HOTELS
Hotel Management Contracts: Evolutionary Tendencies
Given that statistically, the majority of agreements covering the management of a hotel will outlive
most marriages, it is essential that the relationship between hotel owners and their respective
management companies is governed through a fair and equitable agreement. John Podaras outlines
the evolution in hotel ownership in the Middle East and the trends in management contract terms.
Internationally, the nature of hotel owners has changed
and metamorphosed from the inn keepers,
caravansaries and guest house keepers of antiquity, to
the 19th century “hôtelier” to the management
companies, franchisors, asset funds, portfolio owners
and all the stages in between to be found in the market
today.
Hotel Leases
The management of hotels is equally diverse;
traditional owner-managers have given way to hotel
leases for example. Leases initially evolved from typical
property asset leasing arrangements with a flat rent al
fee with indexation built in. This arrangement offers the
owner the security of a fixed inc ome for the dur at ion of
the lease period, with the lessor earning increased
revenues during strong hotel market conditions, and
bearing all of the financ i al ri sk in tim e s of we ak hot el
market performance. Over time, hotel lease rentals have
included a variable component in addition to the fixed
fee element, based on gross revenues or gross operating
profit. Ho t el l eases are r el at ivel y r are i n t he Mi ddl e
East, although they do exist for the mid market and
budget end of hotels.
Franchise Agreements
The significanc e of the hot el br and has br ought wi th it
an increased use of franchise agreements (sometimes
called license agreements). A hotel franchise brings a
number of advantages to the owner, including access to
the brand’s sales and marketing network and booking
engines, enhanced position to solicit debt and equity
financ i ng t hr ough t he assoc i at ion wi th a recogni sabl e
brand and still have a measure of self-determination
and operational independence of their property.
Many hotel owners choose to manage their own
property or use an independent management company
to do so under a franchise arrangement in the belief that
this arrangement will be more responsive to their
needs, limit their costs and generate more gross
revenue. Established brands benefit f rom f ranc hi se
arrangements as they are a well established method of
expanding a brand’s presence for a minimum of
investment, as well as being a lucrative source of
revenue. Franchise agreements also tend to be
standardised and thus less complex to negotiate and
administer than their management contract equivalents.
Franchise agreements however are rare in the Middle
East with many operators preferring management
contracts to ensure their brand standards are being met.
Condominium Hotels
A further complication in the owner/manager
relationship arises with the advent of the condominium
hotel where rooms or suites are sold and then placed
back into a le ing pool f or t he ope rat or t o ma nage.
Another variant is the Sukouk Al-Intifa’a which is an
Islamic property bond enabling Moslems of any
nationality to obtain fractional ownership of a
residential suite in specific de vel opme nt s suc h as t he
Zam Zam Tower in Makkah. In these cases the
company must be structured in such a way that there is
one corporate entity with which the operator will have
a management agreement.
Management Contracts
As the Middle East hotel market matures and expands,
owners are be er i nf or me d a nd t hei r h ot el s mo r e
specialised. The growing market has seen a change in
ownership structure from the high net worth individual
towards organisations with a keen eye for investments
and fiel di ng a stabl e of asset m
a nagers.
The vast majority of branded hotels in the Middle East
therefore are managed under the auspices of a
management contract. With over 100 points needing to
be addressed within a typical management contract,
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 Hotels
negotiations can be lengthy and convoluted. The tone
and tenor of the process however, if not the relationship
itself, depends on the 10 or so key terms that comprise
the initial Memorandum of Understanding (also known
as the Le er of Int ent ).
Fees
These are the most important item on the agenda and
traditionally comprise management fees that are fixed
on a percentage of hotel revenues and incentive fees
that depend on the gross operating profit. Co nt ract s
that place more emphasis on performance-based
incentive fees offer a de gr ee of confidence t o owne r s
and sit comfortably with experienced operators.
Management companies with a strong and exclusive
brand image, o en stipul at e licens i ng and royal ty fees
in addition to the management fee, pushing fixed fees
to as much as six percent of total revenue.
In addition to these fees, management companies look
to owners to contribute to group or head offi ce servi c es
such as sales and marketing, central reservations,
loyalty programmes and training. These charges are
apportioned to the hotel portfolio on a pro-rata basis,
however in reality it is difficul t for an ow
ne r to est i m
at e
the extent of these charges in any given year. These can
add as much as five pe rcent of tot al revenue to the fees
paid out to management companies. Perhaps there is an
argument for negotiating these on a fixed pe rcent age
basis, and in this way provide owners the comfort of
more predictable outgoings, but even if this is achieved,
it is likely that it would only be partially agreed to and
that some proportion of these charges will still be
calculated on a pro-rata basis.
Some operators are charging commitment fees or pre-
opening service charges, where a lump sum is levied on
signing the contract. They will argue that these fees are
required to ensure they are remunerated during the
pre-opening period, whereas owners will claim that
they alone bear all the financ i al risk for the pr oj ect .
Equity Participation
Although currently unusual in the Middle East,
elsewhere operators are equity participants in hotel
projects. Owners’ perception is that by investing in the
project, operators will be more motivated to perform,
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although some operators believe that equity
participation strengthens their right to manage the
property undisturbed.
Contract Terms
Initial contract terms vary from as li le as 10 years to
more than 75 with the option to renew for one or two
further periods which tend to be half the duration of
the initial period. Hotel operators favour longer
contract terms as this provides more safeguard for the
initial investment in taking on the property, a situation
that benefits the own er if the rel at ions hi p is sound and
the property is performing well. Some owners however
may push for shorter terms, especially if they are
looking to become more closely involved with the
running of their property.
Manchising
Where budget and mid-market hotels are concerned,
especially in markets that are strongly driven by
domestic demand, the lines between the owner and
operator role become blurred and the management
contract may well tend towards a franchise. The
“Manchise”, a hybrid between a management contract
and a franchise and increasingly used in places like
India, could be appropriate in the Middle East market
particularly with the imminent arrival of Sharia
compliant hotels, in which the traditional international
brands do not have any experience.
Owner’s Control
Owners will normally seek a measure of control over
the running of the property by ensuring their approval
is required for the annual operating plan and capital
expenditure for the hotel as well as the hiring and
removal of key managers such as the General Manager.
Certain management companies will not agree to any
level of control, claiming that their objectives for the
property and that of the owners coincide and that there
are already suffi cient safeguar ds (such as termin at i on
clauses) within the contract to protect the interests of
the owner.
Termination and Performance
Termination clauses are essential to ensure the owner
can seek an alternative operator in cases where the
 Hotels
property consistently fails to perform to an acceptable
standard. These normally set a minimum GOP as a
target and will allow a minimum of two years for that
to be maintained, although it is not unusual for the
operator to be given the option to make up the
differenc e for one or tw
o years (cur e opt ion) .

Owners will additionally push for a performance clause

whereby the operator is required to guarantee an
agreed level of profit or to m
a ke up the shor tfal l and/ or
stand aside their management fees. These clauses are
unusual in the Middle East, as operators successfully
argue that as they are not equity participants in the
venture, they should not be participating in the risk.
However, the intent of this clause may be
approximated by a suitably worded termination clause.

Territorial exclusivity

This can be a ‘deal breaker’ especially in cases where

the operator is being wooed by a number of owners
with sites that are close. An owner will naturally seek to
protect his investment from another identically
branded hotel competing for the same catchment area
by imposing a geographic exclusivity limit, although in
certain cases, such as high exclusive destination resorts,
the competitive region is much bigger and can include
properties in other countries.

Operators are, within reason, amenable to this although

they will argue that physical proximity offers
operational efficienci es, such as cl ust eri ng s al es and
marketing, revenue management, HR or purchasing
roles. Examples of this in Dubai are the Hilton
properties on the Creek and Jumeirah Beach (same
owners), the JW Marrio , Re nai ssanc e and Ma rri o
Executive Apartments (different own ers) a nd Hy a
(who provide common employee housing).

Like most things in life, management contracts that

prove successful are the ones where both parties walk
away from the negotiating table with something. Win-
Win is the order of the day, especially when entering
the operational phase and the both owners and
operators face the challenges of meeting and exceeding
their projected earning targets.

This article was presented at a workshop session moderated by Peter

Goddard at the Arabian Hotel Investment Conference, 2007.

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