Rental agreements with a fixed rent and a term of up to twenty or even thirty years are very common in the hotel sector. This is exceptional compared to other real estate sectors. Agreements for offices, retail, restaurants and cafés cover much shorter periods. Flexible rental agreements are also on the rise in these sectors: rent is partially linked to monthly turnover, resulting in a deal where both revenues and risks are shared more equitably. That’s more like getting married in community of property.
Blessing or curse?
The other day I spoke with friend and colleague Joost Mees, an expert on hotel contracts, to discuss how contracts are likely to develop. In recent years, we both observed an increasing desire among the owners of hotel real estate to share in the huge success enjoyed by their tenants. While hotel operators were raking in profits like never before, the owners were starting to view their long-term fixed contracts as a curse. But all that changed when the current pandemic brought an unprecedented downturn: for the lessor, fixed contracts suddenly went from curse to blessing. Or so it seemed.
The truth is a little more complex. How much of a safeguard does a fixed contract offer if a court rules that the pandemic counts as a disruption of quiet enjoyment under a lease? Or if there’s a real risk of the operator going bust? Is there a more acceptable alternative or is it simply better to modify the conditions of an existing rental agreement? Despite having a fixed contract, the owner often chooses to sit down with the tenant to make new arrangements or even switch to another type of contract.
For hotels, as for retail outlets, we see flexible rental agreements as a good alternative to fixed contracts. Since the rent depends in part on the hotel’s financial performance, the owner obtains a greater insight into the health of the business. This level of transparency opens the door to closer cooperation. With flexible agreements, both parties have an interest in growth and will invest jointly to make it happen. While this approach requires a little more ‘hotel know-how’ on the part of the owner, greater rewards are on the cards for both parties when the knowledge and skills of the tenant come into play.
A second option comes in the shape of a hotel management agreement. In this set-up, the investor owns both the property and the operation – even the staff is on the owner’s payroll. Only the management itself is left to an experienced hotel operator, often backed by a strong brand such as Hilton, Accor or Marriott, for a partly fixed and partly variable fee.
Management agreements are already commonplace in America and Asia, but are currently gaining ground in Western Europe too. Firstly, this is because more and more hotel investors have entered the market, specialists who are willing to take operational risks and eager to be part of the market that had shown such strong growth and high performance until the coronavirus hit in 2020.
In the transition from rental to management agreements, minimum result guarantees issued by the operator are an increasingly common feature. This approach assures the owner of a certain level of cash flow and a return on their investment. And if the operator consistently underperforms compared to the competition, there are also more possibilities to evict them.
A good marriage
Smart new contract types are reflecting the mood of today, a time when the hotel industry has proven not to be as invincible as we once thought. Let’s see this crisis as a wake-up call, one that encourages owners and operators to share revenues and risks more equitably. It starts with how you draw up your hotel contract. Reap the collective rewards when life is sunny, and share grief in times of crisis. Like any good marriage. For better or for worse, in sickness and health, for richer and for poorer.