Warren Buffet once said, “Only when the tide goes out do you see who’s been swimming naked.” The pandemic sure shone a spotlight on some skinny-dippers, but they thought they had been swimming in a lake where there was no threat of tide until it swept them over.
No one anticipated a pandemic that would eliminate demand and close such a high percentage of hotels. As a result, many management agreements did not consider or incorporate the concept of no revenue, and left many operators with ongoing expenses un-recouped from their owner-partners.
Contributed by Andrea Foster, senior vice president, development, Marcus Hotels & Resorts, Milwaukee, Wisconsin
Awareness of this risk, and its ongoing potential, is pressing management companies into making changes to their management agreements to create protections that will allow them to diligently maintain operations on behalf of owners, while lessening their exposure. A few such changes include:
Minimum management fees. We all know that 3% of $0 = $0, and faced this stark reality in 2020. As a result, some management companies are incorporating minimum fees into their agreements to cover the costs of managing through the hopefully rare situation where our industry finds itself in a significantly reduced demand or imposed restriction environment again.
Closed hotel fees. When a hotel is temporarily closed, there are still operating expenses, including management, human resources, maintenance, and security, that continue even when the doors are shut. The asset needs to be maintained and protected physically, and critical staffing needs to be retained to oversee the property, and associate needs to be ready to reopen the property when restrictions and/or demand allow.
Working capital. This is not a new concept in management agreements, but its importance has certainly been elevated in the last 16 months. A working capital clause ensures a commitment from the owner-partner to cover operating expenses via an account that is both funded and maintained at a minimum balance by the hotel operation (and supplemented by ownership, if/as needed), and solely debited by the management company. The account will pay operating and fixed expenses first (may or may not include payment of debt service), then sweep to an ownership account for dollars (profit) that exceed the agreed-upon minimum balance. It is critical that operators have the ability to quickly terminate the management agreement if the working capital account is not funded in a timely manner. This ensures that management companies do not find themselves in the position of acting as the owner’s “bank.”
Proper management of hotels is not a commodity. Perhaps that is understood more fully now than ever. Operating companies provide critical expertise and exceptional effort in supporting top-line revenues, managing expenses, and generating optimal bottom-lines for their owner-partners. A significant portion of this effort is focused around associates – hiring, training, managing, and developing – and the spotlight that shone on the industry when the tide went out revealed the incredible amount of work that goes into overseeing the labor aspect of our industry. It makes sense to update management agreements to provide protections that will ensure that the operators and the properties they serve will be sustainable under any market conditions.