Hotel management or business lease, which is best?
When it came to drawing a distinction between a hotel management agreement and business lease agreement, traditionally a number of premises were used, which, though general and simplistic, helped focus the issue. The following affirmations were employed: “the manager has a smaller amount of remuneration, but it does not take on the business risk”; “with leases the owner/lessor does not participate in the business, and all the risks and rewards are for the lessee”; “with leases, the lessee has complete freedom to operate the business”; “a lease gives the operator more stability than management”; and so on and so forth.
While it is true that these affirmations remain valid to draw a distinction between many of these two types of agreements; it is also the case that a clear trend has emerged that causes doubts as to whether they completely hold true. Two of the reasons behind this new scenario are the following.
The first is the now not so recent economic and financial crisis we experienced roughly between 2007 and 2013. The sharp drop in hotel revenues caused by that crisis, especially in secondary destinations, endangered the viability of large numbers of lease agreements, many of which had been entered into on premises of fixed income and generally between the end of the 90s and into the new millennium.
The second important factor is a sharp increase in the presence of professional owners/investors, whose profitability parameters go beyond the real estate element to take in the business carried on in them.
While not the only ones, these two factors have altered some of those classic parameters. Two of the most prominent examples of these changes are:
- In the domain of hotel management agreements, the fact of hotel owners demanding a certain gross operating profit level from the operator, secured by making the manager participate somehow in the business; or requiring them to pay key money which is generally used to defray the costs of adapting the hotel for the operator.
- In the domain of lease agreements, the key point has been the fact of making the rent component variable, with all the related consequences.
This variable rent option makes the owner/lessor a participant in how the business performs. And it is precisely this participation by the owner/lessor that is behind the inclusion in these agreements of certain items that have their natural origin in management agreements:
- Early termination clauses in the event of poor performance by the hotel (performance test clauses)
- FF&E (Furniture, Fixtures & Equipment) reserve
- The performance of the business being monitored by the owner; among others.
This last point opens up a source for synergies, but is also a catalyst for discussion over differentiating between information and even the joining forces of the parties, and interference. This discussion has traditionally been associated with management agreements.
These issues, hugely summarized to fit in with the space limitations of this article, help understand our chosen title. We did not want to say that this mixing or crossover between agreement types previously did not exist, instead that it is now apparent that these more particular scenarios are becoming more widespread.
This blurring of boundaries means that at times it has to be reconsidered whether instead of steering the negotiations for a management agreement in one direction, it is better to steer a business lease in the other; and vice versa.
Lastly, the “mutation” of these types of agreement confers even greater importance on the differential element provided by certain strictly legal issues such as:
- Liability of the operating results in extreme cases of unviable businesses
- Problems related to ownership of personnel
- Responsibility for CapEx
- Certainty in long-term contractual relationships.
Although these matters are not as clear-cut as they might seem…
Garrigues Tourism and Hotels Department