JMBM Tax Newsletter: Hotel Management Agreements: The 5 Biggest Mistakes Hotel Owners Make And How To Avoid Them Using An RFP Process

In the course of handling more than $50 billion of hotel transactions, JMBM’s Global Hospitality Group® has developed and refined an approach for hotel owners to attract the hotel operator that is right for their project, and to negotiate management agreements that are fair and reasonable. This is critical, as the terms of your hotel management agreement can easily raise or lower the nominal value of your hotel by 25% or more.

We have found that hotel owners who get into bad situations with their operators often follow the same pattern at the outset. The following are “famous last words” that illustrate the 5 biggest mistakes owners make when seeking an operator or brand for their hotel:

“I just have to have Brand X for my hotel. They are perfect for my project.”Even if Brand X is perfect for your project, the best way to get a great operator and a fair deal is to have a little competition, compare the results, and be sure each operator knows there is at least one other brand they have to “meet or beat.” This process should not feel like an auction, but rather like a controlled, selective competition.

“We met some operators at the recent hotel conference, and they are really interested in our project. I think we can do a deal with them. Or … maybe you can just give me a couple of phone numbers to call.” A casual or accidental process is not the best way to identify, recruit, and selectively draw out the best business and legal terms for your hotel management agreement. You will have already given up more than you know over cocktails or a round of golf in an undisciplined process. Hotel executives make their living by negotiating hundreds of deals with people like you. Without identifying all your project’s strong points at the outset and drawing the blueprint for your RFP process, your deal will get shopworn and tired before it can be properly positioned. And if you let the hotel companies guide the process, you may find yourself with a Letter of Intent (LOI) or term sheet BEFORE you have guided and shaped the hotel company’s expectations. As a result, owners can lose big, important “deal points” that could have been accomplished if they had engaged in a disciplined process.

“Let me get the LOI signed first. It’s ‘non-binding’ anyway. Then we will bring in the management agreement experts.” It is a false economy—usually a near disaster—to negotiate the LOI terms first, and THEN bring in your hotel management agreement advisors. By the time the LOI has been discussed, much less signed, it is too late to protect your interests. Although most LOIs say they are non-binding (except on exclusive dealings with only the one operator and on confidentiality), the custom of the industry is that you are “retrading” the deal if you try to change those “non-binding” terms when your experts try to un-ring the bells that you have set off. Yes, you could probably walk from the deal (after waiting out the exclusivity period), but you have now lost the ability to do a reasonable deal with the operator you thought would be best, and you have lost time and momentum. The operators are well aware of this and they usually will not retrade.

“We have the operator’s interests aligned with ours. They are making an investment in the deal, along with us.” At first it is exciting. The operator thinks so highly of your project that this major institutional, experienced operator is actually willing to co-invest with you in your project. Be forewarned: the operator’s money will be the “most expensive” capital an owner can get—not in terms of the return paid on the capital, but in the terms you will have to “give up” in the management agreement. But the operator will still get its real money “off the top,” before any return is paid to equity.

“I don’t care about the hotel management agreement terms. I just need someone to take over the hotel aspects of the deal so I can do my retail/office/golf/condos. I’m not a hotel guy.” Our typical client is very successful in business, perhaps even in real estate or development. But many of our clients are novices when it comes to hotel development, management agreements and operational issues. For these people, it is usually better to temporarily hire the team of experts needed than to turn the hotel issues over to someone in the organization who has neither hotel experience nor the same commitment to the project.

How to Avoid These Mistakes: The Hotel RFP. Some miserable hotel owners have great operators “locked in” on terrible 50-year, no-cut, operator-takes-all management agreements. Other unhappy owners have great management agreements with operators who cannot execute the business plan or deliver on financial or guest expectations. How do you get the “Goldilocks” balance (not too hot, not too cold, but just right) of a great operator, a shared vision for the property, and fair management contract terms?

Over the years, we in JMBM’s Global Hospitality Group® have developed our version of the Hotel Brand and Operator RFP Process. This Request for Proposal (RFP) Process is an organized, disciplined and highly interactive process. It’s not about “putting your project out to bid.” It’s about strategically positioning your property to attract the right operator for you and your project. Here’s how it works:

Based upon the owner’s goals, the specifics of a project and its market fundamentals, we first identify an exhaustive list of possible brand and operator candidates. With the client, we review and prioritize choices, and compare alternative operator contacts and approaches, tailoring them to the individual project and operator candidates.

Unlike RFPs for many other purposes, we generally recommend that the owner plan to actively “sell” the merits of the project to the brand and operator candidates: Tell them why this is a great project that they want to have in their family of hotels. Clarify your vision of what distinguishes the project, how it will be successful, and why it may be strategically or financially important to their particular hotel company.

Careful planning and execution of the RFP Process is one of the most important keys to finding a good hotel operator and brand and getting a fair agreement. For a discussion of the “next steps” involved in using the RFP process for strategically positioning your hotel project to attract the right operator, go to HotelLawBlog.com and see “How to get the right hotel operator, parts 2 and 3”.

Jim Butler is a hotel lawyer and business advisor specializing in creating solutions for hotel owners, developers and lenders. Jim leads a team of 50 members of the Global Hospitality Group® of Jeffer, Mangels, Butler & Marmaro LLP, where they have assisted clients with more than $40 billion of hotel transactions around the globe involving more than 1,250 properties. In the last five years alone, they have advised clients on more than 80 hotel-enhanced mixed-use projects, virtually all of which have included condo hotels and hotel condos. Jim can be reached at 310.201.3526 or jbutler@jmbm.com.