management contract trends - a · pdf file2 management contract trends ... current trends in...

September 2014

Management Contract Trends - A Review

2 Management Contract Trends - A Review

This report identifies the main commercial trends and conditions contained within a selection of Hotel Management Contracts (HMC’s) across India. Our comments are based on a review of 42 management contracts for properties across various segments, located in the primary and secondary cities of India. The review highlights key trends pertaining to fee structures and important clauses in Hotel Management Contracts and aims to reflect current trends in the industry.

Management Contract Trends - A Review 3

Management contract terms covered in the report

Comparison Parameters Key Aspects Included

Hotel Management Contracts Term

Initial Term Period

Option of Number of Extensions

Period of each subsequent Extension

Fee

Base Management Fee

Incentive Fee

Sales & Marketing Fee

Central Reservation Fee & Loyalty Program

Technical services Fee

Furniture, Fixtures and Equipment (FF&E) Reserve

Operating Budget Authority to Owners for Approval or Rejection

Non-Compete ClauseProtection Period

Protection Zone with respect to the Site

Performance ClauseThresholds based upon GOP, RevPAR or a combination of both

Cure Options

Operator Restrictions Selection of Key Personnel of the Hotel

Owner RestrictionsFinancing Restriction

Non-Disturbance Clause

Termination ClauseTermination with a Cause

Termination without any Cause

Operator Guarantee & Contribution ClauseOperator Guarantees

Equity Contribution by Operator


Research Sample DetailsOur sample set was fairly evenly spread across all segments, with a majority of contracts pertaining to properties located in primary cities.

SEGMENTUniversal Sample - It constituted of 42 contracts. Out of these, 17% belonged to luxury segment, 14% to upper upscale, 26% to upscale, 38% to midscale and 5% to economy segment.

LOCATION81% of the contracts were executed for locations belonging to the metropolitan / tier I cities of India, 12% of the contracts for tier II cities and 7% for tier III.

LOCATION ORIENTATIONOut of the total sample, 52% belonged to business cities, 17% to leisure cities and 31% to cities having a mix of business as well as leisure orientation.

OPERATOROut of the total sample, North- American chains comprised 60% of the sample, European chains comprised 26% and Asian chains comprised 14%.

Sample Distribution by Hotels Classification

Sample Distribution by Orientation of Locations

Sample Distribution by Operator Headquarters

Sample Distribution by Location

All figures in (%)

All figures in (%)

All figures in (%)

All figures in (%)

Metropolitan/Tier I Cities Tier II Cities Tier III Cities

81

12 7

Leisure Business Mixed

17

52

31

North America Europe Asia

6026

14

Midscale EconomyLuxury UpscaleUpper Upscale

1714

26

38

5


Management Contracts - Key Aspects

TERMAmong management contracts, 39% stipulated to have an initial term of 10-15 years, 29% of 16-20 years, 12% of 21-25 years; 15% of 26-30 years, while only 5% of the contracts stated the term of more than 30 years. On an average, the overall initial term of contracts stood at around 19.6 years.

100% of the contracts provided at least one additional term, generally by mutual agreement between both parties. 52% of the contracts stated provision of extension by two terms, while 39% stated extension by 1 term only. The remainder 9% stipulated extension by more than three terms. The more the number of extensions allowed, the lesser was the period of each extension.

Initial Term

BASE FEEBase Fee is calculated either on a fixed model (57%) or a scaled model (43%). Scaled model provides discounts to base fee generally during the initial few years of operations.

This fee is mainly charged as a percentage of Gross Revenue (GR). Overall, based upon fixed base fee and the last year scaled base fee, 2.17% was the average charged base fee stipulated in the sample contracts. 6% of the sampled contracts stipulated a base fee of less than 2%, 75% of the contracts with the fee of more than and equal to 2% and less than or equal to 3% and 19% of the contracts with the fee of more than 3%.

Based upon classification, the average base fee charged for economy hotels is 2%, midscale hotels is 2.66%, upscale hotels is 2.36%, upper upscale hotels is 2.40% and for luxury hotels is 2.15%.

All figures in (%)

Base Fee

All figures in (%)

Fixed Scaled

5743

Base Fee on GR

All figures in (%)

Average Base Fee per Segment as % of GR

10 to 15 Years 16-20 Years 21 to 25 Years26 to 30 Years 30 Years plus

39

29

1215 5

less than 2% more than or equal to 2%, less than 3%more than or equal to 3%

6

75

19


Incentive Fee as % of GOP

INCENTIvE FEEIncentive fee is stated in agreements over and above the Base Fee. The majority of agreements had an incentive fee calculated on Gross Operating Profit (GOP). There were few linked to the available cash flows too instead of a flat fee. Fee is generally scaled from 4% to 10% of GOP. In few of the cases, incentive was nil for GOP being less than 30% of the Gross Operating Revenue (GOR). 19% of the contracts stipulated a flat fee ranging from 6.5% to 8% irrespective of the GOP as a percentage of the GOR.

81% of the sampled contracts had a variable incentive fee linked to profitability.

1) If GOP is less than or equal to 35%, then 25% of the contracts stipulated an incentive fee of less than or equal to 5%; followed by 55% of the contracts with the fee of more than 5 and less than or equal to 6%; followed by 15% of the contracts with the fee of more than 6% and less than or equal to 7% and the remainder 5% charged fee more than 7%.

2) If GOP is more than 35% and less than or equal to 40%, then 25% of the contracts stipulated an incentive fee of less than or equal to 6%; followed by 58% of the contracts with the fee of more than 6 and less than or equal to 7%; followed by 12% of the contracts

with the fee of more than 7% and less than or equal to 8% and the remainder 5% charged fee more than 8%.

3) If GOP is more than 40% and less than or equal to 50%, then 5% of the contracts stipulated an incentive fee of less than or equal to 6%; followed by 5% of the contracts with the fee of more than 6 and less than or equal to 7%; followed by 62% of the contracts with the fee of more than 7% and less than or equal to 8%, followed by 21% of the contracts with the fee of more than 8% and less than or equal to 9% and the remainder 7% charged fee more than 9%.

4) If GOP is more than 50%, then 4% of the contracts stipulated an incentive fee of less than or equal to 7%; followed by 17% of the contracts with the fee of more than 7 and less than or equal to 8%; followed by 50% of the contracts with the fee of more than 8% and less than or equal to 9%, followed by 29% of the contracts with the fee of more than 9% and less than or equal to 10%.

None of the contracts charged incentive fee of more than 10% under any condition.

In less than 5% of the sampled contracts, we found a provision where the incentive fee payable to the operator was sub-ordinate to a pre-determined preferential pay-out to the owner.

50%<GOP

25%

55%

15%

5%

25%

58%

12%

5%5% 5%

62%

21%

7%4%

17%

50%

29%

0%

10%

20%

30%

40%

50%

60%

70%

5%-6% 6%-7% 7%-8% 8%-9% 9%-10%


SALES & MARKETING (S&M) FEEThis fee is mainly charged as a percentage of Gross Rooms Revenue (GRR) or Total Revenue (TR). Overall, 1.95% of the GRR or 1.5% of the TR was the average charged fee stipulated in the sample contracts. 43% of the sample ranged from 1 to less than or equal to 1.5%, 42% ranged from more than 1.5% to less than or equal to 2%, 6% ranged from more than 2% to less than or equal to 3% and 9% ranged above 3%.

CENTRALIZED RESERvATION FEE & LOyALTy PROGRAMFor contracts which stipulates reservation fee, 36% of contracts constituted of a fixed dollar amount per reservation, while 64% stated a mix of dollar amount per reservation and a percentage on room revenue.

Reservation fee charges in flat dollars averaged at US$ 7.79 per booking.

TECHNICAL SERvICES FEEIt is usually charged as a flat fee and paid either monthly or quarterly. Few of the contracts imposed a fine in case of delay in the opening of the hotel. Sometimes it is linked to the no. of keys of the hotel as a multiple. In most of the contracts, it was specified that the owner has to reimburse out of pocket expenses (OPE)s incurred by the operator, while few had an upper limit imposed on this expenditure.

Based upon the classification, the average technical fee charged for midscale hotels is USD 111,400 approximately, for upscale is USD 143,600, for upper upscale is USD 135,250 and for luxury is USD 180,650.

Centralized Reservation Fee

All figures in (%)

S&M Fee as a % of GRR

more than 1%, less or equal to 1.5%more than 1.5%, less or equal to 2%more than 2%, less or equal to 3%more than 3%

4342

6 9

All figures in (%)

Dollar Charges Dollar Charges and % on Room Revenue

Technical Fee Average per Segment in USD

36

64


FURNITURE, FIxTURES AND EqUIPMENT (FF&E) RESERvEOut of all the sampled contracts, 95% showed the trend of increasing the fee by one percent each year over the first few years. The typical FF&E structure is as follows:

year 1: either 1% or 2% of Gross Revenues



year 4 onwards: 4% of Gross Revenues

44% of the contracts specified the fee of 1% in year 1 while 56% of the contracts stated a fee of 2% in year 1.

Furthermore 5% of sampled contracts had flat FF&E Reserve provision fee with an average of 2%. The FF&E reserve across all the sampled contracts averaged to 3.3% of GR per year post stabilisation.

OPERATING BUDGET83% of the sample contracts gave authority to owners for approval or rejection of the annual budget, while 17% had consultative right only. This clause helps the owner as well as operator to work in the best interests of the hotel to improve its performance and monitor it on mutual understanding taking utmost care in deciding the budget. This minimises the risk of untimely termination from either parties as expectations are set based upon in depth discussions of the budget. In case of any disagreement between owner and the operator on the operating budgets, our sample contracts provided for an expert determination/ arbitration as the dispute resolution mechanism

NON-COMPETE CLAUSEOut of the total sampled contracts, 87.5% of them mentioned a non-compete clause. It prohibited the opening of a hotel of the same brand within few kilometers of the site’s location.

16% of contracts stipulated a protection period less than 4 years from commencement of operations, 47% stated a period from 5 to 9 years, 9% stated a period of more than 10 years, 3% for the entire tenure of the agreement while the other 12.5% had a non-compete clause but did not specify the period.

Out of the total agreements, 28% stated protection radius of less than 5 kilometres, 3% each with the radius of 6 to 10 kilometres and more than 10 kilometres, 53% defined the area on the map related to the site. The remaining 13% did not mention non-compete clause.

On an average, non-compete clause restricted the same brand from

Protection Period

Protection Zone

All figures in (%)

All figures in (%)

opening hotels within a radius of 7.4 kilometres of site’s location. In the CBD areas, it was less than or equal to 5 km while in non-CBD areas it was more than 5 km.

1-4 years 5-9 years 10 +Entire tenure of the contractNo specified period

No clause

16

479312.5

12.5

Defined Area No clauseless than 5 kms More than 10 kms6-10 kms

28

3353

13


PERFORMANCE CLAUSEManagement agreements differ in their performance clause structure. The performance clause is usually based upon Gross Operating Profit (GOP) or Revenue per Available Room (RevPAR) or a combination of both. From our sample, the results showcased that 43% of the contracts stated performance based upon GOP, 36% of the contracts were tested for performance based upon RevPAR, 21% were tested against a combination of both.

45% of the contracts mentioned at least one cure option before termination of the agreement on the basis of non-performance. Normal cure provision for operator amounted to payment of differential amount between actual performance and budgeted/benchmark performance for the year in which performance clause gets triggered. Almost, all our sampled contracts provided for the performance measurement period of two consecutive years.

The achievable percentage in a combination of GOP and RevPAR together ranged from 80% to 90% of the GOP/competitive set performance figures for the year.

The achievable percentage for GOP ranged from 80 to 85% of the operating budget on an average for 75% of the contracts stating their performance based upon GOP alone. The other 25% ranged from 70 to 75% of the operating budget.

The achievable percentage for RevPAR threshold was 85% of the competitive set performance.

OPERATOR RESTRICTIONSThe owner’s consent on appointment of the General Manager (GM) and Financial Controller (FC) for the hotel was agreed in 47% of the sampled contracts, while 50% agreed for appointment of GM alone. However, very few mentioned about owner’s consent on choosing expatriate personnel for the hotel.

OWNER RESTRICTIONSRestrictions on owner financing were stipulated in 65% of contracts with the most common restriction being debt to equity ratio of 60-70%. Prohibited entities on sale were specified in all the contracts. On the sampled contracts, provision was found for the operating agreements to survive any change of ownership for the hotel/asset.

TERMINATIONTermination clause with a cause either by operator or owner were specified in detail in all the contracts. However, 7% of the sampled contracts also had an inclusion of a termination clause without any cause. If the owner terminates the agreement without any cause, then he is liable to pay termination fee which is derived from base management fee, incentive fee, and the remaining no. of calendar months of the signed term of operation. In few cases, the termination fee is also charged as a mutually agreed lump sum fee stipulated in the agreement.

OPERATOR GUARANTEE & CONTRIBUTIONNone of the contracts in our sample included an operator guarantee or equity contribution.

ConclusionToday, as the Indian hotel market starts to mature, hotel owners benefit from enhanced knowledge of the nuances of management contracts and the increase in the number of operators present in India has created a highly competitive market, with owners in a strong position to negotiate management agreements. While the key issues in negotiating a management agreement have remained largely consistent over the past decade, there is increased pressure on operators to provide more flexible terms than those provided historically and the balance of power has begun to shift towards being more favourable to owners in comparison to the earlier trends.

Operator's sole discretionOwner consent for GM and FC both

Owner consent for GM alone

3

5047

GM and FC Appointment

All figures in (%)


JLL Operator Search Services

Review plans, market positioning and business plan

Send information memorandum to interested parties

Select preferred bidder

Discuss and decide selection criteria

with client

Liaise with all interested parties prior to proposals

Negotiate terms of contract

Prepare Information Memorandum for

client review

Evaluate proposals and shortlist

preferred parties

Liaise with client’s legal terms

Prepare target list of potential operators to be

approached

Coordinate presentation and

pitches

Finalize and sign management

contract

Pre-mArKetIng & BrIefIng DoCument

oPerAtor seArCh

oPerAtor seleCtIon

AnD ContrACt negotIAtIon

OPERATOR SELECTION & CONTRACT NEGOTIATIONour Added Value- Your success

An experienced hotel operator engaged under a well thought-through contract can make an enormous difference to the financial performance of a hotel investment and its ultimate capital value. Our operator selection team has the depth and breadth of experience to know what to look for and how to button down the detail to protect the owner’s interest.

The process involves:

• Setting appropriate success criteria

• Searching the market using our extensive database and global network

• Finding a good brand match

• Assessing operator performance record

• Negotiating commercial terms

• Ensuring operating profits and any future asset disposal are not compromised

• Working with the owner’s legal team

Our ultimate aim is to maximise operational performance and asset value. We can only do this by finding the most suitable operator, minimising contractual risk and creating the conditions for an effective owner/operator relationship.


Authors

mandeep s lambaManaging Director, IndiaHotels and Hospitality Group tel +124 460 [email protected]

shirat mathurSenior AnalystHotels and Hospitality Grouptel +124 460 [email protected]

harshendra goyalSenior vice PresidentHotels and Hospitality Grouptel +124 460 [email protected]

Christopher thepotHotels and Hospitality Grouptel +124 460 [email protected]

roopa georgeSenior AssociateHotels and Hospitality Grouptel +124 460 [email protected]

About Jll hotels & hospitality group JLL’s Hotels & Hospitality Group serves as the hospitality industry’s global leader in real estate services for luxury, upscale, select service and budget hotels; timeshare and fractional ownership properties; convention centers; mixed-use developments and other hospitality properties. The firm’s 300 dedicated hotel and hospitality experts partner with investors and owner/operators around the globe to support and shape investment strategies that deliver maximum value throughout the entire lifecycle of an asset.

In the last five years, the team completed more transactions than any other hotels and hospitality real estate advisor in the world totaling nearly US $36 billion, while also completing approximately 4,000 advisory, valuation and asset management assignments.

The group’s hotels and hospitality specialists provide independent and expert advice to clients, backed by industry-leading research.

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Jones Lang LaSalle Property Consultants (India) Pvt Ltd © 2014. All rights reserved. All information contained herein is from sources deemed reliable; however, no representation or warranty is made to the accuracy thereof.

About JllJLL (NYSE: JLL) is a professional services and investment management firm offering specialized real estate services to clients seeking increased value by owning, occupying and investing in real estate. With annual fee revenue of $4 billion, JLL has more than 200 corporate offices and operates in 75 countries worldwide. On behalf of its clients, the firm provides management and real estate outsourcing services for a property portfolio of 3 billion square feet and completed $99 billion in sales, acquisitions and finance transactions in 2013. Its investment management business, LaSalle Investment Management, has $48.0 billion of real estate assets under management.JLL has over 50 years of experience in Asia Pacific, with over 27,500 employees operating in 80 offices in 15 countries across the region. The firm was named ‘Best Property Consultancy’ in seven Asia Pacific countries at the International Property Awards Asia Pacific 2014, and won nine Asia Pacific awards in the Euromoney Real Estate Awards 2013. www.jll.com/asiapacific About Jll IndiaJLL is India’s premier and largest professional services firm specializing in real estate. With an extensive geographic footprint across 11 cities (Ahmedabad, Delhi, Mumbai, Bangalore, Pune, Chennai, Hyderabad, Kolkata, Kochi, Chandigarh and Coimbatore) and a staff strength of over 6800, the firm provides investors, developers, local corporates and multinational companies with a comprehensive range of services including research, analytics, consultancy, transactions, project and development services, integrated facility management, property and asset management, sustainability, industrial, capital markets, residential, hotels, health care, senior living, education and retail advisory. The firm was named the Best Property Consultancy in India at the International Property Awards Asia Pacific 2014-15. For further information, please visit www.joneslanglasalle.co.in

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