Hotels: Is your hotel management firm protecting your best interests?

For the past several years, investors in hotels have enjoyed a bull market due to a supply-demand imbalance caused by the 2008 financial crisis on one hand and upswing in tourism and business travel on the other. But with that gap narrowing and 200,000 new rooms slated to come online in the next 18 months, those days are coming to a close. In fact, nearly half of metropolitan markets in the United States are already experiencing negative occupancy growth. And while the topline is battling downward pressure, increased labor costs contribute to tighter margins. ‘

Not surprisingly, real estate transactions involving hotel properties have ground to a halt in many areas. Nonetheless, valuations are expected to remain stable through 2019 with cap rates holding steady. For the private equity investor interested in the sector but who has been waiting for things to cool down, it may well appear that we are at the top of the market and thus time to consider a move. (It’s interesting to note that as it was closing its acquisition of FelCor, RLJ received several unsolicited bids from a private equity firm.) The tightening of traditional bank lending simply reinforces the opportunity for an alternative source of capital.

For private equity firms already in the market, it’s important to re-examine your relationship with your management company in light of current conditions. Existing management contracts were signed when times were good. Even if the incentive clauses were non-trivial, they could be met when RevPAR was steadily rising. Now that this is no longer the case, how will your management company respond? Broadly speaking, there are two possibilities: The first is that they will focus on operations: staffing and maintaining the property while controlling costs. This is basic blocking and tackling, and it can be enough during flush times. 

But in the current environment, private equity investors will be better served by a management company that acts not as operators but as asset managers, building a strategy that is based on the investment thesis and the management company’s deep understanding of the local market. The management company then uses these insights to install a sales and marketing team that is closely aligned with the rhythms of the surrounding city and a human resources staff that excels in employee training and retention. 

In short, the interests of the management company and the private equity firm need to be aligned. Crucially, this cannot be assumed. As it becomes tougher to meet the incentives and the base fee of 2.5 percent or 3.5 percent may be all that can be expected, some management companies may choose to take an operations-centered approach with a leaner staff while trying to scale their portfolio so that the base fee represents a healthy profit. So it is that interests aligned during a rising tide can fall into misalignment. The current market calls for extra care in maintaining this balance.


For more information, please contact Greg Remeikis, Partner, Commercial Real Estate Industry Practice, or 410-783-7422.

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