CEO of HTI Consulting, Wayne Troughton, says this topic is becoming increasingly more relevant and important as markets start to open, hotels are beginning to action their reopening strategies and key decisions are being taken.
“In this profoundly transformative and unprecedented time for African hotels, we are also poised to witness significant transformation in terms have how hotels operate and how owner–operator relationships and hotel management contracts are both forged and defined. We are also seeing more interest from operators in signing contracts for conversions of unbranded properties and signing contracts on new developments focused on apart-hotels and economy hotels,” he says.
Troughton says conversions can allow existing owners to plug into a brand’s distribution system and to help plot a faster recovery and re-entry into markets. Conversions also enable unbranded properties to benefit from consumer trust engendered by newly developed cleanliness standards and crucial operation protocols, which independent hotels do not have.
“The growing interest in apart-hotels centres around less physical contact with guests, as associated with the concept, and longer stays. Economy and mid-market hotels also usually offer select services and less physical contact points and will likely become increasingly attractive to the business traveller, in particular as travel budgets reduce in order to compensate for losses incurred during the pandemic,” he adds.
The prolonged and profound impact of Covid-19 on the sector has created an opportunity for hotel owners says Troughton. “Management companies have been eager to negotiate and sign management contracts for new developments and for the rebranding of independent properties to secure short-term and long-term sustainable cash flows for their business, operators have also generally been more flexible. This, coupled with their lack of ability to travel, has meant they have time to focus on the shorter negotiation times as management companies essentially have more time on their hands and they are incentivized and focused on concluding deals quickly in order to increase the asset value of their hard-hit corporations and share prices.”
As management contracts are usually signed for fifteen to twenty years, the terms laid out in these contracts can carry significant long-term implications for the property under management and impact on the long-term investment case for the project, both for the owner and the future incoming buyers.
Management agreements are also complex and often difficult to understand. “The challenge lies in achieving a balance that is both sustainable and equitable and where the Owner’s interests and needs are taken into consideration,” states Troughton.
“In recent years, significant economic growth in various African countries has seen an increased number of hotel developments as well as mounting interest from both large international management companies and smaller regional hotel management operators,” he explains.
“In 2010 there were only around 14 international and regional operators present in the Africa market, representing around 101 branded hotels. Now, in 2020, the number of operators has risen to around 36 international and regional operators and around 811 branded hotels.”
“Accor Hotels are the current most represented management company on the continent with 149 hotels in 24 countries, followed by Marriott with 146 hotels in 20 countries, Hilton and Radisson Hotel Group occupy the 3rd and 4th spots with 46 hotels in 19 countries and 44 hotels in 21 countries respectively.”
“As the number of hotels on the continent has grown, we have also witnessed an evolution in the types of Owners entering the sector,” Troughton explains “We have seen a transition from single asset owners to owners of multiple properties, we have also seen more institutional and corporate entities (like pension funds, property development companies, hospitality funds, investment companies and owner operators) entering the market. These owners tend to be more seasoned and more cautious, placing greater importance on the mitigation and sharing of financial and operational risk, particularly as they are typically accustomed to more risk-averse lease contracts on various property deals other than management contracts.”
“As a result of the above factors, the African hotel market has become significantly more competitive, reflecting a trend towards management agreements designed to better share the commercial risks associated with hotel projects,” he states.
The problem though, explains Troughton, lies in the fact that many of those owners are new to the hospitality sector lack the experience and capabilities needed to effectively negotiate hotel management contracts. As a result, these contracts traditionally lack a number of critical success factors and (sometimes complex) clauses designed to build in a more equitable share of risk, control the decision-making powers of operators, provide for termination rights for owners and protect these owners against poor performance.
Reaping the benefits of a management company’s brand, reach and expertise comes at a cost in the form of three types of fees: base fees, incentive fees and marketing fees. “There has definitely been a trend of a reduction in stabilised base fees and a move towards more progressive base fees that protect the business interests as the hotel establishes itself in the market,” says Troughton. He adds that “in the ‘older style’ management contract, base fees generally remained fixed, and could be as high as 3% in initial proposals.”
“In more recent contracts in Africa, this figure usually starts at around 2% initially and increases to about 2.5% to 2.75% over a five-year period. Some contracts have stabilised base fees as low as 2% but this is usually on highly desirable and sought-after locations and hotels,” he says.
Incentive fees have followed a similar trend. “In past agreements in Africa, incentive fees were based on fixed percentages per year, averaging between 8% in the first year and 10% in year three and thereafter,” states Troughton. “Structures have now become far more progressive, with fee structures based on achieving specific performance levels. Incentive fees can now be as low as 0% at low Gross Operating Profit (GOP) thresholds and can increase up to 10% or 11% at GOP levels of 45% -50% or even higher. Average incentive fees have dropped from between 8% and 9% to between 7% and 8%”.
Marketing fees are paid to the management company for use of their marketing infrastructure, an area where real value can be created for both the owner and operator if correctly utilised. These fees are usually not negotiable and usually represent either around 1.5% to 2% of total revenue or 2% to 2.5% of gross rooms revenue.
Troughton explains that management contracts should always specify a defined set of performance measures to ensure operators perform according to expectations but, perhaps more importantly, to ensure hotel owners shield themselves from the results of any poor performance. “Performance measurement can be achieved using various indicators or performance measurement tools. The most common test is a two-prong test consisting of both a RevPar test and a Budgeted GOP test,” he explains.
As previously mentioned, with the advent of new ‘types’ of owners and investors entering the hospitality sector, and the increased competition in the market, more owners are requiring operators to share in the business risk. Financial protection or contribution to the owner in the event the hotel does not perform to expectations and, as a result, struggles to meet its financial obligations to lenders, suppliers and shareholders is an example.
“Various financial mechanisms adopted in the African market have become more prevalent in contracts over the years, with operators more willing to entertain discussions around risk sharing mechanisms for the right projects,” explains Troughton.
“These mechanisms can however be complicated and typically require significant negotiation relating to the quantum of the financial support, and how and when payments or waivers kick-in or are recovered,” he says. “Before embarking on negotiations, it is therefore important to seek the advice of a specialist hospitality advisory firm with experience in these types of mechanisms.”
Owner’s Priority Return, or an Incentive Fee Waiver (which it is otherwise also known as), has become far more common in the market. “Historically, Owner’s Priority Returns were only seen on very strategic projects, but recently Owner’ Priority Returns are becoming more prevalent and are the preferred financial support mechanism of many operators.” Key to Owner’s Priority Returns are the specification of the threshold amounts, the escalation rates, and the claw-back mechanisms when operators exceed thresholds in future years.
Key money is one way an operator can contribute to a project and is the most simplistic form of financial support. “Paid during development process or upon opening, the timing of payment and number of instalments is of great importance,” he states. “Key money can typically range anywhere from $250, 000 – $500, 000 on midscale and small to medium developments – up to around $1, 000, 000 on large upper-scale hotels.”
An Operator’s Guarantee is another way of an operator committing to some sort of financial payment on a project. “It is often the strongest form of financial protection offered by the Operator and represents a monetary contribution that can far exceed any key money amount. Operator’s Guarantees are usually only offered on high potential projects, and generally not preferred by Operators at all as these represent a liability on the books of the management company and, as such, impact negatively on the asset value of the management company as a whole.”
“Given the uncertain travel climate, concerns amongst African hotel owners are, of course, still apparent,” says Troughton, “Despite this, an Africa Hotel Pipeline and Developer Sentiment survey conducted by HTI Consulting in July this year revealed that fifteen new hotels were signed by seven operators covering eight countries across the African continent during the time of national lockdowns and travel ban,” he says. “This reveals that current owners have not significantly altered their sentiment toward the hospitality industry, with medium to long term sentiment remaining favourable. Africa remains attractive, and increasingly competitive, and now is perhaps the time to create a new ‘playbook’, not only at property level, but within management company negotiations and operations”.
“Despite the benefits that can be reaped from employing hotel operators to manage properties, a very large part of whether the relationship prospers or falters lies in the operator selection process and the negotiation of the terms and conditions of management contracts. It goes without saying that each management contract is different. Each contains its own intricacies, nuances and fee structures and its negotiation can be a complicated and time-consuming procedure with potentially large financial consequences,” comments Troughton.
“Due to the complex and industry specific nature of management contracts, and indeed the uncertain global economic backdrop in which we are operating, the need for hotel owners to seek assistance in the selection and negotiation process from industry specialists is even more compelling,” he stresses.