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HOTELS

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Internationally, the nature of hotel owners has changed

and metamorphosed from the inn keepers,

caravansaries and guest house keepers of antiquity, to

the 19th century htelier to the management

companies, franchisors, asset funds, portfolio owners

and all the stages in between to be found in the markettoday.

Hotel Leases

The management of hotels is equally diverse;

traditional owner-managers have given way to hotel

leases for example. Leases initially evolved from typical

property asset leasing arrangements with a flat rent al

fee with indexation built in. This arrangement offers the

owner the security of a fixed inc ome for the dur at ion of

the lease period, with the lessor earning increased

revenues during strong hotel market conditions, and

bearing all of the financi al risk in time s of we ak hot el

market performance. Over time, hotel lease rentals have

included a variable component in addition to the fixed

fee element, based on gross revenues or gross operating

profit. Ho t el l eases are r el at ivel y r are i n t he Mi ddl e

East, although they do exist for the mid market and

budget end of hotels.

Franchise A greements

The significance of the hot el br and has br ought wi th it

an increased use of franchise agreements (sometimes

called license agreements). A hotel franchise brings a

number of advantages to the owner, including access to

the brands sales and marketing network and booking

engines, enhanced position to solicit debt and equity

financ i ng t hr ough t he associ at ion wi th a recogni sabl e

brand and still have a measure of self-determination

and operational independence of their property.

Many hotel owners choose to manage their own

property or use an independent management company

to do so under a franchise arrangement in the belief that

this arrangement will be more responsive to their

needs, limit their costs and generate more gross

revenue. Established brands benefit f rom f ranchi se

arrangements as they are a well established method of

expanding a brands presence for a minimum of

investment, as well as being a lucrative source ofrevenue. Franchise agreements also tend to be

standardised and thus less complex to negotiate and

administer than their management contract equivalents.

Franchise agreements however are rare in the Middle

East with many operators preferring management

contracts to ensure their brand standards are being met.

Condominium Hotels

A further complication in the owner/manager

relationship arises with the advent of the condominium

hotel where rooms or suites are sold and then placed

back into a leing pool f or t he operat or t o ma nage.

Another variant is the Sukouk Al-Intifaa which is an

Islamic property bond enabling Moslems of any

nationality to obtain fractional ownership of a

residential suite in specific devel opme nt s suc h as the

Zam Zam Tower in Makkah. In these cases the

company must be structured in such a way that there is

one corporate entity with which the operator will have

a management agreement.

Management Contracts

As the Middle East hotel market matures and expands,

owners are beer i nf or me d and t hei r hot el s mo r e

specialised. The growing market has seen a change in

ownership structure from the high net worth individual

towards organisations with a keen eye for investments

and fiel di ng a stabl e of asset ma nagers.

The vast majority of branded hotels in the Middle East

therefore are managed under the auspices of a

management contract. With over 100 points needing to

be addressed within a typical management contract,

Hotel Management Cont racts: Evolut ionary Tendencies

Given that statistically, the majority of agreements covering the management of a hotel will outlivemost marriages, it is essential that the relationship between hotel owners and their respect ivemanagement companies is governed through a fair and equitable agreement. John Podaras outlines

the evolution in hotel ownership in the Middle East and the trends in management contract terms.

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Hotels

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negotiations can be lengthy and convoluted. The tone

and tenor of the process however, if not the relationship

itself, depends on the 10 or so key terms that comprise

the initial Memorandum of Understanding (also known

as the Leer of Int ent ).

Fees

These are the most important item on the agenda and

traditionally comprise management fees that are fixed

on a percentage of hotel revenues and incentive fees

that depend on the gross operating profit. Co nt ract s

that place more emphasis on performance-based

incentive fees offer a de gree of confidence t o owne r s

and sit comfortably with experienced operators.Management companies with a strong and exclusive

brand image, oen stipul at e licens i ng and royal ty fees

in addition to the management fee, pushing fixed fees

to as much as six percent of total revenue.

In addition to these fees, management companies look

to owners to contribute to group or head office services

such as sales and marketing, central reservations,

loyalty programmes and training. These charges are

apportioned to the hotel portfolio on a pro-rata basis,however in reality it is difficul t for an owne r toest i mat e

the extent of these charges in any given year. These can

add as much as five percent of tot al revenue to the fees

paid out to management companies. Perhaps there is an

argument for negotiating these on a fixed percent age

basis, and in this way provide owners the comfort of

more predictable outgoings, but even if this is achieved,

it is likely that it would only be partially agreed to and

that some proportion of these charges will still be

calculated on a pro-rata basis.

Some operators are charging commitment fees or pre-

opening service charges, where a lump sum is levied on

signing the contract. They will argue that these fees are

required to ensure they are remunerated during the

pre-opening period, whereas owners will claim that

they alone bear all the financi al risk for the pr oj ect .

Equity Par t icipat ion

Although currently unusual in the Middle East,elsewhere operators are equity participants in hotel

projects. Owners perception is that by investing in the

project, operators will be more motivated to perform,

although some operators believe that equity

participation strengthens their right to manage the

property undisturbed.

Cont ract Term s

Initial contract terms vary from as lile as 10 years to

more than 75 with the option to renew for one or two

further periods which tend to be half the duration of

the initial period. Hotel operators favour longer

contract terms as this provides more safeguard for the

initial investment in taking on the property, a situation

that benefits the own er if the rel at ions hi p is sound and

the property is performing well. Some owners however

may push for shorter terms, especially if they arelooking to become more closely involved with the

running of their property.

Manchising

Where budget and mid-market hotels are concerned,

especially in markets that are strongly driven by

domestic demand, the lines between the owner and

operator role become blurred and the management

contract may well tend towards a franchise. The

Manchise, a hybrid between a management contract

and a franchise and increasingly used in places like

India, could be appropriate in the Middle East market

particularly with the imminent arrival of Sharia

compliant hotels, in which the traditional international

brands do not have any experience.

Owners Contr ol

Owners will normally seek a measure of control over

the running of the property by ensuring their approvalis required for the annual operating plan and capital

expenditure for the hotel as well as the hiring and

removal of key managers such as the General Manager.

Certain management companies will not agree to any

level of control, claiming that their objectives for the

property and that of the owners coincide and that there

are already sufficient safeguar ds (such as t ermin at i on

clauses) within the contract to protect the interests of

the owner.

Termination and Perfor mance

Termination clauses are essential to ensure the owner

can seek an alternative operator in cases where the

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Hotels

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property consistently fails to perform to an acceptable

standard. These normally set a minimum GOP as a

target and will allow a minimum of two years for that

to be maintained, although it is not unusual for the

operator to be given the option to make up the

difference for one or two years (cur e opt ion) .

Owners will additionally push for a performance clause

whereby the operator is required to guarantee an

agreed level of profit or to ma ke up the shor tfal l and/ or

stand aside their management fees. These clauses are

unusual in the Middle East, as operators successfully

argue that as they are not equity participants in the

venture, they should not be participating in the risk.

However, the intent of this clause may be

approximated by a suitably worded termination clause.

Terr itor ial exclusivity

This can be a deal breaker especially in cases where

the operator is being wooed by a number of owners

with sites that are close. An owner will naturally seek to

protect his investment from another identically

branded hotel competing for the same catchment area

by imposing a geographic exclusivity limit, although incertain cases, such as high exclusive destination resorts,

the competitive region is much bigger and can include

properties in other countries.

Operators are, within reason, amenable to this although

they will argue that physical proximity offers

operational efficienci es, such as cl ust eri ng sal es and

marketing, revenue management, HR or purchasing

roles. Examples of this in Dubai are the Hilton

properties on the Creek and Jumeirah Beach (sameowners), the JW Marrio , Re nai ssanc e and Ma rrio

Executive Apartments (different own er s) and Hy a

(who provide common employee housing).

Like most things in life, management contracts that

prove successful are the ones where both parties walk

away from the negotiating table with something. Win-

Win is the order of the day, especially when entering

the operational phase and the both owners and

operators face the challenges of meeting and exceeding

their projected earning targets.

This article was presented at a workshop session moderated by Peter

Goddard at the Arabian Hotel Investment Conference, 2007.

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