Excerpt from Commercial Observer
Partner Insights spoke with Michael Kosmas, a partner at Stroock & Stroock & Lavan LLP and head of its global hospitality and leisure practice, for insight on where the sector stands today, and how the pandemic has affected hotel management agreements.
What were some of the more common situations owners and operators found themselves dealing with under hotel management agreements during COVID?
One huge issue was, who has the right to make the decision to shut down the hotel, whether partially or fully, and what does that decision-making look like? Operators wanted to protect the hotel, but they also wanted to protect the brand. Owners tended to be more focused on the bottom line. They may have wanted to shut down immediately to stop the hemorrhaging, where brands might say, look, we need to keep the hotel open to the greatest extent we can because if we shut down fully, and the hotel two blocks down keeps 20 percent of their rooms open, our customer base will shift to that brand. So there were points where the owners’ interest and the managers’ interest diverged. There was also the issue of the types of benefits to offer hotel employees. You have great employees who have been there for decades. Do you tell them to go get unemployment, or does the hotel do something in that area? No one was contemplating this in advance.
So when you started going through these agreements, who did have the right to decide to shut down a hotel?
It’s different in every agreement. COVID was so unprecedented that not too many people had negotiated agreements with this thought in mind. So the agreements were all over the board.
How did you help owners get past that?
We have deep experience and relationships everywhere. I represented Marriott for my first 10 years of practice, so I know how brand managers think. We were able to leverage that experience and say to our hotel owner clients, look, this is the conversation they’re having inside the building at Marriott right now. We helped owners manage requests and expectations considering what management companies would consider reasonable.
What were some other problems that arose from these agreements?
Capex and maintenance issues — obligations under the agreements to spend so much money each year on hotel improvements, driven by the brand standards requirements. None of the brands behaved in a heartless way and most acted in a spirit of partnership with owners, but as the situation with COVID dragged on, you had to have often difficult conversations with your brands. For well-capitalized owners, this was a chance to improve and retool. For others, it was an effort to survive. So figuring out the owners’ long-term obligations for capital improvements and other projects was one issue. Also, guiding clients through insurance issues. Business interruption insurance was by and large not available to deal with COVID issues. There were also issues with lenders, since there was no money coming in the door, but debt service was still due each month. Our hotel management agreements typically provide that owners have to set aside around 3 to 5 percent of total revenue each year into a capital reserve fund, and the manager gets to use that fund for capital improvements — especially for FF&E (furniture, fixtures, and equipment). We were able to negotiate deals with a lot of our management companies and lenders to let us take money out of those reserves to allow the hotels to survive the worst of the pandemic, with promises to replenish the funds in the future. And to date every single one of our clients has lived up to those promises.
Given the circumstances hotels have faced through COVID, do you foresee permanent changes in the way these agreements are approached?
During the pandemic, owners and management companies spent a lot of time thinking about their relationship, focusing on how everyone’s interests can be more closely aligned. To offer one example, before COVID, hotel management companies were almost always compensated with base fees that were solely a fixed percentage of top-line revenue. Now, base fees in many deals are moving away from compensation based on top-line revenue, to compensation based on actual revenue to the owner. This has typically been the way of calculating incentive fees, but now a bigger portion of the overall management fees are being determined by bottom-line performance. Then there are employee considerations. Before COVID, when you had hotel transitions, nobody really thought too much about whether the employees should stay at the hotel or go with the management company. After the “great resignation,” and with a labor market tighter than it has been for decades, we’ve been seeing a very strong tension lately between owners and operators on what happens to good employees. So when we negotiate agreements today, we’re spending a lot more time thinking about that aspect of it because of the effect that COVID has had on the workforce.
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