Top 10 Risks Hotel Owners Face When Hiring a Hotel Management Company
admin
Engaging a professional hotel management company can be a wise strategy to leverage operational expertise, benefit from brand recognition, and enhance market competitiveness. However, many owners are unaware of the significant risks these agreements can pose to the long-term value of their assets. Without careful negotiation, a hotel management contract can favor the operator's interest at the owner’s expense.
Here are ten key risks every hotel owner should understand and prepare for before signing a hotel management agreement.
1. Loss of Control Over Key Decisions
Most hotel management agreements grant the operator wide discretion over day-to-day and strategic decisions, covering staffing, pricing, vendor contracts, capital expenditures, marketing initiatives, and more. If the contract lacks specific owner approval rights, the owner may have little to no say in major operational or financial matters.
- Consequence: Decisions may be made that conflict with the owner’s investment goals or long-term strategy for the property, such as overstaffing, unnecessary renovations, or misaligned marketing campaigns.
- Mitigation: Owners must negotiate clear approval rights over operating budgets, senior staffing, capital plans, and marketing expenditures. The owner should also retain veto power over key hires and brand-standard waivers.
2. Misaligned Financial Incentives
Operators typically earn fees based on gross revenue rather than profitability. While driving top-line revenue is important, it can come at the cost of operating efficiency or prudent expense control.
- Consequence: The operator may prioritize occupancy over rate, over-invest in sales promotions, or ignore cost-saving opportunities, leaving the owner with low or no profit despite rising revenues.
- Mitigation: Tie incentive management fees to a combination of revenue and profit metrics such as GOP (Gross Operating Profit), NOI (Net Operating Income), or GOPPAR (Gross Operating Profit Per Available Room). Include budget-to-actual tests and establish owner approval over high-cost expenditures.
3. Underperformance with No Easy Exit
Hotel management agreements often run for 10, 20, or even 30 years, with limited exit provisions. Unless the contract includes enforceable performance clauses, an owner can be stuck with an underperforming manager with no practical way of making a change.
- Consequence: Operational mediocrity or mismanagement may persist indefinitely, diminishing asset value, frustrating investors, and dragging down returns.
- Mitigation: Include a dual-performance test (e.g., RevPAR Index and Budget-to-Actual GOP) with a short cure period. Most importantly, include a termination-without-cause option or a defined operator buyout clause that allows the owner to exit the agreement by paying a pre-agreed termination fee.
4. Hidden and Uncontrollable Costs
Operators often charge fees for centralized services, loyalty programs, marketing fund contributions, technology platforms, and preferred vendors. These fees are frequently opaque, poorly disclosed, and non-negotiable under standard contracts.
- Consequence: These extra costs can materially reduce profitability, particularly in soft market conditions, without a commensurate return on investment.
- Mitigation: Negotiate transparency and audit rights for all corporate charges. Push for opt-out clauses for loyalty programs or centralized services that don’t demonstrate ROI. Establish spending caps on system charges and consultant fees.
5. Damage to Asset Reputation and Market Position
Operators may fail to deliver a consistent guest experience, underinvest in maintenance, or make brand decisions that conflict with the local market. Additionally, misaligned brand positioning can reduce competitiveness and value.
- Consequence: Declining guest satisfaction, low online ratings, poor reputation, and reduced market share can directly impact revenue and resale value.
- Mitigation: Require regular capital improvement plans and enforce brand compliance standards. Include contract language allowing for operator replacement in cases of reputational damage, material guest satisfaction failure, or brand misalignment.
6. Conflicts of Interest Between the Operator and Owner
Large hotel companies often operate, franchise, own, and develop competing properties within the same market. They may prioritize their own branded hotels or owned assets over those they merely manage for others.
- Consequence: Your hotel may suffer from cannibalization, internal rate competition, or receive less attention and fewer resources than operator-owned properties.
- Mitigation: Negotiate area of protection clauses that prevent the operator from managing or branding directly competing properties in your market. Demand disclosure of all competitive properties under development or consideration.
7. Excessive Capital Expenditures Driven by Brand Standards
Many operators use brand-mandated property improvement plans (PIPs) to impose costly renovations, sometimes for brand marketing purposes rather than true ROI.
- Consequence: Owners may be required to spend millions on renovations with little benefit, impacting return on investment and tying up capital.
- Mitigation: Require owner approval of all capital projects and PIPs. Tie capital spending to a feasibility analysis or ROI projection. Defer non-essential brand upgrades and negotiate amortization over the remaining term of the agreement.
8. Lack of Transparency in Financial Reporting
Some operators limit access to detailed financial data, use internal systems that lack clarity, or avoid providing granular departmental breakdowns.
- Consequence: Without accurate and timely financial reporting, owners cannot properly evaluate performance, monitor cost controls, or identify inefficiencies.
- Mitigation: Include robust reporting requirements with monthly detailed P&L statements, cash flow forecasts, and variance analyses. Include audit rights and the ability to use an external asset manager to oversee operations.
9. Legal and Compliance Risks
Operators may expose the property to risk through improper labor practices, safety violations, or failure to comply with local laws. Because the operator acts as the owner’s agent, liability can flow back to the ownership entity.
- Consequence: Legal action, fines, reputational damage, and in some cases, loss of operating license or insurance coverage.
- Mitigation: Require annual legal and compliance audits. Ensure the operator maintains proper insurance, licensing, and training. Include indemnification provisions and specify that legal compliance is a material performance obligation.
10. Inflexibility During Sale or Refinancing
Hotel management agreements can complicate efforts to refinance or sell the hotel. Lenders or buyers may resist long-term management contracts that limit operational flexibility.
- Consequence: The hotel may lose potential buyers or face discounted valuations due to unattractive management terms.
- Mitigation: Include "sale trigger" clauses that allow for termination of the hotel management agreement upon sale, with or without a fee. Ensure the agreement is assignable and structured to support financing requirements.
