Hotel Contracts - To Lease Or Not To Lease
Hotel managing companies date back to the early 1900s. Back then, the normal method to supply management services was through total property leases by which the operator leased the hotel from the owner. It was only between 1950 and 1960, following the global hotel expansion, that management agreements were created to provide a buffer against the operating risks associated with unknown uncertainties in foreign countries.
Hotel managing companies date back to the early 1900s. Back then, the normal method to supply management services was through total property leases by which the operator leased the hotel from the owner. It was only between 1950 and 1960, following the global hotel expansion, that management agreements were created to provide a buffer against the operating risks associated with unknown uncertainties in foreign countries. In this article, we set out the pros and cons of leases and hotel management agreements, give an example of how they impact on hotel value and discuss the best option for different investors.
Hotel Leases
A lease is an interest in the land and the tenant takes over the property for a certain term. As such, under a lease structure, the hotel company holds the entire financial burden. The hotel company in this case is a tenant and assumes all operating responsibilities together with all the financial obligations; therefore, it enjoys the benefits if the property is successful but suffers all of the losses if the property does not perform adequately. The hotel company receives all of the profits, after rents have been paid. Rental structures can vary depending on the amount of risk that the investor is ready to take. Some of the possible options are:
- Fixed fee: this is a fixed rent with indexed growth. This form of lease structure has a guaranteed return, which bears the least risks for the property owner;
- Share of Revenue: in this variable lease scenario, the rent is calculated on the amount of sales generated. In this case, the property owner shares some of the risks linked to the level of performance of the hotel. They do, however, have the opportunity to assess the performance of the hotel against market data;
- Share of Net Operating Income (NOI): in this variable lease scenario, the rent is linked to the NOI after all the operating expenses have been deducted. This scenario carries the highest risk to the owner, as it also include the operating risk of running the hotel and offers little transparency as to likely income.
Both the revenue‐based and NOI‐based rents can include a base rent, which is a guaranteed return to the owner (hybrid lease). A hybrid lease might also include some clauses that can be found in management agreements, such as an obligation to maintain brand standards.