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This is the fourth article on “Hotel Management Agreements”, in this article, we will compare Hotel Management Agreements which we have reviewed so far, in particular, Franchise and Management Agreements.
Let’s summarise each model with key takeaways;
1. Freehold Model
The owner has the hotel and operates as an independent hotel with all responsibility risk and benefits. It is less and less used model unless it is niche boutique or established companies.
2. Lease Model
Income : Owner received rent and tenant has any profits after the rent
Term : 20 years or more
Financials : Employees, operating and FF&E responsibility of tenants while large renovations, property tax and insurance (negotiable) owner’s responsibility.
Owner point of view
Pros;
Easier to predict returns
Lower risk associated
Easier to obtain financing
Short Term
Good choice for institutional investors such as banks.
Cons;
Difficult to get brands and operators to interest comparing to other models
No control over how the hotel operates and positioning
If they lease an established hotel, risk to loss reputation for the future.
Tenant point of view:
Pros;
The growth of the brand and/or operating company
Total control over the quality of product and CapEx to position according to their structure
Cons;
Operating risks and eventually rent payments
Full liability on balance sheet
Direct impact on brand/operator’s credit rating and share price
3. Management Model
Income : Brand receives base and other agreed fees, Owner has remaining profits
Term : 15-30 years or more
Financials : All employees and property related costs are the owner’s responsibility, the brand has no responsibility
Owner point of view:
Pros;
Easier to finance with strong brand/operator involvement
No involvement in operations or management
Positive return potential
Potential asset improvements by brand-leading design, development and operational support
Cons;
No control over hotel operations
Operating loss risks and guaranteed fee payments
Need to accept brand related global initiatives regardless
Brand point of view:
Pros;
Continuous brand growth with minimal investment
Automatic support to the Brand structure with brand and management related fees with minimal investment
Lower market risk and opportunity to earn additional incentive fees
Cons;
Brand risk due to dependence on owners for developments and CapEx
Limited earning potential with fees
4.Franchise Model
Income : Brand receives royalty and other agreed fees, Owner has remaining profits
Term : 10-20 years
Financials : All employees and property related costs are the owner’s responsibility, the brand has no responsibility
Owner point of view:
Pros;
Full Operational Control other than brand standards requirements
For a new hotel, instant recognition in the market
Direct access to brand GDS, reservation and Marketing systems/programs
Direct support from the brand for design and operational support
Cons;
Higher market/operating risks
In case of any loss, fees are still payable
Need to accept brand related global initiatives regardless
Either need to put a strong team or a third-party operator to manage the property
Brand point of view:
Pros;
Continuous brand growth with minimal investment
No operating or market-related risks
Ability to terminate if non-compliant with brand standards without any penalty
Automatic support to the Brand structure with brand and management related fees with minimal investment and effort
Cons;
Risk of brand image, reputation and guest satisfaction if hotel managed badly
As mentioned in one of the previous articles risk and return comparison is as follows; more owner takes the control and operations of the hotel, more the risk they take on board (adversely if they manage well, they do not need to share the benefit with any third-party). Owner’s return is looking best when they associated with a known brand with their proved brand, GDS, marketing, reservation and operations in their properties.
Differences Between Franchise and Management Agreements
We would like to review two of the models (Franchise and Management), as there are more and more hotels prefer due to more secure and better return opportunities.
We will now compare these two popular agreement models by key areas;
1. What is Granted?
a. Franchise Agreements:
Hotel owner licenced a package of IPR’s, essentially relating to the brand of the operator.
The IPRs are to be used in the management and operation of the hotel.
Centralised marketing, advertising and reservation services are provided for a further fee.
Management and operation of the hotel remain the obligation of the owner.
b. Management Agreements: Operator will;
Manage and operate the hotel on behalf of the owner
Provide technical services
Licence its brand
Provide centralised advertising/marketing/ reservation services
Clearly, under this structure, the hotel benefits from the “hands-on” experience of the operator.
2. What are the Owner’s Obligations?
a. Franchise Agreements: Whilst the overall management of the hotel remains with the owner, the owner is required to;
Adhere to the operator’s brand standards
Participate in group marketing and advertising
Participate in the group’s reservation system
Open the hotel on a specific date
Prepare and maintain records and accounts to be shared with the operator
Comply with all legal requirements and provide the operator/franchisor with protection against any claims
b. Management Agreements: Although the management and operation of the hotel is provided by the operator, the owner will remain responsible for;
Compliance of the hotels with the operator’s brand standards and cost of renovations associated with them
Cost of maintenance and repairs
Insurances
Employment of non-management employees
In some cases, obtain licences
Real estate issues
Some owners will seek the right to approve annual budgets, capital and FF&E budgets, approve key personnel positions, review accounts etc.
3. What are Operator’s Obligations?
a. Franchise Agreements:
Training on the operation of the hotel according to the ‘system’ (some training maybe incorporated in fees, some may involve additional charges,
Providing and updating the brand standards
Occasional pre-opening services,
Access to the operator’s marketing, advertising and reservation systems
Technical services may be provided for other areas albeit this is likely to be for additional fees.
b. Management Agreements:
Operate the hotel to brand standards
Include the hotel in the operator’s marketing, advertising and reservation systems
Have the authority to conduct the day-to-day operation of the hotel including purchasing goods and services, conducting litigation, managing staff etc.
Provide technical services relating to the design and development of the hotel (this is often a separate fee)
4. How is the Fee Structures Works?
a. Franchise Agreements:
An initial fee (this is often linked to the size of the hotel). In some cases, this fee is non-refundable.
Continuing or royalty fees (this is based on the room revenue). Typically, this is between 3% and 5% of the room revenue
Advertising/marketing contribution (also based on the room revenue). This fee generally goes towards a fund for group (not necessarily local or regional) marketing. Typically, between 2% to 4% of room revenue.
Reservation
b. Management Agreements:
“Base Fee” typically between 2% and 4% of gross revenues
“Incentive Fee” typically around 10% of gross operating profit
Technical services fees; lump sum or payable on time and materials basis for relevant services
Centralised services fees, often made up of;
Marketing fees; typically, in the region of 2% of room revenues
Reservation fees; calculated per room or against room revenue
Loyalty and other programmes provided
The content of this article is a compilation of our first-hand experience, several well-known books, industry related articles as well as research reports. Our intention to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
This is the fourth and last part of Hotel Management Agreements series, aim to provide a detailed and comprehensive information on the subject matter.
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