Hotel Lease Agreements, Franchises and Management Contracts: Which Model Is Right for Your Hotel?

In recent years, the hotel industry has seen a proliferation of brands and different models for managing and/or operating a hotel. Hotel brands, owner companies and hotel operators have created hybrid models and combinations of operating models that, when used appropriately, can (or may not) improve profitability, make a project more attractive to investors and add value for guests. With this in mind, the question owners should ask themselves is: This article aims to provide a brief overview and comparison of leases, franchises and management agreements.

The Rental and Lease Agreement

A lease agreement is defined as a contract under which one party transfers its asset, facilities, services, etc. to another for a specified period of time, generally in exchange for periodic payments. A lease agreement involves a lessor and a lessee, the latter of whom may choose to operate the hotel directly or outsource operations through management agreements and/or franchises. Under pressure from investors to adopt asset-light balance sheets, major hotel companies have moved away from ownership and leases, as fixed lease payments are shown as a liability on their balance sheets.

The Management Agreement 

Under a Management Agreement, an operator will take over the operations of a property in exchange for a fee. The owner will assume all risks (including employment contracts), while the operator will handle all management matters. While hotel owners and operators can provide significant value to one another, their goals and priorities may not always be aligned and can sometimes conflict due to the nature and interests of each party, which generally do not coincide. Given this, and the generally long-term and binding nature of a management agreement, careful and expert negotiation is advisable to ensure mutual benefits.

The Hotel Franchise

Under a franchise agreement, a franchisee has the right to use a franchisor’s brand, distribution channels and know-how. The owner retains all the risks and responsibilities of the business but, unlike under a management agreement, also retains control of the property. A franchisee may choose to operate the asset directly or appoint a third-party operator to run the property on its behalf. Although not always necessary, using a third-party operator can bring valuable expertise, flexibility and strong cost control to brand distribution systems. As with management agreements, the differing objectives of the parties involved require a franchise agreement to be properly structured to meet the requirements of the owner, the brand and, where applicable, an operator.

Main Advantages of Outsourcing Management to a Third Party

• Seamless standard operating procedures that ensure optimised results.
• It can free you from staffing—the main headache for many—and from human resources management, one of the most critical aspects of hotel management.
• Greater property visibility thanks to a well-defined marketing strategy.
• A disciplined approach to costs. They will spend what is necessary regardless of revenue levels because they know that building brand loyalty takes time.

Main Disadvantages of Outsourcing Management to a Third Party

• Some management agreements, and all lease agreements, are so tightly drafted that they may even prevent you from entering the property to carry out any inspection.
• From that point onwards, you will have little or no control over any operational area of the hotel, let alone its positioning, marketing, pricing and customer mix.
• As an entrepreneur, if you want to get involved in operational or marketing matters, you would be better off putting that idea out of your mind.
• You will be paid rent or a percentage of gross sales/net profit. But we all know the accounting manoeuvres that can be made in profit and loss accounts to bring net profit close to freezing point—i.e., zero—or to create fictitious highs, as convenient.
• There may also be an initial deposit that you will forfeit should you decide to terminate the agreement before the stipulated term.

The main models offer a range of options for both owners and operators. Each comes with its own set of advantages and disadvantages, making it more or less suitable depending on the owner’s requirements and priorities. A lease agreement provides a predictable cash flow for the owner, but removes the owner from participating in operations. Management agreements allow owners to enter the hotel sector when they have limited management experience and to enjoy profits when business is good, but at the cost of assuming greater operational and market risk. Franchises give the owner the right to operate the hotel under a brand and access the franchisor’s marketing and distribution systems in exchange for royalty payments; however, they must also have significant management experience or engage an operator.