Is it time to re-think your management agreement?
As the hospitality industry moves toward recovery, many hotel owners are re-evaluating the management of their properties. A good manager can bring great value to a property; a poor manager can reduce its value. Some studies have concluded that a good management agreement – one that provides for meaningful accountability, transparency and performance – can add or subtract 50% to the value of a hotel. The next normal will likely require rethinking how to maximize the efficiency and effectiveness of operations, rather than simply riding post-recession boom, and to plan for the future, not just hearken back to the past.
The Global Hospitality Group® at Jeffer Mangels Butler & Mitchell LLP has been negotiating, re-negotiating, litigating, arbitrating and advising clients for more than 30 years on more than 2,500 hotel management and franchise agreements. Our experience extends to virtually every brand and every significant independent manager, as well as many less well-known players. Based on that experience, we thought it would be helpful to provide a few tips that owners should bear in mind when considering the hotel management agreement.
1. Owners and managers are not partners. Owners and managers often look at the management agreement as a means of “aligning the interests” of the owner and the manager, and managers often characterize themselves as “just like a partner” in the hotel. While the interests of the owner and manager can be reconciled, they are not aligned – even when the operator provides key money, has incentives to make the hotel profitable or even makes an equity investment in the hotel. Managers are charged with making profits for their stockholders and are focused on increasing the value of their entire portfolio of properties, while hotel owners are concerned about the value and income of a single property (or their portfolio of hotels). Managers can “sacrifice” the profitability of a single property so long as the value of their portfolio is enhanced; moreover, managers get their money “off the top” from gross revenues, whether or not the hotel is profitable. Owners need to profit from each property to make the investment in building and maintaining a hotel justifiable.
2. Managers are NOT taking ownership risk. While it’s true that hotel managers take on some costs and risk in managing a property, the fact is that in almost all cases, their risk is dwarfed by the owner’s risk. Regardless of profitability, owners are responsible for all costs and liabilities of the operation (except when the operator is guilty of gross negligence or breach of contract); managers are not. Those who raise funds for charities often refer to the difference between “involvement” and “commitment.” And they like to make an analogy to a ham and egg breakfast, where they say the chicken was involved, but the pig was committed. In the world of hotels, managers are “involved,” but owners are “committed.”
3. The Hotel Management Agreement or HMA is important. Many commentators, including those with experience in the industry, argue that the manager’s track record is more important than the management agreement. We agree that an owner should verify the manager’s track record before making a commitment, and that a manager with a poor track record cannot be reformed with a well-drafted agreement. However, the track record alone is not enough. First, while every management company has a list of highly-touted successes, every management company also has a less-publicized list of disappointments – the track record goes both ways. Beyond that, a hotel management agreement is a complex document that identifies the expectations of parties for a period of five, ten, twenty, fifty years or more. Over that period of time, a good track record can turn into a disappointment, and relying on decades-old assumptions may be disastrous. The history of mergers and consolidations among hotel managers is littered with changes of key personnel, revised corporate objectives and forgotten promises.
4. Owners need meaningful approval rights. All of these factors lead to a key conclusion – owners need to have a meaningful say in hotel operations. While owners hire managers to operate properties because of their expertise, resources, personnel and reputation, the relationship between owners and operators is “asymmetrical,” and the goals of the two differ. While managers would like a hotel management agreement where the owner simply hands the keys to the manager and hopes for the best, today’s owners are, and should be, vitally interested in operations. This means that owners should have clear oversight and approval rights over budgeting, expenditures and key operating decisions. They should not be dissuaded from exercising those rights because of an operator’s track record.
5. The gap can be bridged. Despite the differences between owners and managers, the gap can be bridged, but to do so requires expertise and experience with the options and alternatives available to the parties. From the owner’s point of view, an attorney that understands what managers need and how their requirements can be met is essential. Just as important is bringing to the table advisors that can recommend meaningful and practical compromises, and who are known to be credible players in the industry.