Jones Lang LaSalle Hotels

Hotel Owners Increasingly Willing To Share Profit and Risk With Operators

London, 2^nd July 2001

The current trends of globalisation and consolidation in the hotel investment market are affecting the management agreement negotiation balance between hotel owners and operators.  In a world first, Jones Lang LaSalle Hotels and global law firm Baker & McKenzie have jointly reviewed over a hundred recently negotiated hotel management agreements, spanning Europe, the Americas and the Asia Pacific.  The findings are presented in the latest edition of Hotel Topics - Jones Lang LaSalle Hotels’ quarterly research paper.

“Owners are recognising the benefit of providing hotel operators with adequate incentives to deliver superior profits and results, above pre-agreed hurdle rates” said Arthur de Haast, Managing Director, Europe at Jones Lang LaSalle Hotels. “This is particularly the case where operators are willing to be remunerated on an incentive fee basis only.”

The survey revealed a marked shift towards higher operator fees over the last three years both in Europe and the Americas.  This is particularly true of incentive fees, where variations to fee calculation are emerging.   Whilst the favoured formula is a fixed percentage of Gross Operating Profit (GOP), methods such as sliding scales, which reward a higher level of GOP with a higher percentage fee, are showing increased prevalence. In 34.5% of European agreements, the incentive fee is scaled as a percentage of GOP – the average incentive fee is 6.9% and the most popular fee is 10%. 

Also noted was a strong trend towards financial performance criteria, with failure to achieve a specified benchmark resulting in an opportunity to terminate the management agreement. Almost half of all European management agreements analysed contain performance guarantees by the operator in favour of the owner. "An operator guarantee gives a degree of certainty of return to the owner, but it comes at a price. It is interesting to note that in Europe more owners are prepared to trade off greater up-side potential for a guarantee than in the Americas" stated Mark Wynne-Smith, Executive Vice President at Jones Lang LaSalle Hotels.

"These trends show that owners are increasingly willing to share profit risk with operators" continued Mr Wynne-Smith.

In the European region, Jones Lang LaSalle Hotels and Baker & McKenzie surveyed 6,026 rooms in 12 countries. The survey revealed that the average base fee payable to the operator is 1.8% of Gross Revenue, slightly higher than in Asia Pacific at 1.5%, although lower than the American level at 2.7%.

The range of incentive fees is much more widely dispersed than base fees, averaging at 6.9% for European management agreements. The most common fee as a specified percentage of GOP is 10.0%. The most common range for sliding scale is between 5-15%.

"Over the recent past operators have become more competitive in their base fees so as to attract owners while hoping to recoup their earnings via higher incentive fees. There appears, at least in recent times, to be an inverse relationship between these two fees" said Mr Wynne-Smith.

"The ability of an operator to maximise profitability is critical if the property is to eventually realise its true asset value potential" stated Mr de Haast. "When negotiating, owners should closely link agreement provisions, such as management fees, to the return generated for the owner. If provisions are agreed that closely align the interests of an owner with the operator, then there is less likelihood of disputes during the long term business relationship."

The structure of the typical management agreement in Europe is also shifting somewhat, to accommodate the needs of both the owner and the operator. The average length of contract in Europe is 19 years with more than half of all contracts analysed containing option renewals. The trend is moving towards having shorter initial terms with an option to extend in the contract. "A shorter initial terms provides the owner with more flexibility and the opportunity to benefit from an unencumbered sale at the end of the term" stated Mark Wynne-Smith.

In terms of maintaining the asset, 72.4% of management contracts analysed included a fixtures, fittings & equipment (FF&E) reserve and it is expected this ratio will increase in the medium term. FF&E contribution is usually a sliding percentage of GOP, spread between 1% and 5% in Europe.

In addition, European management contracts have a contribution to the operator (average 2%) towards head office expenses.

Compared to the Asia Pacific and Americas, there is a lower percentage of management agreements with a 'termination without cause' clause. Rather it is more common for contracts to allow for termination on the sale of the asset. "The rights of termination or absence of them can have a significant impact on the realisable selling price of a hotel" concluded Mr Wynne-Smith.

Hotel Topics is a free quarterly publication, based on topical issues. The recent edition analyses the results of a global review of recently negotiated hotel management agreements. The report highlights current trends regarding the following key negotiation terms: ¨ Terms; ¨ Fees; ¨ Restrictions and obligations of Owner and Operator; ¨ FF&E Reserve; and, ¨ Termination.

The publication is available from Jones Lang LaSalle Hotels, and can also be downloaded from the website: www.joneslanglasallehotels.com.

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