Hotel Owners Increasingly Willing to Share Profit and Risk with Operators

In a world first, Jones Lang LaSalle Hotels and global law firm Baker & McKenzie jointly reviewed more than 100 recently negotiated hotel management agreements from Asia Pacific, Europe and the Americas. Among the findings, says Arthur Adler, managing director of the Americas for Jones Lang LaSalle Hotels, are that, “Globally, owners are recognizing the benefit of providing hotel operators with adequate incentives to deliver superior profits and results, above pre-agreed hurdle rates. This is particularly the case where operators are willing to be remunerated on a heavily incentive fee weighted basis.”

The survey revealed a marked shift toward higher operator fees during the last three years in all regions except for the Asia Pacific. This is particularly true of incentive fees, where variations to fee calculation are emerging. While the favored formula is a fixed percentage of gross operating profit, methods such as sliding scales–which reward a higher level of GOP with a higher percentage fee–are increasingly prevalent.

Also noted was a strong trend toward financial performance criteria, with failure to achieve a specified benchmark resulting in an opportunity to terminate the management agreement.

“These trends show that owners are increasingly willing to share profit risk with operators,” Adler says

According to David Jacobs, partner, Baker & McKenzie, “Of the three regions, operators in the Asia Pacific are subject to the most competitive pressures when negotiating management agreements; American operators experience more competitive pressures than their European counterparts.”

In the Americas, Jones Lang LaSalle Hotels and Baker & McKenzie compared agreements over a sample period of 10 years. The general trend in the US has been toward shorter agreement terms; half the agreements were for a period of less than 10 years, and 28.6% were for a period of more than 20 years. The vast majority of US management agreements contained renewal options, the most popular of which was one or more options of five years. Five-year options were also common in the Asia Pacific and European agreements.

“Interestingly, the average base fee for the American agreements reviewed is 2.7% of gross revenue, which is the highest rate of all world regions,” adds Adler. “Scaling of base fees is more prevalent in the Americas as well.”

American agreements exhibit a significant departure from the traditional measure of incentive fees as a percentage of GOP. Many American agreements tied the operators’ incentives to a minimum return on investment for the owners, as opposed to a level of gross profits. Overall, the trend is that there is a closer alignment of the owners’ and operators’ interests in the Americas than in other regions of the world.

A significantly lower percentage of American contracts (48.1%) require the owner’s consent for the appointment of the general manager when compared to Asia Pacific (80.4%) and Europe (75%). Over a quarter of agreements specify that no approval is required, while another fifth require only cursory notification by the operator and require only comment on the appointment by the owner.

A surprisingly high level (22.2%) of American agreements do not require the owner’s consent to grant leases and concession. Of those that do restrict the operator, it is usually not only on the basis of the term of the contract, but also in relation to the notice of termination period.

When compared to the Asia Pacific and European contracts, a lower proportion(25%) of American agreements allow termination without cause. All of these cases require compensation to be paid to the operator. In some agreements, termination fees decline in proportion to the remaining years under agreement.

Hotel Topics is a free quarterly publication. The recent edition analyses the results of a global review of recently negotiated hotel management agreements and highlights current trends regarding terms, fees, restrictions and obligations of the owner and operator, FF&E reserve and termination. It is available from Jones Lang LaSalle Hotels and can also be downloaded from its website: www.joneslanglasallehotels.com.