Changing expectations from consumers coupled with an increasing consolidation of the market is changing how owners and operators of hotels negotiate and implement management agreements.
By 2025, millennials will make up more than half of the global travel market, according to Cornell Center for Hospitality Research. These travellers bring new demands for impeccable technology and service, an emphasis on health and wellbeing, and unique experiences.
At the same time, the hotel market is witnessing further disruption with increasing consolidation of hotel brands, like the recent mergers of Marriott and Starwood, Accor and Mantra, and Accor and FRHI.
“Every aspect of the hotel industry is changing quickly, including management agreements,” says Daniel Yip, from JLL’s Hotels and Hospitality Group in Asia Pacific. “Management agreements anchor how the hotels operate, and the agreements and commercial terms are to account for new clauses and commercial terms.”
Management agreements effectively dictate the relationship between a hotel owner and operator. It is one of the most comprehensive documents between the two parties, that covers a wide-range of topics from the commercial terms to the rights and obligations of each individual party.
Updated contracts should serve to better align owners and operators, says Yip.
Here’s three key ways that management contracts are changing to reduce risks and adapt to the new hotel landscape:
1. Pay for performance
As the hospitality industry becomes more competitive, operators are looking for creative ways to make their management agreements more attractive. More than half of hotel management agreements contain an incentive fee structure that is based on the operator receiving a higher incentive fee if they achieve a higher GOP margin. This incentivises the operators to manage expenses and maximise profitability, according to a recent study by JLL.
Hotel management agreements can have an immediate and lasting impact on a property owner’s cash flow, says Yip. “Despite the owner bearing most of the financial risk, in an ideal world the agreements maximize the returns for the owner and operator. For certain projects, we are seeing the sharing of the financial risk by rewarding or penalising and operator based on performance.”
“Now, we are seeing owners seeking more income security. They are shifting the financial risk to operators by including incentive fees for performance.”
2. Say goodbye, if it doesn’t work out
Occasionally the partnership between owners and operators doesn’t work and the management agreement needs to be severed. Owners are now able to employ the right of termination in the event the operator fails to meet a set of agreed performance criteria or there is a sale. This change is slowly evolving as the thresholds and criteria for measuring performance and potential failure are becoming more transparent. Similarly, if an owner requires then they have the ability to request for the right to terminate in the event of a sale.
“If a hotel owner has a divestment strategy then the inclusion of an early right of termination would impact the value of the asset and widen the buyer pool,” adds Yip.
Now, according to JLL more than one-third of management agreements in Asia Pacific contain Termination Upon Sale clauses to protect the owners, and more than half of agreements in Australia / New Zealand have such a provision, suggesting that Australian hotel owners may be considering an exit strategy.
Additionally, the hotel branding and the ability to command a termination right matters. “You’ll find that a flagship luxury asset is less likely to achieve an early right of termination, compared to an upscale or midscale hotel,” says Yip.
3. Lifestyle Brands dominate management agreements
An influx of new supply of competing hotels can have a direct impact on the performance of any property. The number of new agreements being signed for luxury and trophy assets decreased roughly 20 percent, demonstrating that key sites are becoming harder to source. Traditional opinions have caught up to the market, that there should only be one of the same brand in the same city.
“Around the world there are only a handful of luxury and trophy hotels in top travel destinations, and those properties tend to be highly sought after by operators. However, in the last three years we are seeing the emergence of soft brand and lifestyle brand segment, which can be lucrative for operators. They provide a different offering to an owner’s core hotel brands and help diversify their portfolio,” concluded Yip.
In the recent survey, particularly in the last 3 years, there was an increase in signings of soft brands and lifestyle brands. Soft brands are unique and don’t always fit in with one of the recognizable brands, so an owner is able to create the hotels identity but benefit from the distribution and management of an operator. Typically, for soft brands, other than fire life and safety, the brand standards are kept broad. Similarly, lifestyle brands provide an interesting solution for owners looking to create more than just a place to sleep, that includes F&B and co-working spaces.
It is no secret that hotel owners have choices and the actual hotel management agreement is evolving to account for industry trends. Operators are becoming more and more creative in making them stand out – to the extent that some operators are even simplifying their agreements to make their agreements more understandable to an owner.
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Daniel Yip, JLL’s Hotels and Hospitality Group in Asia Pacific / www.theinvestor.jll