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Hotel Management Agreements (Part-1)

Hotel Management concept starts in the early 1900s, as there are more and more people travel around the need for hotels are raised and as a result, hotel managing companies was born. It was easier for the hotel owners to find a suitable company to fully lease their properties and supply full management services.

This concept is developed further in the 1950s and 1960s following global hotel expansion. More professional and detailed management agreements were created to protect both owners and managing companies for any operational risk and uncertainties on the international stage.

Since then too many things has changed due to globalisation, ease of travel, investment companies, the emergence of limited service and select service hotel and hotel expansions. Hotel agreements have been evolved and rather than just five-star luxury properties, there are too many players in under different brands, segments and budgets to meet ever-changing demand, and provide a range of services and opportunities depending on risk/benefit appetite of investors and owners.

So, let's start with “What is a hotel management agreement?”, type of agreements currently in use in international hotel landscape with their pros and cons, and how they impact on hotel value with the operator, the owner and the lender point of view.

A hotel management contract, also known as a management or operating agreement, is an arrangement whereby a hotel's owner contracts with a separate company, or an operator, to run a hotel.

There is four main type of Hotel agreements which provides different levels of control to owners, operators and lenders. We will review and highlight the key factors, pros and cons accordingly. These are;

  1. Freehold Sale

  2. Leasehold Agreement

  3. Management Agreement

  4. Franchise Agreement

There is no right or wrong as each of the above agreements has its own merit and mainly depending on; Owners risk and reward appetite as well as Brand's strategic appetite on geographic preferences and brand development strategy.

As a rule of thumb, when we look at the above list from top to bottom while owners return increases with the risk attached to it.

1. Freehold:

Owners buy the entire Freehold of the hotel as an investment with a plan to forward sale after a period. To be able to be profitable, it generally requires 3 years to stabilise and gain optimum value of the property. As there are less and less used in today's world, we will not go into details.

2. Leasehold:

This is an interest in the property; while the landlord retains ownership of the property, the tenant has total control of the business duration of the leasehold. The general agreements in this type on average 50+ years leasehold agreement. It used to be useful for big banks as bucket investment with stable profit gains in long-term while property values are also increasing. However, the agreements in this type are also used less and less as the owners would like to maximise their returns and would not like to tie themselves for long-term commitments.

The basis of rent generally categorised as fixed, variable or both combinations.

  • Fixed rents reviewed every five years based on Open market value, RPI/CPI (Cap or Colar). Some fixed rents could have a combination which means annually RPI/CPI related increases and then open market value every five years.

  • Variable rents are also called Performance Related Rent. There is generally a guaranteed base rent which with a base cap could be annually or cumulatively with a pot. Variable elements based upon Revenue with a different percentage for different revenue streams (as a guidance rooms conversion calculated around 72-74% while F&B conversion calculated between 24-28% for variable rent element). Variable element based upon EBITDA.

When arranging leasehold agreements, the lease usually also includes FF&E (features, furniture, fixtures and equipment) and therefore, it is important to define what is maintaining and repairing cover on what standards and condition. User clauses also important for the owners as it gives bargaining chips to the owners for additional value creation. Good business review provisions are also vital for the owners.

3. Management Agreement:

If a hotel owner decides to bring in a management or operating company to run its hotel business then its main concern will be to find one that has the correct "fit" for its own hotel. A well-established track record in similar hotels, expertise in key areas and a competitive fee structure will be important considerations in establishing which of the many quality hotel operators is best suited to that particular hotel.

4. Franchise Agreement:

A Franchise is the right to use the brand and the business model of a specific parent company for a prescribed period of time. It is a method for expanding a business and distributing products and services through a licensing relationship. Simply, the hotel brand is shared by a franchisor to do business under his trade name, according to terms and conditions of the contract.

This is the first part of Hotel Management Agreements article; the second part will be focusing on “Management” and “Franchise” which are both currently most used agreements in the hospitality industry.

I hope you find this article useful. Please feel free to contact us to get advice, assess your property needs and help to optimise the usage of the hotel's physical and human assets to achieve superior standards of service and deliver maximum value to owners and investors within agreed profit objectives. You can reach us either Contact tab on my website or via email directly on to arrange a private chat.

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