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Redifining the owner/operator relationship: Hotel Management

When The Lancaster Group, a Houston-based management company with properties in Los Angeles and New York, was offered a chance to manage a 115-room luxury property in Alabama, it did something few, if any, other management firms would have even considered. The Lancaster Group declined the job.

"It was a terrific property -- a luxury hotel similar to the ones we manage, and it was an attractive deal," explains noted hotelier J. William Sharman, Jr., Lancaster Group president. "But it didn't fit in with our corporate philosophy, and we knew it. We didn't want to take the assignment, not be able to do a great job and leave a few years later. Life is too short. True, we would have received management fees for those years, but it could have been at the expense of our excellent reputation."

A hotel management company turning down a chance to manage a luxury hotel? Welcome to the hospitality world of the 1990s. The free-spending days of the "Me" decade have given way to the cost-conscious 1990s. Forget mints on the pillows or plush terry cloth robes in the marble bathrooms. Today, hotel owners want results from management companies, not just ambiance.

"Investors in our industry are no longer satisfied with long-term capital appreciation and psychic income that heretofore were often the justification for otherwise seemingly uneconomic investments in hotel property, or indeed, hotel chains," explains Roger S. Cline, worldwide director, Hospitality Consulting Services for Arthur Andersen. "The first reality is that there is a very specific and identifiable relationship between the bottom line performance and value. Improvements in business operations raise values. It is not surprising, therefore, that new owners attracted to this industry in recent years have new sets of demands."

Accordingly, the days of unbreakable, "I'll get my percentage fee even if the hotel is losing millions," 20-year management contracts have gone the way of the nickel newspaper. The industry has been transformed from an old guard group of investors and owners to income-and-return driven newcomers. No longer are management companies in the catbird seat; no longer are contracts secure for years on end.

The problems the hotel industry faced in previous years has helped lead to this new style of ownership and management, according to Jerry Earnest of Lexington Mortgage Company.

"The numerous problems affecting the hotel industry as a result of excesses and poor practices from the late 1980s have resulted in a significantly more competitive hotel industry today. While occupancy levels and rates have recovered in many hotel markets during the past few years, relentless pressure on operating costs remains a fixture of the hotel industry."

As Singer Bob Dylan has wailed, the times are a-changing. "Owners have become more active," explains Philip M. Barnes, general manager of the Auckland Regent, the leading hotel in New Zealand. "Only a few years ago, owners were passive. Many merely approved the annual budget, made a few suggestions once in a while and that was about it. But now owners are becoming involved in all areas of hotel operations from the selection of general managers to the direction of direct mail marketing. For management companies who are on the cutting edge like Regent, it's no problem. For complacent management firms, it can be a nightmare."

Spearheading this new wave is the fact that hotel owners now feel that the boom years of hotel expansion only served the interests of management companies, with profitable deals, long-term contracts and strong termination clauses. From the perspective of hotel owners, management contracts negotiated in the 1980s became increasingly burdensome as the industry faltered because the pacts generally provided for base fees that were unsubordinated. While a property owner might be unable to pay off the property's debt, management fees stood in first position, regardless of the property's financial performance. In short: owners became disillusioned as management companies raked in the fees and they lost a fortune.

"Years ago, management got long-term, non-cancelable, full-fee contracts," says Peter Krause, managing director at Morgan Stanley Realty Inc. in New York. "With the downturn, owners saw managers getting fees for running hotels, with no money flowing to owners. They finally woke up and sought changes."

Craig Hunt, senior vice president/worldwide franchising for Atlanta-based Holiday Inn, says management contracts are now shorter in duration. "In fact, many require short notice periods for termination, also based on performance," he continues. "I believe the future also holds that managers will be required to put forth more performance guarantees or contribute to equity."

Shorter contracts are the result of a different kind of hotel owner emerging in the 1990s, says Timothy Aho, sr. vice president of development at Prime Hospitality Corp. "Earlier, hotel managers actively solicited owners for management contracts. The owners were institutions which did not necessarily mean to own the hotels. These accidental owners became much more sophisticated, often employing asset managers to guide them through the manager selection process," Aho says. "As a result, contract terms swung in favor of ownership, that is, fee percentages were greatly reduced, terms shortened and ownership involvement increased."

As the industry continues to stabilize from the recent downturn, relationships between managers and owners continue to be in flux with new patterns of ownership, finance and management emerging. Today's hotel owners are seeking contracts in which incentive fees based on profitability make up a higher proportion of total tariff paid. This, in effect, pushes the fee down the income statement, more directly tying funds paid to the management company to the property's financial performance.

"The classic 5% of gross management fee has disappeared," contends Morris E. Lasky, CEO of Lodging Unlimited Inc., a firm specializing in nursing ailing hotels back to financial health. "Fees are now basically a smaller percentage of the gross and a larger percentage of profit or improved profit. Today management fees, depending on the size, can be 2% to 4% but they may run as much as 10% to 12% of net operating profit before debt service."

Both owners and managers are looking at the equation quite differently nowadays, reports Bob McKinley, vice president of sales and marketing for hotel development at Pittsburgh-based Interstate Hotels Corp. Instead of merely managing a property, he adds, they are seeking something more. "Owners are looking for two things -- profitability and asset appreciation. They want to make money, and they want their asset to increase in value."

For this reason, notes McKinley, the days of ego-driven operators who load their properties with services and facilities that make guests happy but the owners poorer are numbered. "You can have a four-star level hotel that is spending tens of dollars a month on exotic flowers, and that's nice for guests, but it doesn't have a lot to do with increasing revenue," he explains. "Owners today want well-run properties, with good service and facilities, headed by management companies who look for ways of reducing costs without guests noticing."

Ken Mason of Mason Hospitality Services, Inc. points out the importance of maintaining quality service. "Although the industry does appear to be more costconscious, there is a certain realization by better operators and managers that the guests of the 90s are seeking overall value for their travel expenditures," Mason says. "Those who deliver consistent quality services, modern well-appointed and clean accomodations will continue to excel over those who try to improve the bottom line by reducing services or amenities that affect guest satisfaction."

Thus management companies must now be innovative and aggressive, open to suggestions and able to offer creative solutions to pressing problems. The bottom line has become the yardstick they are judged by, not kudos in travel magazines.

"First and foremost is operating performance of the management company to create performance of the property," emphasizes Dana Michael Ciraldo, senior vice president of Hospitality Valuation Services of Mineola, N. Y. "Historically we haven't seen performance clauses that establish hurdles managers must clear, but we are seeing them now. Sometimes, certain specific competitor hotels are identified, and the owner requires the management company to maintain a revenue par that's close to that. If the hotel across the street is running at $70 ADR, your owners could say the property needs to run within 5% of that."

But John Todia of Winegardner and Hammons points out that there is a distict difference between the small independent companies, that only run a few hotels, and the large management companies and franchise organizations. Hotels are becoming more cost conscious, but the changes are coming mainly from large management companies.

"I believe the independent owner and operator have been cost conscious for years. We have nothing else to sell but our abilities and our response to the needs of the owner."

Owners want management companies that look for different ways of achieving objectives. Wyndham Hotels & Resorts reported its best year ever in 1994, adding 19 properties to its portfolio last year. It accomplished this feat by working closely with owners to achieve mutual objectives, according to Jack van Hartesvelt, corporate vice president/development.

For one hostelry, Wyndham put its money where its mouth was and bet on its future performance. The hotel owner needed to refinance, but there was a multi-million-dollar shortfall between the current debt and the value of the property. "The reason he couldn't refinance was because of the performance of the hotel, and we felt that performance could be improved," says van Hartesvelt. "We lent the owner the difference. It was a mezzanine debt piece -- a second mortgage. We took over the hotel and increased cashflow. As a result, the owner was able to refinance the project and took our mezzanine out. It was good for the owner, because he could refinance, and it was good for us because we showed them what we could do."

Management companies can be inventive in other areas too. Tony DiRico, senior vice president at Manorcare Hotels, the hotel ownership and operating arm of Manorcare Inc. that includes Choice Hotels International, is experimenting with new concepts in food and beverage service. "For instance, the Clarion Hotel in Mobile, Alabama was converted to a new K-Minus concept," DiRico, explains. "Food is purchased fully prepared from a central commissary and is kept refrigerated until just prior to serving. The result: one employee is needed in the kitchen to prepare food for hundreds and production costs are reduced to 2% or 3% of sales."

L. W. "Biff" Hawkey Jr., senior vice president of development for the Hostmark Management Group, says a lot of hotel industry changes result from new technology "Not only are we as management companies having to produce results better, faster and cheaper, but we need to have systems which are prospective rather than historic," Hawkey says.

With such innovations by others, it's no wonder a number of stodgy management companies are feeling the heat. Contracts, rather than physical buildings, represent a management company's primary assets; if they can be easily terminated or easily renegotiated, the company's strength and credit worthiness may be at risk.

"What's happened is that a few years ago, when the industry went into the slump, we went from 350 management companies to 1,700," explains Lasky of Lodging Unlimited Inc. "You had every manager who lost his job, creating a management company, working out of his basement, using his wife as secretary, competing for contracts."

Now the weeding out process has begun. Greg Hanis, president of Hospitality Marketers Inc. (HMI) of Milwaukee, Wisconsin, points out that consolidation is occurring in the industry; some of the larger companies are starting to eat up the smaller ones. "I think the industry is heading back to a more professional stature," says Hanis. "An industry that could support 250 management companies suddenly had more than 1,000. We're starting to see ones that have weathered the storm and have proven track records."

In this environment, reports Tom Mc-Connell of Arthur Andersen, the most sensitive issues of management companies revolve around trends toward reduced fees for services -- the weakening of termination clauses in favor of owners and shorter contract terms. "Reduction of fees has aroused further concern among management companies that the resulting 'squeeze' can threaten their ability to provide quality services," he adds.

Analysts say the real problem with many management companies today is complacency. Aggressive companies are snapping up management contracts and shaking up the industry. Wyndham was recently hired to manage a hotel that had been another brand for decades.

"The management company was unwilling to respond to the needs of the owners; they didn't think up ways to cut costs," explains Wyndham's Hartesvelt, who declines to name the property. "When the owners came up with ways of increasing revenues, like taking airline crews, the management company refused because it would lower the rate even though it would increase revenue. From the owners' viewpoint, if you have empty rooms, $50 for a room is better than nothing. But from a management company's view, when you average it in, it reduces the average daily room rate. The management company thought it would be injurious to it. The management company was going after its selfish interests to the detriment of the owners."

With shorter management contracts the norm and increasingly bottom-line fees the rule, many hotel companies such as The Lancaster Group are becoming extremely picky in what properties they seek to manage. "Nowadays, some management companies agree to manage a property for a year -- and that oftentimes can be detrimental to both the owner and the operator," explains Sharman. "We don't sign a management contract simply to generate fees. We do it when it fits with our strategic objectives."

Probably the best advice owners and management companies could follow for the future is increased communication -- from the beginning of the process to the end. Brian Murcott, vice president, membership development and quality assurance for Phoenix-based Best Western International Inc., notes that hotel owners can avoid pitfalls in first selecting a hotel management company by doing their homework before signing on the dotted line.

"The owner should fully understand the fine points of the contract and get any questions answered in writing -- for example, how to handle expenses that go beyond the direct operations of the hotel," Murcott explains. "Some management companies tend to send regional accounting or regional operations people to visit a property and then charge the hotel for expenses. The owner needs to know if the senior vice president is going to come and stay a week if he's agreed to pay for that."

At the same time, owners must recognize the management company is only as good as the manager of the property. "If the guy isn't working out, what provisions are there for change?" asks Murcott.

Even so, once the management contract has been signed and a new team is installed, management companies can no longer sit back and collect their percentages. Hard work is still required; it's best to nip any problems in the bud. "The trick is bond with the owner," continues Barnes of the Auckland Regent. "We're in a service business. It is really their hotel, so we listen carefully to them. Owners are smart, if they weren't, they wouldn't have been able to form capital to put the deal together."

Agrees McKinley of Interstate Hotels Corp.: "The best thing for a manager to do is to stay tuned to the owner's objective. The management company that listens to its ownership and reacts will be more successful. Management companies that don't listen to owners will turn over properties very frequently."

Hans Willimann, general manager of the Four Seasons Hotel Chicago, may have one of the toughest management jobs around. He must maintain his hotel's No. 1 ranking in the nation's third-largest city despite a slow-down in the economy and a plethora of new properties. If that weren't enough, Willimann is constantly on the hot seat -- literally. Three of the hotel's owners live at the Miracle Mile property.

Yet the Swiss-born hotelier is unfazed. "We're constantly searching for new ways to make the Four Seasons Hotel Chicago even more efficient without sacrificing any of the luxuries Four Seasons is known for," says Willimann, who managed properties in Houston and Boston before opening the 343-room Michigan Avenue property six years ago. "The key is communication and innovation."

Willimann, who prides himself on the Four Seasons Chicago putting the "WOW!" back into hotel stays, doesn't get complacent even though the hotel has the highest average daily room rate in the city, $212 compared to $130 for competitors, and an 80% occupancy rate, according to Smith Travel Research.

"We're a luxury hotel. People pay for staying at the Four Seasons, but that doesn't mean we can afford to throw money around," he explains. "It's all reflected in the bottom line, and our owners review operations almost daily."

Willimann succeeds in the highly-competitive market through:

* Innovation. He began a program catering to children that includes totsized robes, milk and cookies at bedtime and popcorn served with family movies. "If you treat the chidren right, they'll bring their parents back and will come back later on their own."

* Cost cutting. Rather than settle on service from one gas company, the Four Seasons Chicago took bids from several. "We constantly seek to reduce costs that the guests don't see -- in the back of the house," says Willimann. "It works."

* Sensible staff reductions. When times were tough several years ago, Willimann elected not to fill executive positions in order to keep lower-salaried ones. "We had a situation of keeping five busboys or one executive -- and we went with the busboys," he explains. "We didn't lay anyone off, and our staff appreciated that."

* Communication. Several times a week, Willimann meets with JMB Realty representatives to discuss the hotel's operations. "The key is to keep owners informed and provide no surprises," he advises.

According to the first quarter 1995 results for the U.S. lodging industry, announced by Smith Travel Research, Hendersonville, Tenn., the hotel industry's occupancy and room supply rates have increased while demand has experienced a lower growth rate.

Industry occupancy reached 60.6%, an increase of 0.9 points versus first quarter 1994, while average room rate gained an impressive 4.9%, hitting $67.27. Revenue per available room, the combination of occupancy and average room rate and a key industry productivity measure, grew 6.5% to $40.77 in first quarter 1995.

Driven by economy hotel construction, industry room supply increased 1.3% in the first quarter of 1995, the largest rise since the 1.6% growth in first quarter 1992. Industry demand growth moderated to +2.9% in the 1995 first quarter, the lowest first quarter growth in four years. Aggressive first quarter room rate increases have helped surge industry room revenue to 7.9%.

Looking at regional performance, the Mountain U.S. census region ran the highest absolute first quarter 1995 occupancy at 65.6%, down 1.7 points versus prior period. Room supply in the region increased by 1.1%, and room demand fell by 1.5%.

First quarter 1995 average room rates in the Middle Atlantic region were the nation's highest at $82.30, growth of 7.8% versus same period 1994. First quarter supply and demand growth in the region were virtually even at about 1%.

"Slower industry demand growth along with increased room supply is not good news," said Randell A. Smith, CEO of Smith Travel Research. "We believe slower demand growth is a result of the cooling economy and strong prior year comparisons. All industry segments are aggressively pushing room rates."

Smith Travel Research provides regular industry reporting to all major U.S. chains, many independent hotels and a variety of management companies and owner groups. The company also tracks lodging industry performance in Canada and Mexico.

First Quarter 1995 Results






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