As discussed in previous posts, a common model for hotel development transactions in the Middle East is for the hotel to have a separate owner and a separate operator.
The owner is the investor or group of investors that provides (i) funding necessary for the construction, maintenance and operation of the hotel, and (ii) high-level (usually financial) oversight of the hotel's performance as a business. The owner typically hails from the country in which the hotel is located, or from elsewhere in the Middle East.
The operator, in turn, is a company that specialises in the planning, design and day-to-day management of hotels, and runs the hotel on the owner's behalf in exchange for fee-based compensation that is typically a percentage of the hotel's gross revenues and operating profits. Most major hotel operators are international companies based in North America, Europe or East Asia.
The owner and operator typically enter into a hotel management agreement that provides a framework to govern their working relationship, detailing their respective rights and responsibilities. One important aspect of this relationship is the owner's right to approve certain key actions by the operator. Such approval rights are obviously important to the owner as a way to help protect its investment in the hotel. However, the operator will resist owner approval rights that would hinder its ability to run the hotel in accordance with its own best judgment.
Typically, the owner will have approval rights with respect to items such as:
• The yearly budget for the hotel as projected by the operator;
• Capital improvements or renovations to the hotel over a certain dollar amount;
• Leases of concessions to third parties (e.g., retailers or spa operators) within the hotel over a certain dollar amount; and
• The appointment of key hotel personnel such as the general manager and financial controller.
Tuesday, January 24, 2012
Hotel Management Agreements - Owner Approvals
Wednesday, September 14, 2011
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.
Thursday, August 4, 2011
An Introduction to Hotel Management Agreements
With the continued growth of Oman’s tourism sector serving as a centerpiece of the government’s ‘Vision 2020’ economic development plan, one can expect a significant number of new hotels to open in the Sultanate over the coming years.
This article explains what hotel management agreements are and why they are crucial to most hotel development transactions. Next month, we will cover some of the key issues that typically arise in the negotiation of management agreements.
What is a management agreement?
Many hotels, particularly the large-scale, luxury hotels on which the Omani tourism sector is focused, are managed by one of the major international hotel operating companies. These operating companies are the household names whose signage adorns hotels across the globe, such as Ritz-Carlton, Hyatt, Intercontinental or Mandarin Oriental. A number of the international operating companies own some of the hotels they manage. However, many of the operating companies are engaged principally in the business of managing hotels owned by other investors, in exchange for fees.
The management agreement is the primary written contract between the hotel owner and the operating company, setting out the parties’ respective rights and responsibilities, typically in exhaustive detail. There are often other ancillary agreements between the hotel owner and the operating company as well, covering such matters as the use of the operating company’s intellectual property or the payment of the hotel owner’s share of expenses related to activities – e.g., staff training, reservations or marketing – that the operating company conducts jointly for all of the hotels under its management on a regional or worldwide basis.
Why are management agreements so important?
Hotel management agreements are crucial for two main reasons. First and most obviously, large luxury hotels are big business – there is a great deal of money, jobs and prestige on the line for both the hotel owner and the operating company, so management agreements must be negotiated thoughtfully and drafted carefully, commensurate with their high-quantum, high-stakes nature.
Second, hotel management agreements are important because they are the framework that govern a very long-term business relationship. Most hotel management agreements run for a term of at least 10 years and often 15 to 20 years, typically with the option for the parties to extend for an additional 5 or 10 years by renewal. The hotel management relationship often lives on long after the individuals who entered into the relationship – on both the owner and operator sides – have left their respective organizations. Thus, a well-drafted management agreement can play an important part in maintaining a long, mutually prosperous and harmonious relationship between the hotel owner and the hotel operating company.
