Hotel Management Agreements – Operator Fees

In a previous post we presented an overview of what hotel management agreements are and why they are crucially important to hotel development transactions. Now we shall discuss one of the key specific issues that hotel management agreements cover: operator fees.

The fees that the hotel owner pays to the operating company for managing the hotel, which can be thought of as the contract price of the hotel management agreement, are naturally of paramount importance. Indeed, operator fees are one of the critical issues that are often agreed by the hotel owner and the operator up front via an initial letter of intent or memorandum of understanding, before the parties even begin to negotiate the hotel management agreement in earnest.

Operator fees typically consist of the following:
• the base fee;
• the incentive fee; and
• other fees and/or reimbursements.

Base fees
Under most hotel management agreements, the operator receives an annual base fee equal to a percentage of the hotel’s gross revenues for that year. The base fee percentage is heavily negotiated between the hotel owner and the operator. Although base fees for large, international-grade hotels frequently range between 1 to 2 percent of the hotel’s gross revenues, the figure which the owner and operator arrive at will depend on a variety of factors, including:
• current market conditions;
• the parties’ relative bargaining power; and
• the unique characteristics of the hotel in question.

Incentive fees
In addition to base fees, many hotel management agreements also provide for the operator to receive an annual incentive fee equal to a percentage of the hotel’s operating profits for that year. The percentage level of the incentive fee often will be keyed to a sliding scale based on the hotel’s profit margin (e.g., operating profits divided by gross revenues) – the higher the hotel’s profit margin for the year, the higher the percentage of that year’s profits the operator will be entitled to receive as its incentive fee. This structure, of course, is designed to encourage the operator to run the hotel efficiently and to achieve a high profit margin as well as a high level of gross revenue.

Other fees and/or reimbursements
Although base fees and incentive fees comprise the core compensation for hotel operators, the owner might also need to pay additional amounts to the operator (or its affiliates) pursuant either to the hotel management agreement or to a related agreement. These additional amounts, which are sometimes characterized as fees and other times characterized as cost reimbursements, may include payments for such things as (i) technical assistance by the operator or its affiliates in designing or renovating the hotel, or (ii) marketing efforts for the hotel or training programs for staff provided by the operator or its affiliates.