While the Survey only relates to Asia-Pacific, an extrapolation of the results (and the trend lines over the last 20 years) gives a fairly unmistakable indication as to the direction in which the hotel industry is heading globally.

As we have indicated in other newsletters, the hotel industry competes ferociously on the global stage for its share of relatively scarce available capital which can be both capricious and discriminating. The terms of these agreements dictate in large part whether this capital receives a fair return and hence underwrites the attractiveness of the hotel industry to the stewards of these vast capital pools.

We will leave you to ponder whether the trend in hotel management agreement terms favours owners or operators.

As always, the views expressed in this newsletter are those of the authors alone – this also includes JLL.

Insights arising from the Survey

Agreement term

• While agreements are generally 10 years or over, the longer the term, potentially the more adverse the agreement is to the owner due to the fact that it exacerbates the pain and potentially depresses the sale price of the hotel if an operator underperforms substantially and for a prolonged period. Generally an owner is unable to prematurely terminate the agreement for under performance (reasons for this set out below).
• The Survey found that the agreement term is 17.4 years on average which is significantly more than 50% longer than 10 years.
• Operators appear to have the upper hand when it comes to demanding longer terms.

Renewal term applications

• The Survey found that 61% of agreements are renewable with mutual consent. If renewal terms needs to be addressed then mutual consent is the best outcome for both parties.
• Automatic renewal (which the Survey indicates remains prevalent) is potentially adverse to both parties' interest. If either the owner or the operator defaults and the innocent party seeks damages then the amount of the damages award will be increased by reference to the automatic renewal period. For example if the owner breaches and, consistent with the survey, automatic renewal is two five year periods then damages will include forgone fees and other operator charges for this 10 year period in addition to the period which comprises the unexpired term of the agreement.

Operator fees

• Operators generally provide a highly competent professional service and should be remunerated handsomely if their efforts and initiatives significantly contribute to maximising hotel operational performance and sale value.
• To correctly align owner and operator interests, base fees (which incentivise an operator to maximise revenue) should be as low as possible (generally starting around 1% of gross revenue). With a Survey average base fee of 1.6%, this represents a base fee more than 50% higher than 1%. Rather than seeking to maximise base fees, the over-riding focus should be given to primarily rewarding operators with appropriately generous incentive fees (which incentivise an operator to maximise profit).
• The Survey clearly shows that excessive attention is being given to maximising the quantum of base fees. Intriguingly and inexplicably the quantum of incentive fees are shrinking perhaps explaining why the quantum of sales and marketing fees are increasing substantially.
• This approach to fee structure composition as discovered by the Survey means that the parties' interests remain largely unaligned with the result that the ability to maximise hotel operational performance and sale value is being compromised. This is a major issue for the hotel industry generally and particularly owners and operators.

Operator performance termination provisions

• Almost all agreements contain a form of performance termination provision which is ironic since experience clearly shows that these provisions do NOT work in practice. It would be inconceivable in most industries for a principal to be unable to terminate a service provider in the face of sustained and prolonged under-performance but this is the norm in the hotel industry.
• If an operator fails to perform and the standard performance termination provisions are impotent in dealing with the issue, then a savvy owner should focus its attention elsewhere – such as no fault termination. However the Survey indicates that no fault termination is virtually extinct.
• If the problem is day to day operational performance on the operator's part then manchises provide a viable solution to fix it.
• It will become increasingly difficult to attract capital to the hotel industry whilst this major agreement shortcoming remains unaddressed.

Key money

• Different sub-regions approach the attractiveness of key money vastly differently. In ANZ it appears very attractive as distinct for all the other sub-regions surveyed. It is difficult to rationalise this disparity.
• Key Money should generally be rejected unless absolutely necessary to make the deal work – it is by far and away the most expensive funding source available to an owner in the market.
• An owner's desire to obtain key money generally compromises its ability to obtain the best commercial terms to influence and induce an operator to maximize service delivery with the prospect that hotel operational performance and sale value are compromised – on occasion significantly.
• Key money usually costs the owner dearly.

Senior staff appointments

• Owner input in relation to senior staff appointments, particularly the general manager, has generally been conceded by operators. Owners want a say in such appointments and operators are generally pleased to agree to this.
• Relevantly, tension remains as to the extent to which an owner is entitled to a say in relation to the termination of senior staff (even though they are generally owner employees).

Contracts leases & concessions

• Owner control over major contractual arrangements has generally been conceded by operators. The battle lines remain as to what precisely constitutes "major" in any given situation.
• Some owners appear to be seeking to use these provisions to delve into the minutiae of hotel operations. Clearly competent operators need to be given the freedom and latitude to do their job without excessive owner interference.

FF&E Reserve

• A FF&E Reserve provision is a mainstay in hotel management agreements.
• It is difficult to conceptually understand the logic of an owner being required to set aside a pool of funds to finance FF&E expenditure when a similar requirement does not apply in relation to hotel operations.
• For an owner it is clearly preferable for the reserve to be notional rather than cash based. Operators understandably push for a cash reserve to provide the comfort that necessary funds will be available when FF&E expenditure is required.
• The debate between cash and notional reserves is clearly a second order issue.

Conclusion

A massive amount of work goes into the process of preparing a meaningful survey of hotel management agreement trends for a region such as the Asia-Pacific. However if that work creates an opportunity for the industry to pause and give detailed and focused consideration to the commercial drivers embedded in a hotel management agreement and the impact of those drivers then the time is well spent.

As Albert Einstein said "The definition of insanity is doing the same thing over and over and expecting different results".

There is an argument that the current approach taken by the hotel industry to the commercial drivers contained in these agreements needs to be rethought and done differently in an attempt to maximise the industry's attractiveness to global capital surveys such as the one we have just completed are a guide as to what is happening in the industry and are an essential part of the process.