As published in Scotsman Guide's Commercial Edition, September 2011.
Hotels are arguably the most complicated piece of commercial real estate to operate because of the nature of the business. Working with hotel and lodging deals can be just as complex. Daily operations are important to the valuation of hotels, so commercial mortgage brokers should know how the experience and expertise of a property’s operating partner can affect financing. Knowing what to look for in operating partners and how they affect a property’s value can help brokers advise clients as they proceed with lodging deals.
A seasoned operating partner is a key component to any business’ success; this is especially true in lodging. Hotel operators have the daunting task of managing leases that renew daily, all of which are negotiated at varying price points. Many external factors can also impact a hotel’s overall performance, including the overall economy, destination type, location within the destination, price point, positive and negative press, and fuel prices. An experienced management company will have the knowledge and expertise to navigate through these obstacles, creating value in good times and retaining it in bad times.
When choosing an operating partner, there are many attributes owners should seek. Three of the most important are:
Co-investments or management fees: Operating partners can either be co-investors in the property or receive management fees. Co-investment creates a platform for a mutual alignment of interests. With an investment, operators are not only incentivized to maximize top-line revenues but also to contain expenses. Lower expenses means more is brought to the bottom line, and net operating income (NOI) is the most important factor in determining a property’s value. Many hotel owners prefer no co-investment or are prohibited from receiving an investment from their operating partner, however. In these cases, an owner and manager can be creative when structuring management fees. In many cases, owners opt to pay a market-base management fee (usually 3 percent) with a strong incentive management fee.
Past experience and future strategy: When comparing management companies for a potential contract, owners should analyze the manager’s current portfolio and review their experience operating similar assets. Key pieces of information to review include: operating margins, market penetration and overall profitability. Owners also should probe potential operators on their sales and revenue-management approach. For example, an owner might ask, “What is your strategy for revenue growth and increasing market share?” or “Do you centralize your accounting and/or revenue-management departments?” It is important to understand how they plan to operate the asset to maximize the investment. Centralizing certain functions like accounting and/or revenue management decreases overhead expenses at the property level. Accounting and revenue management can cost $5,000 a month, while an accounting and revenue-management department on the property can cost $12,000 a month for just salaries and benefits. By investigating these issues, owners can weed out weaker candidates.
Relationships: Maintaining positive relationships is essential for management companies. A good management company will have symbiotic relationships with the major hotel companies representing the brands in their portfolio. A solid relationship with brands can play a crucial role in many ways, including negotiating fees and property-improvement projects. Another area to research is the operator’s relationships with other owners. Advise your owner clients to ask prospective management companies for references.
These are just a few areas to consider when dealing with a potential operating partner. Brokers and their clients do their due diligence when buying or financing an asset; they should be sure to do it when choosing a management company, as well. Choosing the right partner will help maximize the value of the asset — which means not only a better bottom line but also a better deal when financing.
David Smith Ruger has more than four years of hospitality consulting and operations experience.
He is a manager in the development department at Aimbridge Hospitality, where he underwrites and sources deals for potential acquisition and third-party management. When evaluating potential hotel acquisitions, Ruger works to identify potential conversion and strategic repositioning opportunities. Before Aimbridge, he worked at Capital Hotel Management near Boston and Hospitality Valuation Services in San Francisco. Reach him at (214) 550-5536.