In this paper, hotelintel.co advisory board member and hotel veteran Giovanni Angelini presents a guide to traversing the often unforgiving terrain of Owner - Operator hotel agreements including Management Agreements, Leases, Franchises and others. This is all done with the goal of aligning the Owner's and the Operator's goals.

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Excerpt

A: INTRODUCTION


This paper examines the way in which hotel management, lease, franchised and other agreements have evolved over recent years. It looks mainly at the commercial terms of contractual agreements and should not be construed as a legal document.

Motivated by their insatiable appetite to continually expand, and forced by institutional investors and hotel owners to change, operators have become very flexible in their approach to structuring hotel transactions and asides from actually owning the asset. There are now several ways (agreements) for hotel operators to expand their groups/chains without using their own funds.

Hotel managing companies date back to the early 1900s. Back then, the normal method to supply management services was through total property lease by which the operator leased the hotel from the owner. It was only between 1950 and 1960, following the global hotel expansion, that management agreements were created to provide a buffer against the financial risks by bringing professional operating expertise to new and existing hotels, especially given uncertainties involved in expansion, in various countries around the world.

At present, around 70% of all rated hotels around the world are branded/operated by hotel companies, (STR survey). More independent hotels are joining/entering into agreements with professional operators/brands with the objective to tap into their marketing power distribution channels and operating efficiency, given the growing challenges of operating as an independent hotel.

Of course, independent hotels with strong established positions in their respective markets are the most likely to reject offers to join a large group/chain.

Before entering into any agreements, it is strongly recommended that appropriate legal advice is taken from counsel experienced in such matters and with knowledge of the local countries laws, as well as the law which the contract is subject to. “It is recommend that prior to contacting a lawyer, the Term Sheet (primary business terms) should be drafted to cover most business terms, even if they aren’t defined and detailed out. This saves time and money when getting to the legal documents.”

Most of the large operators offer several agreement schemes/models;

  • Management agreement
  • Lease agreement
  • Franchise agreement
  • Manchise agreement
  • Royalty or brand License agreement
  • Affiliation/Marketing Agreements
  • Soft Brand Concept Agreements
  • Digital Disruptors – OTAs Agreements (new alternative)
  • Other

This document addresses the 3 most popular agreements: Management, Lease and Franchise. And briefly touching on the Affiliation/Marketing Agreements, on the Soft Brand Concept Agreements and to a possible new Digital Disruptors-OTAs Agreements.

The hotel industry needs to honestly ask itself whether sufficient attention is being given to research and development to explore what improvements can be made to hotel agreements. This is certainly a challenge for the operating companies with the enhanced importance that hotel agreements now have on their intrinsic value. But it is not just the operating companies. At no stage in the evolution of the hotel industry has hotel ownership been so concentrated. Many owners hold substantial portfolios of hotels spiraling in value into the billions of dollars often in far-away and diverse locations.

When one party wishes to engage in an agreement with a management company it must be aware that this is a complex legal-commercial relationship, which requires understanding the material differences and priorities between the two parties.

Hotel agreement negotiation can be a long and complex process. This negotiation must satisfy both the operator and the owner to help ensure an effective and trustful relationship is established between the two parties, while taking into consideration the medium to long-term financial ramifications for both. The only period of true leverage and negotiation is during this period; “like dating prior to a marriage, it doesn’t get any better”.

While owners have become far more knowledgeable in recent years, global operators have also become larger and more powerful, particularly given the recent consolidation, mergers and acquisitions by the major hotel operators in the industry. Accordingly, the reduction in competition has made it more difficult to negotiate with them. “The reduction in competition has resulted in the major brands being much less flexible or interested in negotiating” Despite the consolidation, the industry is still relative to other industries highly fragmented and the numbers of small and medium size operators are increasing very fast and some of them are successful at competing in the market.

In some areas/countries, there is a move towards agreements with third-party operators. As the hotel is becoming a more mainstream asset and owners are gaining a better understanding and insight, third-party operators (TPO) are on the rise as they are usually more focused on the Owner’s individual asset(s) in comparison to the broad range and number corporately managed properties. Well established in the US market, this model which is relatively new in Europe and Asia, is now growing rapidly, bringing more flexibility to owners and allowing them in some instances to the responsibilities of the staff to the TPO’s balance sheets. A hotel managed by a TPO is very often combined with a franchise from a major hotel brand.

As more management companies have/are entering the market place, competition for agreements has increased with direct impact on lower base fees, higher incentive fees, performance clauses and often, shorter terms.