Leases vs Hotel Management Agreements: The age-old debate
One of the questions that seem to come up regularly with clients who are considering developing hotels is, can they get a lease? If not, what is the difference between a lease and a hotel management agreement?
For many years it was believed that a lease provided owners/developers with a combination of security and surety and they could happily put a known brand in place and then just stand back and watch the money flow. Lenders preferred them as it gave them consistent earnings no matter the economic environment, and there were usually generous provisions for the tenant to upgrade the hotel/serviced apartment on a regular basis.
Hotel management agreements, on the other hand, were sometimes seen as too uncertain for first-time developers as the owner had to bear all risk, whilst the hotel operator stood back and watched the fees flow.
It’s incredible what a virus can do to change things.
“Landlords who could not rely on the lease to ensure payment and ended up in disputes with their tenants…”
There has been ample news of late regarding landlords who could not rely on the lease to ensure payment and ended up in disputes with their tenants, ultimately leading to termination of the leases. The fact that their tenant was a national brand did not protect the owners as there appear to have been a genuine dispute that could not be resolved. I am confident that those owners did not expect this, but it is a reminder that all investments attract risk, and nothing is guaranteed.
Uncertainty around hotel management agreements, whilst not as prevalent, has still occurred, with experts around the world trying to work out the best way to resolve disputes in clearly uncharted territory. Even the National Law Review has explored the implications of COVID-19 on these agreements. And, whilst branded hotels may be able to attract more customers due to consumers having a greater level of trust in the brand, hotel owners appear to be shying away from this. They wish to explore alternative means of management, where they have more control.
So, what is the ideal model?
Without trying to sit on the fence, the answer is, it depends.
It depends on the owner’s long-term strategy for the asset. We are told regularly that transaction yields for HMAs are always better than for a lease; however, it depends on the owner’s risk appetite and level of experience.
It depends on the level of owner’s exposure to hotels – experienced hotel owners tend to prefer HMAs because they know how to maximise their ROIs and know that HMAs invariably deliver higher profits over a longer period. On the other hand, some institutional investors are unable to enter into HMAs due to the terms of their funds, and hence leases are their only option.
It depends on the manager’s level of comfort that owners will still be able to pay fees, even when the hotel is closed.
It depends on the traveller’s new reluctance to commit to regular travel again.
If you ask any manager or owner, they will all have a view on how they see the development of management models, but we can see a number of changes occurring.
“The pandemic affecting the world has changed much more than the hotel industry…”
If a hotel management agreement:
Terms may be reduced with an increased ability to sever agreements.
Force majeure provisions will be more closely scrutinised than ever before.
Owners will be more likely to seek underpins or more detailed guarantees.
Managers will be seeking even more detailed ‘know your customers’ (KYCs) to ensure that the owners can weather any future storms.
And of course, termination clauses will be fine-tuned with both sides seeking to protect themselves.
If a lease:
Tenants will be seeking to incorporate greater protection for future pandemic-style events and ensure that the steps to resolution are clearly defined and not reliant on government direction.
Owners will want to ensure that their tenants have the balance sheets to support prolonged periods of uncertainty and have underwrites from master franchisors or parent companies.
Termination provisions will also be more closely examined to ensure that (for the tenant) their investment in the lease is protected against events they cannot control. And (for the owners) that they can replace tenants more easily if rent obligations are not met.
There may be more hybrid models appearing where the parties share both the risk and the reward through base rentals plus a share of profit.
The pandemic affecting the world has changed much more than the hotel industry: of course, it has transformed almost every aspect of our lives in ways that 12 months ago were unimaginable.
The challenge for developers, owners, and operators then is to work together to find ways in which all stakeholders can still be protected and prosper. This will require lateral thinking and an ability to change, but the early signs are there and are exciting.
We are looking forward to the future.