Consider the Package
Hotel owners must consider an alignment of interests and skills, integrity, experience and flexibility in selecting a company to manage their properties.
“Every owner of every hotel has different interests in investment strategy,” says Rick Swig, president of RSBA & Associates. “One owner may want to own forever while another wants to own 18 to 24 months. Alignment of interests is critical.”
So is alignment of skills. Owners need to consider their hotels' geography, product and brand, and align a management company's skills with their hotel requirements.
“Owners need to pick a manager with brand, size and location experience and the market segmentation their hotel requires,” says Swig, a hotel owner, asset manager and consultant.
Shaun Burchard, president and chief executive officer of third-party management company Meridian Hospitality Group, says owners should look for integrity and confirm it through reference checks.
“Some managers position themselves as qualified managers who aren't,” he says. “Find somebody with a proven track record who is willing to put you in touch with their current management contracts.”
Mark Kucera, executive vice president of operations of Expotel Hospitality Services LLC, which manages nine hotels and asset manages one, agrees.
“Make sure the manager has integrity and experience managing the brands that you want managed,” he says.
Randy Carroll, president of Lazer Lodging Asset Management, says selection of a third-party management company must be made with the brand in mind. “A typical buyer may not be able to select a brand, because that often comes with the hotel he bought,” says Carroll, who launched his company in May after working six-and-a-half years as senior vice president of real estate and asset management for MeriStar Hospitality Corp. “If the hotel is unencumbered by a management contract, pick the brand first, then the manager. Brands tend to want to manage the major market hotels, but not in the secondary markets. Make sure that the brand will approve the management company you select.”
Chad Crandell, president of Capital Hotel Management, says the management company's capabilities must match the owner's objectives.
“An owner who wants to reposition the hotel and sell it unencumbered by a management contract would not be a good fit with a management company that wants a long-term contract,” said Crandell, whose company is a third-party asset manager and investment advisor to 20 hotels representing 14,000 guestrooms.
“Just as hotel brands are different, so are management companies. Some are better with resorts, urban or suburban hotels.”
Bill Brewer, a partner with the Dallas-based law firm of Bickel & Brewer, says the owner needs to consider all the business factors related to performance issues and the types of relationship the owner wants to have. Also consider long-range planning factors, he advises.
“Times and neighborhoods change, and so does a hotel's clientele. In fact, they change more often than the terms of most management contracts. Owners should pay close attention to termination provisions. Typically the Big Three (Starwood, Marriott and Hilton) want 20-year management contracts with additional five- or 10-year renewal options at their discretion. Third-party management companies will have much shorter horizons. They tend to live based on their ability to perform in the short term. Typically, they are terminable, at the will of the owner, in 30, 60 or 90 days.”
THIRD-PARTY VERSUS BRAND MANAGERS
Owners building new hotels or ones unencumbered by a brand can select an independent third-party manager or a brand manager. Managers and owners agree that independent mangers will stand firmer against brands when contentious issues arise.
“There is more pressure on a brand manager to participate in the programs that his brand develops than on third-party managers,” says Swig. “In contentious issues, a third-party manager will contend better than a brand manager who has to live in the same neighborhood with the brand franchise. It's easier to get mad at a third party than at your brother or sister. A brand manager will say that they work at an arm's length from the brand, but it is a short arm.”
Crandell agrees. “Branded management companies are all connected to publicly traded hotel companies and have to work for two different constituents,” he says. “One is the shareholders, which is the brand, and the second is the duty and obligation to the owner. Sometimes those don't line up so well and the brand management company is faced with what's best for the brand may not be best for the owner.”
In those cases, the brand manager always will place loyalty to the brand first, according to Burchard.
“The brand manager's first priority is the health of the brand,” he says. “That may not serve the investor. Our loyalty is to the investor or owner, even if we have to go head-to-head with the brand. Our number-one priority is to make money for the investors, which is not always the brand's first priority.”
Dealing with smaller organizations will result in more personal attention, according to Kucera.
“Brands are much larger and you can get lost in the program,” he says. “Owners will get more personalized service and care from a smaller third-party manager, as well as the ability to customize a program that best fits their style and expectations. Owners will deal directly with key principals of a third-party management company instead of a distant brand leader.”
Sometimes hotel financing can sway an owner to select a manager, according to Carroll. “Many independent third-party management companies have money they can co-invest with the owner of the hotel, which is a strong inducement to do business with them,” he says. “Many developers are thinly capitalized owners who have a financing gap to get the deal done, and the operator might be the answer.”
Many owners like the idea of having managers as limited investors because they think they will get more attention and better managers.
“Managers who have skin in the game will definitely pay close attention to your asset,” Carroll says. “They will not neglect an owner's hotel or use it as a training ground for new employees. They need to work hard and manage well to get their money back and redeploy it.”
TRENDS AND FEES
U.S. hotel companies paid management companies 8.9 percent more to operate their properties in 2005 than they did in 2004, according to the 2006 edition of Trends in the Hotel Industry published by PKF Hospitality Research. This increase in compensation occurred during a year when hotel revenues grew 8.8 percent and profits jumped 15.5 percent.
Typically, growth in management fee compensation correlates closely with growth in hotel revenue, according to R. Mark Woodworth, president of PKF-HR. Some 40 percent of the hotels reporting payment of an incentive management fee in 2005 did not report one in 2004.
Burchard says that his company prefers a base fee based on a percentage of revenues and an improvement of gross operating profit incentive.
“As we improve GOP, we ask to take a very small part of that improvement,” Burchard says. “We ask over a five-year spread to take a graduated 10 to 15 percent of the improvement only. Owners like it because they get the lion's share of the improvement.
“This makes us pay attention to the top-line revenue and the bottom-line profit. If I generate $10,000 more in revenue, but spend $15,000 to do it, that's not in the owner's best interest.”
Kucera says incentives are becoming more common because both parties realize the common value.
“The management company is incentivized to perform because they share in the windfall,” Kucera says.
Today's management contracts “almost always” involve incentive fees, according to Carroll. “They are hard to generalize and are highly negotiated,” he says. “They usually are based on money that the owner can take to the bank.”
Brewer says brand managers tend to negotiate higher incentives than third-party managers.
“Brand managers have more to sell — the brand. They deliver management expertise, sales and marketing support, loyalty programs and worldwide advertising. That allows them to negotiate a higher fee.”
Base-fee-only contracts have been stagnant for eight to 10 years, says Crandell.
“Brand and third-party managers want more incentivized contracts,” he says. “We try to structure contracts where there is a return on the invested capital. The management company can participate incrementally after a base and threshold has been met.”
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How often should management companies provide financial updates to owners or asset managers?
Rick Swig, president of RSBA & Associates: “At the owner's preference, but no less than monthly.”
Shaun Burchard, president and chief executive officer of Meridian Hospitality Group: “Monthly should be standard.”
Mark Kucera, executive vice president of operations, Expotel Hospitality Services LLC: “We present monthly. Some only want it quarterly and other want a daily report, but that is rare.”
Randy Carroll, president of Lazer Lodging Asset Management: “Monthly financial statements. In addition, the good management companies will supply a daily flash report on yesterday's revenues, which also includes month-to-date and year-to-date figures.”
Bill Brewer, partner at Bickel & Brewer: “Whatever the owner wants needs to be spelled out in the contract or the manager will provide what he thinks is adequate.”
Chad Crandell, president of Capital Hotel Management: “We look to get weekly information and we want it electronically.”
Items that cause contention between owners and management companies include:
- Capital improvements
- Management company expenses that are not part of the base fee, such as marketing and advertising fees and human resource and training expenses
- Lack of transparency about fees and expenses
- Using brand programs of questionable benefit to owners
- Human resources/labor deployment
- Service levels/staffing issues
- Not enough on the bottom line
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