if the rel at ions hi p is sound and the property is performing well. Some owners however may push for shorter terms, especially if they are looking to become more closely involved with the running of their property.
These are the most important item on the agenda and traditionally comprise management fees that are fixed on a percentage of hotel revenues and incentive fees that depend on the gross operating profit. Co nt ract s that place more emphasis on performance-based incentive fees offer a de gr ee of confidence t o owne r s and sit comfortably with experienced operators. Management companies with a strong and exclusive brand image, o en stipul at e licens i ng and royal ty fees in addition to the management fee, pushing fixed fees to as much as six percent of total revenue. In addition to these fees, management companies look to owners to contribute to group or head offi ce servi c es such as sales and marketing, central reservations, loyalty programmes and training. These charges are apportioned to the hotel portfolio on a pro-rata basis, however in reality it is diffi cul t for an ow ne r to est i m at e the extent of these charges in any given year. These can add as much as five pe rcent of tot al revenue to the fees paid out to management companies. Perhaps there is an argument for negotiating these on a fixed pe rcent age basis, and in this way provide owners the comfort of more predictable outgoings, but even if this is achieved, it is likely that it would only be partially agreed to and that some proportion of these charges will still be calculated on a pro-rata basis. Some operators are charging commitment fees or preopening service charges, where a lump sum is levied on signing the contract. They will argue that these fees are required to ensure they are remunerated during the pre-opening period, whereas owners will claim that they alone bear all the financ i al risk for the pr oj ect . Equity Participation Although currently unusual in the Middle East, elsewhere operators are equity participants in hotel projects. Owners’ perception is that by investing in the project, operators will be more motivated to perform,
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Contract Terms
Manchising Where budget and mid-market hotels are concerned, especially in markets that are strongly driven by domestic demand, the lines between the owner and operator role become blurred and the management contract may well tend towards a franchise. The “Manchise”, a hybrid between a management contract and a franchise and increasingly used in places like India, could be appropriate in the Middle East market particularly with the imminent arrival of Sharia compliant hotels, in which the traditional international brands do not have any experience. Owner’s Control Owners will normally seek a measure of control over the running of the property by ensuring their approval is required for the annual operating plan and capital expenditure for the hotel as well as the hiring and removal of key managers such as the General Manager. Certain management companies will not agree to any level of control, claiming that their objectives for the property and that of the owners coincide and that there are already suffi cient safeguar ds (such as termin at i on clauses) within the contract to protect the interests of the owner. Termination and Performance Termination clauses are essential to ensure the owner can seek an alternative operator in cases where the
Hotels property consistently fails to perform to an acceptable standard. These normally set a minimum GOP as a target and will allow a minimum of two years for that to be maintained, although it is not unusual for the operator to be given the option to make up the differenc e for one or tw o years (cur e opt ion) . Owners will additionally push for a performance clause whereby the operator is required to guarantee an agreed level of profit or to m a ke up the shor tfal l and/ or stand aside their management fees. These clauses are unusual in the Middle East, as operators successfully argue that as they are not equity participants in the venture, they should not be participating in the risk. However, the intent of this clause may be approximated by a suitably worded termination clause. Territorial exclusivity This can be a ‘deal breaker’ especially in cases where the operator is being wooed by a number of owners with sites that are close. An owner will naturally seek to protect his investment from another identically branded hotel competing for the same catchment area by imposing a geographic exclusivity limit, although in certain cases, such as high exclusive destination resorts, the competitive region is much bigger and can include properties in other countries. Operators are, within reason, amenable to this although they will argue that physical proximity offers operational effi cienci es, such as cl ust eri ng s al es and marketing, revenue management, HR or purchasing roles. Examples of this in Dubai are the Hilton properties on the Creek and Jumeirah Beach (same owners), the JW Marrio , Re nai ssanc e and Ma rri o Executive Apartments (different own ers) a nd Hy a (who provide common employee housing). Like most things in life, management contracts that prove successful are the ones where both parties walk away from the negotiating table with something. WinWin is the order of the day, especially when entering the operational phase and the both owners and operators face the challenges of meeting and exceeding their projected earning targets. This article was presented at a workshop session moderated by Peter Goddard at the Arabian Hotel Investment Conference, 2007.
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International experts in hotels, tourism, leisure, and real estate. • • • • • • • • • • • • • • • • • • • • • • • •
Asset Management Bid Advisory Brokerage Business Valuations Concept and Development Planning Consumer Research Custom Market Research Debt Workout Strategies Destination and Large Scale Project Master Planning Development Strategies Due Diligence Studies Highest and Best Use Studies Hotel Management Company Selection and Negotiation Management Company Contract Review Market Analyses and Forecasts Market and Financial Feasibility Studies Market Studies Operational Reviews Physical Assets and Capital Expenditure Review Pre-Feasibility Studies Sector Reviews Strategic Planning Tourism Master Plans Trend Analyses
For further information, contact: Peter Goddard Managing Director [email protected] Gavin Samson Director gavin.samson@ trimideast.com P. O. Box 31933, Dubai United Arab Emirates TEL: +971-4-345 4241 FAX: +971-4-345 8502 Email: [email protected] Web: www.trimideast.com Offices in: London, United Kingdom Dubai, United Arab Emirates
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this arrangement will be more responsive to their needs, limit their costs and generate more gross revenue. Established brands benefit f rom f ranc hi se arrangements as they are a well established method of expanding a brand’s presence for a minimum of investment, as well as being a lucrative source of revenue. Franchise agreements also tend to be standardised and thus less complex to negotiate and administer than their management contract equivalents. Franchise agreements however are rare in the Middle East with many operators preferring management contracts to ensure their brand standards are being met. Condominium Hotels A further complication in the owner/manager relationship arises with the advent of the condominium hotel where rooms or suites are sold and then placed back into a le ing pool f or t he ope rat or t o ma nage. Another variant is the Sukouk Al-Intifa’a which is an Islamic property bond enabling Moslems of any nationality to obtain fractional ownership of a residential suite in specific de vel opme nt s suc h as t he Zam Zam Tower in Makkah. In these cases the company must be structured in such a way that there is one corporate entity with which the operator will have a management agreement. Management Contracts As the Middle East hotel market matures and expands, owners are be er i nf or me d a nd t hei r h ot el s mo r e specialised. The growing market has seen a change in ownership structure from the high net worth individual towards organisations with a keen eye for investments and fiel di ng a stabl e of asset m a nagers. The vast majority of branded hotels in the Middle East therefore are managed under the auspices of a management contract. With over 100 points needing to be addressed within a typical management contract,
1
Hotels negotiations can be lengthy and convoluted. The tone and tenor of the process however, if not the relationship itself, depends on the 10 or so key terms that comprise the initial Memorandum of Understanding (also known as the Le er of Int ent ).
although some operators believe that equity participation strengthens their right to manage the property undisturbed.
Fees
Initial contract terms vary from as li le as 10 years to more than 75 with the option to renew for one or two further periods which tend to be half the duration of the initial period. Hotel operators favour longer contract terms as this provides more safeguard for the initial investment in taking on the property, a situation that benefits the own er if the rel at ions hi p is sound and the property is performing well. Some owners however may push for shorter terms, especially if they are looking to become more closely involved with the running of their property.
These are the most important item on the agenda and traditionally comprise management fees that are fixed on a percentage of hotel revenues and incentive fees that depend on the gross operating profit. Co nt ract s that place more emphasis on performance-based incentive fees offer a de gr ee of confidence t o owne r s and sit comfortably with experienced operators. Management companies with a strong and exclusive brand image, o en stipul at e licens i ng and royal ty fees in addition to the management fee, pushing fixed fees to as much as six percent of total revenue. In addition to these fees, management companies look to owners to contribute to group or head offi ce servi c es such as sales and marketing, central reservations, loyalty programmes and training. These charges are apportioned to the hotel portfolio on a pro-rata basis, however in reality it is diffi cul t for an ow ne r to est i m at e the extent of these charges in any given year. These can add as much as five pe rcent of tot al revenue to the fees paid out to management companies. Perhaps there is an argument for negotiating these on a fixed pe rcent age basis, and in this way provide owners the comfort of more predictable outgoings, but even if this is achieved, it is likely that it would only be partially agreed to and that some proportion of these charges will still be calculated on a pro-rata basis. Some operators are charging commitment fees or preopening service charges, where a lump sum is levied on signing the contract. They will argue that these fees are required to ensure they are remunerated during the pre-opening period, whereas owners will claim that they alone bear all the financ i al risk for the pr oj ect . Equity Participation Although currently unusual in the Middle East, elsewhere operators are equity participants in hotel projects. Owners’ perception is that by investing in the project, operators will be more motivated to perform,
2
Contract Terms
Manchising Where budget and mid-market hotels are concerned, especially in markets that are strongly driven by domestic demand, the lines between the owner and operator role become blurred and the management contract may well tend towards a franchise. The “Manchise”, a hybrid between a management contract and a franchise and increasingly used in places like India, could be appropriate in the Middle East market particularly with the imminent arrival of Sharia compliant hotels, in which the traditional international brands do not have any experience. Owner’s Control Owners will normally seek a measure of control over the running of the property by ensuring their approval is required for the annual operating plan and capital expenditure for the hotel as well as the hiring and removal of key managers such as the General Manager. Certain management companies will not agree to any level of control, claiming that their objectives for the property and that of the owners coincide and that there are already suffi cient safeguar ds (such as termin at i on clauses) within the contract to protect the interests of the owner. Termination and Performance Termination clauses are essential to ensure the owner can seek an alternative operator in cases where the
Hotels property consistently fails to perform to an acceptable standard. These normally set a minimum GOP as a target and will allow a minimum of two years for that to be maintained, although it is not unusual for the operator to be given the option to make up the differenc e for one or tw o years (cur e opt ion) . Owners will additionally push for a performance clause whereby the operator is required to guarantee an agreed level of profit or to m a ke up the shor tfal l and/ or stand aside their management fees. These clauses are unusual in the Middle East, as operators successfully argue that as they are not equity participants in the venture, they should not be participating in the risk. However, the intent of this clause may be approximated by a suitably worded termination clause. Territorial exclusivity This can be a ‘deal breaker’ especially in cases where the operator is being wooed by a number of owners with sites that are close. An owner will naturally seek to protect his investment from another identically branded hotel competing for the same catchment area by imposing a geographic exclusivity limit, although in certain cases, such as high exclusive destination resorts, the competitive region is much bigger and can include properties in other countries. Operators are, within reason, amenable to this although they will argue that physical proximity offers operational effi cienci es, such as cl ust eri ng s al es and marketing, revenue management, HR or purchasing roles. Examples of this in Dubai are the Hilton properties on the Creek and Jumeirah Beach (same owners), the JW Marrio , Re nai ssanc e and Ma rri o Executive Apartments (different own ers) a nd Hy a (who provide common employee housing). Like most things in life, management contracts that prove successful are the ones where both parties walk away from the negotiating table with something. WinWin is the order of the day, especially when entering the operational phase and the both owners and operators face the challenges of meeting and exceeding their projected earning targets. This article was presented at a workshop session moderated by Peter Goddard at the Arabian Hotel Investment Conference, 2007.
3
International experts in hotels, tourism, leisure, and real estate. • • • • • • • • • • • • • • • • • • • • • • • •
Asset Management Bid Advisory Brokerage Business Valuations Concept and Development Planning Consumer Research Custom Market Research Debt Workout Strategies Destination and Large Scale Project Master Planning Development Strategies Due Diligence Studies Highest and Best Use Studies Hotel Management Company Selection and Negotiation Management Company Contract Review Market Analyses and Forecasts Market and Financial Feasibility Studies Market Studies Operational Reviews Physical Assets and Capital Expenditure Review Pre-Feasibility Studies Sector Reviews Strategic Planning Tourism Master Plans Trend Analyses
For further information, contact: Peter Goddard Managing Director [email protected] Gavin Samson Director gavin.samson@ trimideast.com P. O. Box 31933, Dubai United Arab Emirates TEL: +971-4-345 4241 FAX: +971-4-345 8502 Email: [email protected] Web: www.trimideast.com Offices in: London, United Kingdom Dubai, United Arab Emirates
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