Hotel management: the rules have changed, and it's a whole new ballgame

A changing hotel business has forced management companies to follow suit by carving out new roles for themselves beyond their traditional duties. As owners are looking for better results and lower fees, management companies are finding new ways to stay alive.

If it's Tuesday, it must be Belgium for Clement J. Barter, senior vice president of Conrad International Hotels, the rapidly growing division of Hilton Hotels Corp. The well-respected hotelier travels every few days to identify properties the Beverly Hills-based company could manage, or maybe even contribute equity to, as Conrad seeks to add two dozen new properties to its portfolio by the end of the century.

The Ireland native visited London, Istanbul, Amsterdam, Egypt and Barcelona for Conrad last week. He takes off for three more cities this week. "You have to go where the opportunities are," says Barter, who is also managing director of the Conrad International Brussels, considered the city's premier hotel. "You have to be relatively quick these days. If you're not, your competition will get there before you do."

Conrad International has identified key markets in Europe, the Far East and Africa and has created a rapid response team to go after the business. "We've made a list of where we want to be and have updated it, but we're flexible," Barter says. "Because of the intense competition, some companies are willing to sacrifice standards to get a contract in a city they want to be in. We won't lower our standards." Barter and Conrad are not alone. Across the country and throughout the world, hotel management firms are on the prowl for new opportunities.

A changing business

Aggressively pursuing new business while holding on to current clients, companies are discovering that the hotel business has changed and are adapting accordingly. Today's hotel owners are demanding better bottom line results and reduced fees. Management companies are seeking stability and a bigger share of the pie. Hotel landlords continue to put the squeeze on management companies, with some forming close relationships with certain managing entities. At the same time, the management industry itself is consolidating, while increasing numbers of properties are adapting to the current economic times.

"I think the hotel management business has experienced a large increase in the number providing management services," says John A. Lambert, senior vice president of operations at Englewood, Colo.-based Richfield Hospitality Services Inc. "It's an easy business to get into really."

However, Lambert says, the reason for the consolidation of the management industry stems from the fact that as clients are becoming more sophisticated, they expect more out of their management providers. And that's good news for large companies like Richfield. "The exciting thing is that it is becoming more sophisticated forcing organizations such as ourselves to become more specialized."

For some used to a magic carpet ride, it's a whole new world. "I think pure fee management contracts by now are pretty much dead, replaced by joint ventures and equity contributions, along with other types of alliances," says J. William Sharman Jr., president of the Lancaster Group, a hospitality firm that operates hotels in Los Angeles; Washington, D. C.; Chicago; Houston; and Great Neck, Long Island. "Institutional owners know they can require management companies -- particularly the bigger, more capitalized ones -- to actually make contributions to a property, whether it is equity, a loan, an investment in a joint venture or a contribution of furniture, fixtures and equipment."

Sharman adds that it's even possible down the road that the concept of hotel management could change further. "We may even see more of the triple net lease situation, where a hotel management company becomes the lessee and bears the risk of generating income for lease payments, which are guaranteed to owners," Sharman says.

Ken Mason, president of Alexandria, Va.-based Mason Hospitality, agrees the industry is not like it was five years ago -- the difference being that many owners now look at a management fee as an expense instead of an investment.

"I think the reason is that for a lot of years, in the heyday of management contracts, people just sat back collecting fees," he says. "They weren't really involved in the management of the hotel. They had long-term contracts; they were protected; they didn't have to produce. So they just hired a manager and put them in place and sat back and collected fees."

Mason recently talked to a general manager who was bemoaning the fact that the management company he previously worked for hired him, put him on location and then became almost invisible. The only time he saw or heard from the management company executives was when they had a meeting with owners.

"They gave him no back-up support in sales and marketing and no other assistance in helping him manage the property," says Mason. "When the owner became unhappy with the property's progress, the management contract company let the GM go so they could keep the management contract."

In these competitive times, that's the wrong approach, Mason says. Most of the properties Mason Hospitality is currently associated with have been with the company for some five years, he says, and each of the properties have shown significant growth each year in ADR, occupancy and profit. "We manage for a group of owners willing to reinvest in the hotels and make our job somewhat easier," he continues. "The key today is for the management company to be involved on a day-to-day basis, and I think in our instance, we're doing that successfully. We manage hotels instead of just monitoring the activity of the on-site general manager."

Niche markets find strengths

There is no substitute for hands on experience, says Jack Giacomini, chairman and CEO of Santa Fe Management in Carlsbad, Calif., and no replacement for bottom line results. "We're highly incentive-ized, we only make money when the owner is making money," he says. "We've developed a niche market. Santa Fe works for passive investors who require a good amount of involvement. The secret of our success is that we limit ourselves to only 16 properties. We want to be small. If an asset manager wants to pick up the phone and ask a question of a large management company, he may have to talk to the GM who has to go to the regional manager who contracts the vice president of the division and then maybe to the president of company; it could be a week or longer. At Santa Fe, our owners talk directly to me."

Santa Fe Management is extremely busy nowadays, Giacomini says, with a number of projects in the pipeline like hotels throughout inter-mountain and West Coast areas. "We try to channel the hotels we identify as good acquisitions and management contracts to our parent company or to our investor clients for consideration as an acquisition candidate," he says.

"Typically, what we're looking at is 12 to 24 months turnaround. We would take over the property via management or client acquisition and spend six to 12 months performing deferred maintenance, initiating the marketing and management acquisition, then creating a turnaround," Giacomini says. "Typically, it takes 12 to 18 months for a hotel to improve in value for new owners and produce a return on investment."

In the West, Giacomini says, prices for hotels are remaining stable and are beginning to increase as occupancies and daily rates rise. "In the inter-mountain areas where we do business, we're seeing a lot of renovations going on at older hotels where they are correcting a lot of deferred maintenance," he says. "Older hotels are being sold, but not at fire sale prices."

Down the road, Giacomini feels there are some serious decisions for management companies. "I see big management companies going toward equity, becoming owner-operators and keeping the management contracts.

"Our philosophy is we are not owner-operators, but third parties. We eliminate any conflict of interest on a client property. I think there will be room for a regional management company such as ours, which manages only a limited number of properties and spends time and resources on those properties as a fiduciary manager, working those properties as an actual owner would."

Incentive fees gain importance

Kirby D. Payne, CHA, who is president of American Hospitality Management Co. in Minneapolis and chairman of the International Council of Hotel-Motel Management Cos., points out that incentive fees are becoming more important and are more closely tied to exceeding the owner's anticipated return.

"We have a deal where the investors were promised a 12% cash on cash return every year, not counting appreciation of the hotel," Payne says.

"We don't get our incentive fee until investors get their 12%. You're going to see more of that because one, the competition, and two, investors and owners are going to demand it. There are a lot less management companies today than there were two to three years ago. Some of the big management companies are smaller."

Over the past several years, management contracts have changed dramatically, particularly in the area of performance-based compensation, says Karen Johnson, a vice president in the Los Angeles office of PKF Consulting. "Even the payout of historically fixed `base' fees is now being linked to the achievement of minimum performance levels," she says. "A portion of the base fee is now driven by one of three factors: a certain value of net income, dollar improvement of specified revenue or expense line items or the attainment of an agreed-upon net operating income percentage."

According to a study by PKF Consulting, variable "incentive fees" are usually subordinated to a specified amount of debt service, as well as to the owner's preferred return. Generally, base fees and corporate office charges are lower for independent management companies than for the chain management/franchisors. When faced with the prospect of paying both a franchise fee and management fee, owners find that the combined fees of a total manager/franchisor package to be more economical, she adds.

Business becomes more competitive

Because of their willingness to manage hotels in REO portfolios and those pending sale, independent companies predominate in short-term contracts, charging a premium to take on properties in this predicament unless their contract is with an established client.

Johnson believes there will be a continuation of such trends as performance-driven base fees, the reduction or elimination of corporate office charges and relatively short terms for management contracts.

For such reasons, the hotel management business is becoming much more competitive than it's ever been, says Morris Lasky, CEO of Lodging Unlimited in West Chester, Pa., who has been in the business 41 years and has had over 250 management contracts. New hotel owners are more in the way of owner/operators, he continues, with the number of contracts available to independent management companies becoming more limited.

In the 1980s, when the hospitality business began to experience problems, Lasky says many of the people who were fired on the executive level began to operate management companies from their homes. "You had a guy in his basement with his wife as his secretary who could charge a 1% or 2% management fee, while the guys with a support staff had to get 4%, 5% or 6%," he says. "During that time the industry went from 400 or 500 management companies to 1,700. But the pie began shrinking. Now you have a lot of owner/operators, who purchase a hotel with the intention of operating themselves. The supply of potential clients is getting smaller. Competition is becoming so fierce, management contracts are becoming less and less profitable."

For independent management companies, there are fewer contracts available for a smaller amount of money. "We've survived because we diversified," he says. "We started doing consulting, turning around sick properties and conducting audits."

Still Lasky predicts that in three or four years, a number of today's hotel deals are "going to waffle." "There'll be a lot of weakness in certain markets and we'll see some areas soften," he says. "Just look at Orlando. Every hotel inside Disney World is profitable but, outside the gates, that's different story. The same for Atlanta. Once the Olympics are over, I think you'll see lots of problems -- and lots of opportunities for management companies such as ours."

A number of hotel firms have become more aggressive in the past few years.

C. A. Anderson, vice president/development for Red Lion Hotels Inc. on Vancouver, Wash., says his company is enhancing its relationships with current owners as well as eyeing joint ventures and limited liability partnerships to assist Red Lion's growth.

"We're putting in on the equity side, as well as providing our expertise," he continues. "In the old days, you went out and got a pure management contract, but we haven't found a lot of those. So we go shoulder to shoulder with owners, risking our capital."

Red Lion is pursuing growth in a number of ways, he says, including management agreements, in the form of joint ventures, future opportunities in franchising and even leasing some assets from insurance and pension fund investors. A recent joint venture undertaken by Red Lion involved the former Sheraton in Spokane, now the Red Lion City Center. The partnership that had the asset was in need of additional capital; the hotel continued to lose market share.

"We offered to underwrite the current loan, recapitalize the joint venture and bring an additional $7 million in renovation capital," Anderson says.

"In exchange, we received a 25% equity position with an option to buy an additional 30%, and we received long-term management for the hotel and another flag. Already the hotel is beating its plan, half-way through renovation."

Red Lion has a number of similar types of joint ventures, he adds, and the company feels very aggressive about its management abilities so it is willing to contribute capital. "Owners are more sophisticated now than in the early 1980s, and they are expecting significant returns," Anderson says. "They want other capital at risk, and more and more major (management) companies, will do that. We're going to see more consolidation of management companies, and we're going to see more management companies become equity players."

Hotel sales rebound

Currently, one of the closely watched sectors in the hospitality industry is hotel sales. William J. Hoffman, president of Trigild Corp. in Del Mar, Calif., notes that the hotel business in the Golden State, which was so distressed for the last few years, is rebounding nicely. Sales prices are moving up very quickly, attributable not only to a feeding frenzy for bargains, but also to a tremendous interest in buyers looking for hotels in California. Thanks to an upswing in visitors and business opportunities in California, occupancy and earnings are improving too.

"Our office gets many calls every day from people who say, `We have cash, we're anxious to buy hotels, do you know of any that are available'," Hoffman says. "What we get is a sense that some people are afraid they are getting left out. Hotels have been a bargain for the last few years, but some investors were frightened off until now. But now the bargains are running out. There are fewer hotels with a large discount to replacement costs."

A few years ago, investors were buying hotels at $0.20 to $0.30 on the dollar in California, but then there were not as many buyers willing to gamble. "Today, you can get hotels for $0.75 and $0.80 on the dollar but there is competition for those properties," he says.

Trigild took over a property from the RTC a number of years ago, Hoffman notes. It was on the market three years before it was sold and the sales price declined steadily. In contrast, Hoffman continues, Trigild was given a five hotel portfolio for a lender last fall. Those properties sold in short order at a price 30% above that the owners thought they would receive six months ago.

Owners are still changing flags, with management companies like Trigild being sought out to manage more properties. The difference from five years ago is that management is for a shorter period, with terms usually more attractive to the owner. "Fees tend to be lower, and there is more demand," Hoffman says. "Smaller management companies have disappeared, as profit margins have narrowed."

Industry remains strong

Continuing to whet the appetite of management companies is the continued strength of the hotel industry -- nationally and internationally. Craig Schafer, president of Colliers International Hotel Realty, a hotel brokerage company in Seattle, adds there is still a great deal of investor demand for hotels, particularly for full-service products that can be purchased for less than replacement value. But there are less of those assets on market as the supply and demand scenario continues to shift.

"It's a seller's market, although there is still a significant number of assets expected to trade over the next few years, particularly from the Japanese owners," Schafer says. "There have been a number of properties in the pipeline. It depends on the market region. There are many regions where we're starting to see a peaking of occupancy and, therefore, fewer assets available. We're starting to see a cycle of new supply that will, in turn, loosen up a number of assets that are not distressed, because owners think it's a good time to take their profits."

Basically, buyers today continue to be opportunity funds as well as REITs and hotel management companies that have aligned themselves with capital sources. "You're talking Capstar and Equistar as well as Interstate with Blackstone, HEI with Prudential -- a core group of about 10 hotel management companies that are either going public, are public or who have aligned themselves with capital sources to acquire properties."

Yet the sales may slow in the future, particularly where the costs of acquisition effectively gets closer to replacement costs. Such a scenario will eventually result in a new supply of rooms. An imbalance could be created, Schafer says, but that will depend on how much new construction occurs.

"It's going to take time for new construction to impact the marketplace, so we don't see a distressed period until 2000 or beyond," Schafer says. "As far as management companies, we're in for more consolidation. There will be a strengthening of the fee base as there are fewer management companies and the market firms up. The pendulum has swung in favor of the owner, and it's still in favor of the owner, but we see that position softening a bit, with more of an equilibrium. The management companies who have survived over the past two to three years and produced results will thrive."

Craig R. Mueller, senior manager at the Atlanta office of Deloitte & Touche, says there's still a lot of buyers and a good number of sellers in the hotel marketplace, but the business has become more competitive. "A good chunk of buyers are bringing in their own management teams," he says.

"It's become more competitive," Mueller says. "All the bank and government related workouts are pretty much gone. Insurance companies have unloaded their hotels and are starting to lend as well. Values are coming up, and profitability has improved as the markets have improved, but competitiveness is driving caps down a little and pushing values up."

Says Kirby Payne of American Hospitality Management. "I think the wise investors are laughing when people are trying to say you can still buy hotels for less than replacement cost. That may be true, but with some of those hotels, would you have replaced it in the first place?"

And with all the strength that the hotel industry is experiencing right now, Richfield's Lambert says that cannot take away from the importance of good management. "Strength (of the hotel business) won't hurt the management business -- it's emphasizing the importance of it."

Industry turns to new construction

Still acquisitions are out there, Payne says, and he sees some management companies doing them on their own, particularly with joint ventures. "You're going to see management companies doing more construction with more institutional investors loaning money, so the next step is investing," he says.

Paul Novak, president and CEO of Dallas-based Bedrock Partners, adds that hotel management companies are still being affected by the real estate whirlwind.

"There's just so much capital chasing those few hotels that are available," he says. "That tends to drive prices up, and you spend a lot of time working pretty hard and don't have real good odds to secure the deal."

Novak agrees that new construction is occurring, primarily in the limited-service sector as well as a new niche, the extended-stay product. The limited-service area has received a lot of attention, Novak says, but there is a some concern in the industry that the niche is headed for a significant overbuilding in the next 12 to 24 months. The other area of development that has created tremendous interest in the last six months is the budget or moderate priced extended-stay products. "Studio Plus and Homestead Village have had that market to themselves until recently, but there's been an incredible jump into that segment," Novak says. "In my over 25 years in this industry, I've never seen so many products announced within such a short period of time. We're talking about building 200 or 300 properties. If anywhere near the numbers of extended-stay properties get built that are being discussed and proposed, the sector could have a problem. It's hard to imagine the writing isn't on the wall."

Management companies should have some favorable opportunities with all this new construction, says Novak, but the unknown factor is who the developers of the new products will be. "If it's investors and they don't have operating expertise, it should be a terrific opportunity for hotel management companies," he says. "If it's developers who are operators, it won't be that lucrative. There could be a whole lot of hotels to manage in maybe another six to eight months."

Not content to wait around for possible hotel industry growth has been Rolling Meadows, Ill.-based Hostmark Management Group, which is embarking on its own expansion plans. "We've been trying and working very hard to continue to add new product to our portfolio," says company president and COO Robert J. Cataldo. "We're working on some new Wingates, which is a cross between a Hampton and a Courtyard, and we're also looking at doing a couple of conversions -- retrofitting older properties, changing them, adding a new flag and bringing them back."

Cataldo, whose firm has been in the hotel management business for 25 years and currently manages or has equity interests in 41 properties, adds that there are quite a few opportunities for new development as well as for turning properties around. "It's just a matter of being able to team up with the right project," he says. "As the market gets tighter, it's going to require an investment or possible purchase of property so you can have continued growth."

Hostmark is renovating the Oxford in down-town Chicago and will build a new, all-suite property in Atlantic City. "Basically, the Oxford is an older property, and we're going to close it down and do a total gutting, then bring in a national flag," Cataldo says. "The market in the area is very strong, and we believe it's only going to get stronger."

Hostmark has signed up for a Wingate franchise in Champagne, Ill., Cataldo says, and is working on a project in the Chicago O'Hare area as well as one in Las Vegas.

"We're just in the embryonic stage of doing something internationally, and we've had contact with Middle East as well as Pacific Rim companies who we might joint venture with," he says. "One company doesn't feel they have the expertise to expand and wants to get an American firm in there. We'd be doing new construction in the Pacific Rim. And we'd be growing."

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