The hotel management landscape appears to be changing. In this edition, and based on their team's recent experience, Baker & McKenzie will discuss some of those areas undergoing change, and some areas for improvement.
We should make some preliminary observations:-
• this article draws upon the experience of the Australian offices;
• over the last few years approximately half the hotel management agreements (HMAs) we have worked on have been for Australian properties and the balance for properties outside Australia;
• Australia and most of the other jurisdictions in which we negotiate HMAs tend to be markets or involve players that are relatively mature, and where the playing field tends to be pitched in favour of owners rather than operators;
• we usually act for owners (operators, particularly international chain operators, are generally represented by in house counsel). On that basis, our perspective may be skewed to some degree; and
• the spread of contracts we work on covers a wide variety of operators (both domestic and international) and jurisdictions.
So what's hot or about to be hot?
The changing face of hotel owners
Traditionally the bulk of hotels were owned by wealthy individuals or families. The trend today is for hotels increasingly to be acquired by large public corporations or institutions, including pension funds.
Institutional owners are on the whole less concerned about day to day control and more concerned about the seminal events which can impact on the profitability or capital value of the hotel. Examples include the budgeting process and the ability to take action if the owner considers that the general manager is not acting in the best interests of the owner.
The aggregation of hotel ownership
This trend toward the big end of town has contributed to a concentration of hotel ownership: more and more hotels are being acquired and owned by fewer and fewer owners. Pension funds and private equity players increasingly do not have the time, resources or inclination to participate in a sale process for a single property.
Ultimately we expect this will create a major shift in the way the HMA negotiation process is conducted and the manner in which such hotels are operated. We see a growing emphasis being placed on the overall relationship between operators and owners, with bigger portfolios attracting more love and attention from operators and better commercial terms.
The movement into the retail market
At the same time as wholesale owners are bulking up, condo hotels are emerging with fractured ownership.
We discussed the emergence of condo hotels in the last edition of the newsletter. Condo hotels consist of hotel rooms which have been sold off to individual investors, who then pass ongoing operational control of their rooms to the hotel operator secured by means of a HMA or similar legal device.
Condo hotels tend not to have the profitability potential to attract the interest of wholesale owners, but retail investors can live with lower returns they generate (perhaps sweetened by an ability to holiday at a concessional rate with other add on benefits).
Condo hotels require a more considered approach than straight hotel management projects, especially if the operator's brand will be leveraged in the retail sale process and if the developer intends to exit the project when the condos are sold.
Operators are shedding property
For a variety of reasons operators are selling the hotels they own - generally operators are seeking to enhance their profitability and to focus management attention on hotel management rather than hotel ownership.
This is going to place greater importance on the HMA used by operators, particularly in mature markets where the level of competition between operators is high. Factors such as how owner friendly an operator's HMA is will become increasingly important in winning new deals.
The paradigm shift
Over time we have witnessed a move from the 'them and us' mentality between owners and operators to a 'we're in this together' approach.
This is reflected in the following changes to HMAs:
• management fee formulations are increasingly aligned to owner profitability;
• control provisions that recognize the central role of aspects such as the budget setting mechanism and the relationship between the owner and senior management (particularly the general manager);
• the increasing importance of regular meetings between owner and operator representatives to work through hotel operational issues before they escalate;
• agreement terms becoming shorter (except for genuine trophy sites); and
• an increasing recognition of the need for owners to be able to terminate on sale of their hotel
That said, as indicated below there is still a lot more research and development that can be undertaken to potentially increase the size of the pie for owners and operators alike.
Centralised services
Technology is becoming more sophisticated every day, and a bigger component of hotel fit outs and operations.
To pay for this technology, and for the additional bolt on services that it is allowing the operators to provide (for example PMS and off site reservations support), centralized services fees are becoming an increasing proportion of the overall fee mix required by operators - particularly global chain operators.
The challenge for operators is to convince owners that the benefit of all this technology in terms of bottom line profit justifies the cost, and to give owners some of the transparency on these costs that they are seeking.
Clustered services
Rather than all the hotels in a particular area each having a financial controller and an accounting team, operators can generate efficiencies by centralising an operating function (such as accounting) across a number of hotels. The centralized teams or individuals, which may be located at one of the hotels or remotely, then provide back of house functions to all the participating hotels.
Response from owners to this development has generally been positive where operators can demonstrate that it will lower the cost of operating each of the hotels, or generate additional upside from a similar cost base (i.e. increased bookings).
A minority of owners are sceptical, thinking that it is harder to sever the relationship with the operator under this operating model rather than a 'stand alone' model.
Operators are becoming more risk adverse
This is borne out of two key aspects of the HMA - the willingness (or lack thereof) of operators:-
• to make financial contributions to the owner; and
• to agree to any form of termination without cause (except for an arm's length sale).
In these 2 areas, generally speaking, the approach of operators has hardened - even in mature markets.
This approach on financial contributions is based on the increasingly held view that operators are service providers and not insurers or, on the whole, equity players. On this reasoning, hotel owners should be the parties who bear the risk of hotel operations and not the operator.
Similarly, the prevalent view among operators is that once they obtain a contract it should be able to run its course in the absence of a serious failure to perform (or in some instances an arm's length sale).
Of course there are exceptions to these approaches - particularly for trophy properties or a trophy owner.
What's not hot?
Performance tests
As owners are focusing more on guaranteed exit rights through termination on sale or without cause, experienced negotiators are showing less interest in performance tests because of perceived difficulties in effecting termination pursuant to these provisions.
Education
In our experience operators are increasingly mistaking push back on HMA terms for owner antagonism (although the push back can become antagonistic if it is not dealt with properly).
Operators, the 'chess masters' in the HMA negotiation process, sometimes fail to see that owners (particularly first time owners) are novices in the complex arrangements that constitute the modern HMA and need to be educated as to why the contracts are drafted in the way they are.
This is perhaps the greatest challenge that operators currently face in quickly bringing new deals to the market.
Research and development
Although there have been significant strides in moving to a more aligned relationship on the financial and other drivers which come together in the HMA, this seems to have largely been tentative and reactive on the part of the operator community.
There seems to be little real evidence that operators are investing significant amounts in research and development in relation to their relationship with owners. For example there appears to be little work being done in formulating an arrangement which rewards the operator out of the capital proceeds of the sale of a hotel in circumstances where the operator can demonstrate using objective information that it has made a contribution to the value of the hotel over the term of its management.
This may be a function of the current focus of the development teams - their current approach and deal terms may be acceptable in China and India, without the kinds of evolution that North America, Europe and the South Pacific have seen.
Brand standards and the uniform system of accounts
Many HMAs used by major operators underpin many of their provisions by reference to either of these concepts.
In a number of instances the detail available in relation to the Brand Standards leaves one with the view that such standards are significantly less definitive than one would believe to be the case.
Similarly references are made to the Uniform System of Accounts, often with insufficient understanding of what the Uniform System actually provides and its true relevance to the provisions of the HMA that it is meant to relate to (such as the provisions which govern the calculation of the operator's fees).
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