What financial contributions are we talking about?

A financial contribution provided by an operator is usually akin to "key money" and is usually agreed to be paid around the time of hotel opening. It is in fact a financial inducement on the operator's part to secure the right to manage the owner's hotel with the following characteristics:

• It is usually a fixed, specified and substantial amount expressed in the local currency (or in US dollars in some jurisdictions where there are substantial fluctuations in the value of the local currency).
• It may be dependent upon specified pre-conditions (for example that the payment is conditional upon hotel opening occurring prior to a specified date).
• The financial contribution may be in the form of a non-refundable payment (subject to certain pro rata repayment obligations if the management agreement is prematurely terminated) or a loan repayable in years when Gross Operating Profit (GOP) exceeds a specified benchmark as well as premature termination or in some other way.
• We are not talking about performance payments, which an operator agrees to pay if the GOP in one or more operating years falls below a specified benchmark or a cure payment to prevent the owner from triggering a performance test fail.

Our view on the attractiveness of financial contributions to the owner

We do not consider and have not seen any evidence to support the view, that the presence of a financial contribution super charges the operator's motivation to maximise hotel profit or sale value. Why would it? In essence it allows an operator to "buy" an income stream. This means that an operator needs to ramp up the commercial deal with the owner to obtain its requisite internal rate of return taking into account the recoupment of the contribution.

Yet, in our recent 2024 Asia Pacific Hotel Management survey conducted in conjunction with Jones Lang LaSalle (JLL), we noted that since our last survey in 2018 financial contributions increased significantly from 14% of the contracts surveyed to 22%. More interestingly, 65% the contracts surveyed in Australia and New Zealand containing a financial contribution constituted 65% of all contracts surveyed in these jurisdictions which is significantly higher than the remainder of Asia Pacific.

Unless absolutely necessary, we strongly counsel against an owner seeking to obtain a financial contribution from an operator for the following reasons:

• Due to its impact on an owner's ability to negotiate the most competitive commercial terms, an operator financial contribution is usually the most expensive funding source on the planet. We do not understand why owners and particularly their financiers are so keen to obtain this funding.
• Quite appropriately, in return for a financial contribution, the operator will usually insist on a number of terms such as:
  • A term significantly longer than 10 years which, in our view, is the shortest term to which most, if not all legacy operators, will agree.
  • A base fee/incentive fee configuration skewed in a manner which fails to properly incentivise the operator to maximise the hotel's profit not to mention higher fees than are generally in currency in the market.
  • An absolute refusal to agree to termination on sale or no fault termination.
  • An absolute refusal to agree to a manchise.
  • An absolute refusal to agree to or a significantly watered down Area of Protection.
  • An absolute requirement to obtain a non disturbance deed from the owner's financier.
  • An unworkable performance termination test.
  • An operator first right of refusal on sale of the hotel.
  • The operator's ability to sue the owner for significant damages if the hotel is not constructed in accordance with construction milestones.

The financial cost to the owner of some or all these concessions can be eye watering. In most if not all instances the cost can easily be in the hundreds of thousands of dollars to millions of dollars if a lucrative sale cannot be effected because of one of these provisions. In our opinion the cost dwarfs the benefit.

The actual benefit can be even skinnier if the financial contribution is really only a loan subject to repayment over the term of the management agreement (as referred to above) rather than a payment. In such circumstances the real value of the benefit is not the face value of the contribution but any interest cost saved while the contribution is with the owner. This may only be a small fraction of the face value which diminishes as interest rates decline. For example, if there is an interest free loan of AUD 1 million which is repaid in three years, in a financial environment where the market interest rate is 5%, then the maximum real benefit of the loan is only AUD 150,000.

• A repayment mechanism which is based on the operator's ability to exceed the budget adds an additional impediment by inclining the operator to "low ball" the budget further squandering the owner's potential profit both from operations and any potential sale.

Conclusion

We fail to see how a financial contribution makes an operator more incentivised. There is no return to the operator arising from the contribution particularly if it is an outright payment.

In our view an operator should be motivated through a savvy fee configuration to maximise hotel profit and a term which is sufficiently brief to not make the operator complacent, coupled with a premature termination regime which allows the owner to terminate the operator's performance if it falls below the owner's expectations (and/or entitles the owner to convert the relationship to a franchise).