What’s Hot And What’s Not With Management Agreements?
The hotel management landscape appears to be changing. In this edition, and based on our team’s recent experience, we will discuss some of those areas undergoing change, and some areas for improvement.
Mike Goodson, Senior Vice President, Capital Investments with InterContinental Hotels Group, shares some of his thoughts with us and these are referred to throughout the article.
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.
Mike's thoughts…We’re seeing this around the world as increasingly hotels are an acceptable asset class for the institutional investor, which previously had been focused on the big three of office, housing, and retail.
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.
Mike's thoughts…I’ve often heard it’s easier to finance a $400m deal than it is a $40m deal!
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.
Mike's thoughts…Very much so, as we see the larger owners become more sophisticated in how they think about the relationship they want and have with their operators. And the operator can be sensitive to the owner’s needs and objectives, which is going to win the deal more often than not.
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.
Mike's thoughts… As an operator listed in the UK we’re finding that reducing our capital intensity is making us a much more attractive investment in the equity markets as we’re focusing on what we do best – franchising and managing hotels – and letting the property players do what they do best, then marrying the two in mutually acceptable management and franchise agreements.
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.
Mikes thoughts…Could not agree more!
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.
Mike's thoughts…This is crucial in the new era of separation of property from operations.
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
Mike's thoughts…while at the same time recognizing the need by the operator to maintain the brand presence in many instances.
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.
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.
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.
Mike's thoughts…We’re doing a lot of this around the world, taking advantage of low labor cost markets to carry out non customer facing activities.
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.
Mike's thoughts…Agreed, but this is also a sign of the growing sophistication of the owners. Owners don’t want a project subsidized by the operator as that is just ignoring reality. If the property owner is in the game for yield and property upside, the best way to get both of those is the right brand and operator, properly incentivised to perform.
What’s Not Hot?
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.
Mike's thoughts…We do still see these in a lot of instancse, which are the quid pro quo for no guarantees or other financial support - the view is ‘perform or perish’.
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.
Mike's thoughts…I could not agree more and a savvy operator that takes advantage of this is only asking for trouble down the road.
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.
Mike's thoughts…Interesting thoughts and you are right that most of what we do today is only a variation on what we did 20 years ago!
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).
Mike's thoughts…Great point!
Selected Recent Transactions
Unique Sale Of Maldivian Resort
Baker & McKenzie Sydney, acted in the sale of the White Sands Resort & Spa located at the South Ari Atoll in the Maldives. The Resort was acquired by Naiade Resorts Ltd, a Mauritian public listed hotels group.
The transaction was jointly led by Partners Roy Melick and Caroline Ho, with the assistance of Senior Associate, Robert Williams. Caroline noted that interests in islands in the Maldives are held under long term leases from the Government. This was a rare, if not the first, sale of a resort in the Maldives to an international investor dealing with a sublease interest which introduced specific issues in addition to matters relating to the structure of the sale. Despite the fact that the seller was based in Europe, the seller's legal advisers in Australia and the purchaser and their legal advisers in Mauritius, it was a relatively swift transaction with completion taking place 8 weeks after due diligence commenced.
Sale Of W
Baker & McKenzie Sydney, has advised its long standing client Harilela Hotels ("Harilela") on the structured sale of the W Hotel at the fashionable Finger Wharf, Woolloomooloo, Sydney to the Mumbai based hotel operator Taj Hotels, Resorts & Palaces ("Taj") for A$36 mil. The Harilela group bought the 104 room hotel in 1999 for approximately A$27.5 mil.
The team was led by Partner Roy Melick and Senior Associate Robert Williams of the firm's Sydney office. Roy commented "Following our recent work on the InterContinental Hotels Group/ Eureka transaction, we were able to deliver a streamlined due diligence and transaction execution process for Harilela. The competitive process delivered significant value to our client." He also added that "Baker & McKenzie is very pleased to have been involved in Taj's first hotel acquisition in Australia, as we have been involved in almost every significant deal in the Australian hotels and lodging sector for 2005."
Acquisition Of Travelodge Hotels
Following its work on the acquisition of 9 Travelodge Hotels during 2005 and early 2006, Baker & McKenzie Sydney acted for the Tuckerbox Hotel Trust ("Tuckerbox") in the purchase of two further hotels in Newcastle (NSW) and Perth (WA). The existing Hotels, previously operated under the banners of Capri Plaza and Commodore Hotel respectively, are to be converted to the 10th and 11th Travelodge Hotels in Australia, and have a combined purchase price of approximately $30 million.
Purchased under the structure developed by Baker & McKenzie during the initial purchases, the new hotels are to be operated by Value Lodging Pty Limited, the Toga/Medina operator of Travelodge Hotels under licence from Tuckerbox throughout Australia. The Sydney based team led by Senior Associate David Jones, under the supervision of Partners Graeme Dickson and Roy Melick, negotiated and completed the complex structuring arrangements with associated land and business sale contracts within very tight timeframes, building on the suite of documents and inter-party contractual arrangements that have been developed over the previous 9 transactions. Since its purchase of the original 8 Travelodge Hotels in 2005, the expansion of the Travelodge portfolio by Tuckerbox has proceeded at significant pace and this looks set to continue into the future.
New Hotel For Hyatt In Kyiv
Partner Adrian Moore of the firm's Geneva office led a team of four Ukrainian lawyers acting for Sofia-Kyiv, a Ukrainian real estate development company, on the hotel management agreement with the Hyatt International for the 5-star hotel currently under construction in the central part of Kyiv. Upon completion of this deal, Maxim Sokiran, who previously held the position of the head of legal department in the Closed Joint Stock Company "Sofia-Kyiv", joined Baker & McKenzie’s Kyiv office in October 2005.
New Football Stadium In Dripropetrovsk
Partner Serhiy Piontkovsky and Senior Associate Lina Nemchenko of the firm's Kyiv office successfully advised Hochtief Construction AG, a major international construction company, in connection with the EUR40 mil contract for the design and construction of a football stadium in Dnipropetrovsk, one of the largest cities in Ukraine. Currently, the team is advising Hochtief Construction AG on the next project of construction of a football stadium in one of the largest industrial, cultural and political cities of Ukraine.
Mandarin Oriental In Barcelona
Xavier Junquera, a Partner in the firm's Barcelona office, led a team acting for Mandarin Oriental Hotel Group in relation to the due diligence process, negotiation and drafting of the necessary documents for MOHG to undertake the management of a 5-star Grand Luxe Hotel to be located in two adjacent historical buildings at Passeig de Gracia, Barcelona, which are currently under refurbishment.
Pierre & Vacances (Manilva And Tarragona)
A Xavier Junquera led team acted in relation to the development of Pierre & Vacances and Bouygues Inmobiliaria, a tourism Complex in Manilva (Málaga). The Complex consists of 17 buildings with 328 apartments, 302 parking places, a swimming pool, restaurants, business premises and gardens.
A Xavier Junquera led team advised on tax and real estate structures for the setting up of a tourism Aparthotel Complex in Bonmont (Tarragona). The Complex consists of 7 buildings with 215 apartment-rooms, a swimming pool, restaurant, gardens and common areas.
A Xavier Junquera led team acted for Ponte Gadea which is a joint venture partner in the development of a twin tower project on the mouth of the Miami River in downtown Miami, Florida. One tower will be a residential condominium and the other a residential condominium stacked on a hotel. Kimpton Hotels (San Francisco) has been selected to be the operator of the hotel which will compete with the Ritz, Four Seasons and Mandarin Oriental. The project will cost $560 mil and is scheduled to open in two and a half years.
Ty Warner Hotels & Resorts, LLC
Real estate attorneys Richard Cremieux, Sarah Winston, and Clara Lipton of the Chicago office, assisted by Lyn Walsh, real estate paralegal, represented Ty Warner Hotels & Resorts, LLC, in closing a $425 mil direct to capital markets securitized loan transaction, which was facilitated by GMAC Commercial Holding Capital Markets Corp. The transaction involved five ultra-luxury resort properties: the New York Four Seasons Hotel, located in New York, New York, the Four Seasons Biltmore Hotel, located in Santa Barbara, California, the San Ysidro Ranch, located in Santa Barbara, California, the Kona Village Resort, located in North Kona, Hawaii, and the Las Ventanas al Paraiso Resort, located in Los Cabos, Mexico, together with related condominiums and adjacent land.
Shangri-La Hotel Condominium, Chicago
Partner Richard Cremieux and Associate Clara Lipton of the Chicago office represented the U.S. hotel management affiliate of Shangri-La International Hotel Management Limited in structuring and negotiating a Hotel Condominium Management Agreement for the Shangri-La Hotel to be developed in Chicago as part of the Waterview Tower project.
Shangri-La Hotel, Las Vegas
Partner Richard Cremieux and Associate Clara Lipton of the Chicago office also represented an affiliate of Shangri-La International Hotel Management Limited in finalizing a Hotel Management Agreement with respect to a new hotel property which will be located in the Echelon gaming complex to be developed by Boyd Gaming Corporation in Las Vegas, Nevada.
Westin O’hare Hotel, Rosemont, Illinois
Real estate attorneys Richard Cremieux, Sarah Winston, Clara Lipton and Lyn Walsh of the Chicago office represented Westin O’Hare Hotel Venture, an Illinois general partnership, in the negotiation and closing of the sale of the 525 room four-star/four-diamond , located near the Chicago O’Hare International Airport in Rosemont, Illinois.
Other Items Of Interest
Vietnam Decree On Gambling Activities
Vietnam's Ministry of Finance is in the process of finalizing a draft Decree that is expected to allow a number of gambling activities, such as lottery, betting, and prized games, etc. This move signifies a change of view by the Government on gambling activities - which is heavily tabooed by the Government, but prevalent (in both legal and illegitimate forms) in society.
The apparent new mindset is that a sound legal framework would help the authorities control and regulate gambling activities, and also bring in substantial income for the State.
Under the draft Decree, enterprises can register to run lottery, betting and prized games activities. However, it is not clear, at this point, whether all types of enterprises - i.e., Vietnamese-owned, foreign-owned, and State-owned - would be permitted to engage in this business. As for soccer lottery and betting, the draft Decree provides that the State will have the monopoly over these.
This draft Decree is likely to prompt a change in Article 248 of the Penal Code, which provides that any gambling activities, under whichever form, is illegal. For hotel and casino developers, this is likely to signify further liberalization of the gambling industry in Vietnam - which has so far been limited mainly to electronic slot and prized games machines that cater only to foreigners.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.