Hotel Tourism and Leisure lounge

which way out? - dealing with distressed contracts

 

The hotel industry has been facing an increasing number of distressed hotel operating agreements. Once a hotel lease agreement needs to be labelled as distressed, the first step is for both parties involved to simply acknowledge the fact and to find a way out which gives both the lessor and the lessee a fair chance to survive ... read more PKF Newlsetter

who’s paying? - adequate terms of hotel lease contracts

www.pkfhotels.com - HTLupdate 2

the art of operator selection   One does often hear that the first step of developing a successful hotel is to secure a great location. This certainly holds true, however, the value of a hotel project is then further increased if one succeeds in having the second step accomplished, being finding the right operator with the right contract. The large hotel groups tend to offer mainly management contracts with the aim of minimising their exposure to risk and hence enabling them to sign a higher amount of deals.

what’s next? - trends in lease, management and franchise contracts

www.pkfhotels.com - HTLupdate 1

The contractual relationship between owner and operator has always been a key issue in hotel development. In the past, we have seen significant changes in this relationship which resulted from various factors such as the expansion strategies of hotel groups, the types of investors active in the hotel market, and the requirements of lenders with regard to debt funding. major developments On a global scale, hotels operated under a management agreement are prevailing and increasingly replacing owner-operated hotels and other contract constellations such as lease agreements. This development can be traced back to  the expansion strategies of the major international hotel operating groups. In order to facilitate faster growth, these groups have been pursuing an asset-light business model. On the one hand, this was implemented by major sale-and-manage-back transactions of existing assets which have set free valuable capital for new developments. On the other hand, the focus was clearly put on an expansion by signing new management agreements. Most hotel groups are focusing on their core competence of managing hotels and — as a consequence — are shifting operational risks to the owner. However, in some regions (e.g. Europe), the lease agreement is still the predominant contract model and its replacement by the management agreement is proceeding at a slow pace. This can partly be ascribed to the background of hotel investors and to the requirements of lenders. A significant share of hotel investment in Europe is undertaken by institutional investors such as real estate funds, pension funds or insurance companies. These investors often require (either by law or their articles of incorporation) income from rent and lease. Due to this fact, these investors can only enter lease agreements, but not management agreements (which would generate income from trade and business). Furthermore, lenders in Europe are still rather conservative, which becomes evident in their preference of lease agreements, where the lessee bears the full operational risk and the lessor can provide a steady cash flow to cover the amortisation of debt. However, the assumption that a lease agreement always carries less risk than a management agreement has to be generally questioned.In times of economic prosperity, over-rented agreements were signed by lessees anticipating a continuous economic growth. In the economic downturn, lessees were often not able to (fully) pay the rent. If no guarantees (e.g. bank or corporate guarantee) were provided by the lessee (which would cover such a shortfall), a default of the loan repayment by the lessor was often the consequence. Thus, a lease contract per se is not always a safe bet and therefore should be analysed in conjunction with several factors such as the creditworthiness of the lessee, the provided guarantees and, of course, the cash flow the lessee can generate. In order to evaluate as to whether a reasonable coverage of the rent is feasible, the rent coverage ratio (= adjusted net operating income before rent divided by rent) is the figure being used most commonly. As a rule of thumb, this ratio should not be below 1.2 in order for the lessor to feel comfortable that the lessee still has a certain buffer in difficult economic times. tri-party agreements The above-mentioned development has also set the framework for the so-called tri-party agreement. In this contract constellation, a franchisor (which is usually an international hotel operating group) provides a brand name, brand standards and selected services (e.g. reservation system) to the franchisee operating the hotel. Additionally, a so-called owner agreement between the owner and the franchisor is concluded, which records the owner’s right to maintain the brand name in the case of default of the franchisee and often includes the provision that the franchisor steps into an interim management agreement until a new lessee is found. In addition, the franchisor usually commits to identifying potential successor lessors (e.g. amongst their existing network of franchisees). The Courtyard Vienna Messe (see picture) is one example where such a tri-party agreement has been realised. Overall, this constellation facilitates the risk-averse expansion strategy of hotel groups acting as franchisors. At the same time, it provides a lease contract for the owner which increases the chances of securing debt funding. Thus, the tri-party constellation is an agreement expected to occur increasingly often.