WASHINGTON—When Noah Silverman used to negotiate Marriott International’s management services with owners, he insisted on 30-year contracts to preserve operational consistency and the legacy of the brand.
What a difference a few years can make.
“What we’ve realized in the last few years is that model is increasingly different if not impossible to get. We have come to the realization that the No. 1 important objective to us is to preserve the distribution, preserve the fee stream and preserve the flag for the long term,” said the chief development officer for North America full-service hotels at Marriott during a panel on owner-operator agreements at last month’s Bisnow Lodging Investment Summit.
Today Marriott’s management contacts may be terminable after five or seven years with a fee, provided the owner converts to a franchise agreement, Silverman explained.
Such flexibility represents a broader evaluation in management contracts that seek to better align interests between owners and operators.
Shorter-term contracts largely have been the result, panelists said, driven by owners who want the ability to change management if property performance proves unsatisfactory.
“We want them to be as short as possible,” confirmed Fred Grapstein, senior VP of Vornado Realty Trust.
Joseph Bojanowski, president of PM Hospitality Strategies, said the average for third-party managers is now five years.
That forces discipline into the management of hotels because operators must continue to prove themselves in order to renew their contracts, Silverman said.
Also key is a fee structure that rewards operators’ strong performance—but only after the owner has recouped the majority of his initial investment.
The latter is ensured by owner’s priority, which is a relatively new twist in the long history of management contracts, said panel moderator Nelson Migdal, co-chair of the hospitality practice at Greenberg Traurig. Inserting the provision ensures owners a return on their investment before the operator’s incentive fee kicks in.
“That is thought to also better align the interest because the owner is going to get a return on their investment,” he said. “It does mean that the operator is not only making a gross revenue but making sure the owners can make a return.”
Base fees are typically 3% on top line gross revenue, panelists agreed. Incentive fees can range anywhere from 12% to 20%.
“There’s a wide range and it depends on the owner’s priority,” said Jim Abrahamson, CEO of Interstate Hotels & Resorts.
Termination
The ideal scenario sees happy owners sharing bountiful returns with the operator responsible for generating them. But that’s not always how it shapes up, sources said.
When problems do arise, the first step for either party is to communicate concerns.
“We remain flexible all the time. We’re willing to try new things. We’re open to (owners’) suggestions,” said Kevin Urgo, senior VP of development and finance for Urgo Hotels. “At the end of the day, it’s about reputation and it’s about the relationship between you and that individual owner.”
Being quick to address such concerns has given Urgo Hotels’ a solid track record.
“We’ve never had an issue where there’s actually been a termination or a meaningful threat of termination,” Urgo said.
Not all management companies are so lucky. As recent court rulings in New York and Florida have shown, owners have the power to terminate a management contract at any time. They just might not have the right.
That means owners can be held accountable for damages paid to the operator. When the owner of the Turnberry Isle Resort & Spa in 2012 ousted managers Fairmont Hotels & Resorts with more than 50 years still left on the contract, the decision was upheld in court—but at a cost. The owner paid Fairmont nearly $20 million in damages, Migdal explained.
Owners typically are required to pay fees in less hostile situations as well, such as the sale of hotel free of management contract, panelists said.
“There is always the ability to exit. The question is what the cost of that is going to be if there will be any,” Bojanowski said.
Termination fees can be forgiven if the operator underperforms and falls below agreed-upon performance thresholds. Marriott includes a two-pronged test in its contracts. The first threshold is based on revenue-per-available-room index of the hotel against an agreed-upon competitive set. The second is a net-operating-income threshold, Silverman said.
Regardless of scenario, the decision to change operators should not be taken lightly, Grapstein said. Owners must undertake careful due diligence, assessing what different companies bring to the table and whether future projections would offset the cost of termination, if applicable.
Beyond brand managers
Marriott and its branded brethren are slowly moving out of the management game as owners call upon third-party operators that bring more flexibility.
The company is seeing more growth in standalone franchise sales, Silverman said.
“There’s been a definite trend in that direction of franchise and third-party management,” Urgo said.
The trend has been prominent in the select-service space for years, although it’s now gaining traction in the full-service sector as well, he added.