A growing number of hotel companies are shifting day-to-day management activities from hotel brand managers to third-party management companies.
Where third-party managers are a good fit
Today it is estimated that only 20 per cent of hotels today are still managed by the brands, as opposed to 50 percent 20 years ago.
“There's a number of areas, just by design, that a third-party can be more efficient and maybe more effective than brands,” he said. “We're finding opportunities, big opportunities in administrative and general expenses. We’re finding opportunities in the sales, direct sales—bringing that in-house and providing accountability for that property, as opposed to some of the brands,” said John Hamilton, executive vice president of Business Development for Pyramid Hotel Group, a third-party management company.
Hamilton noted that his company is not set up to manage operations for very large hotels over 1,000 rooms, or those that require special skills, like conference center hotels, which involve relationships and methods that Pyramid doesn’t have or do. He said, however, that Pyramid does manage some luxury hotels, “but under a branded scenario, I think the brands are better suited to be the curators of that brand, that positioning.
“What we’re finding is that our sweet spot is really the 300- to 700-room, branded hotels,” Hamilton continued. “And if we can get our people focused on a single asset, the asset that that's paying their salaries, we're getting much better revpar penetration on the cost side,” he added, noting that as a large purchaser, his company also qualifies for rebates, 100 percent of which go to the owner or brand that hired Pyramid.
Dan Hanson, who heads development for Hyatt Hotels Corporation in the Americas said that his company tries to find the best management solution for hotel owners. “It’s not predicated on a bias one way or another,” he said, stressing that there are certain luxury branded hotels, like the Park Hyatt in Washington, D.C. that his company wants to protect, not just the integrity of physical plant, but also the guest experience.
“It’s important to note that brand and brand management are two separate things,” Hanson noted.
“There are teams that manage hotels, and separate teams manage hotel brand—it’s not the same people.”
“So there's a dedicated focus on operations on one hand, and a dedicated focus on evolving the brand to where it needs to be to stay ahead of trends and changes in the industry,” he continued.
“I've always felt like a good GM has a good P&L and a bad GM has a bad P&L,” Hanson added. “It doesn't matter where they work. So I think the focus is on isolating talent, rather than any long standing preference for brand vs. third-party management.”
Considerations for hiring third-party managers
Opportunities for third-party managers to step in generally occur when hotels are sold or a brand decides to step back from an operations model to be a franchisor. On the revenue generation side, third party managers can be more effective because many have their own sales organization that layers sales on top of marketing of national brands, with a focus on the type of guests that asset accommodates.
Hamilton cited, for example, a 700-room asset in Palm Springs that was converted from a Waldorf to a Curio, and in the first year after the conversion, the hotel’s NOI grew from $19 million to $25 million.
While third-party managers may improve the bottom line, it is important that hotel owners consider the whole package before switching to third-party management, as it increases the fee burden on an asset 2 – 5 per cent, based on the size of the asset and length of the contract. Most agreements are for a minimum of 10 years and pointed out that an unencumbered property gets better capitalization rates and exit values than encumbered ones at time of sale.
For a company like Hyatt the challenge is maintaining a consistent level of luxury or lifestyle service at its higher-end, iconic brands and control over the guest experience are paramount to their success. With the frictional cost of a brand manager, it starts to become overbearing with a fewer number of rooms. There are some advantages with size and scale.
Key money challenge
Key money is one area where third-party managers have a difficult time competing with brands, Hanson continued, noting that if brands want to manage and brand assets, they have a balance sheet to make that happen through key money.
Hamilton agreed, noting he’s seen brands offer $40 - $50 million in key money for big assets, whereas key money for third-party management company like Pyramid may be worth $4 – $5 million. “That's meaningful [the amount], and it's not a comfortable discussion to have with our investment committee,” Hamilton said, noting that in considering the company’s limited economics, Pyramid has to find something above and beyond key money to do to secure contracts
Hanson noted that historically brand-managed hotels with basin incentive fees (a performance-based compensation structure for hotel management companies) generate the highest top-line revenue and gap margins, but some generalities are starting to diminish. “Existing contracts are what they are, but going forward, there is a lot more flexibility than we've seen in the past for deals and opportunities that we feel are going to be accretive, not just to the brand and the portfolio, but to the whole network system,” he said.
Hanson suggested that key money, in many instances, has gotten out of hand. “It feels like the brands are, at some point, asking you to fund complete conversions of properties. This is, largely unsustainable. It’s not just free money that goes away. We look at it very thoughtfully about what our total return would be on the issuance of that capital over the life of the term,” he said.
Hyatt has a preference for managing its own properties, especially large projects with complex components, like residential or a conference center hotel, but there are instances when the company would consider bringing in a third-party manager, even to manage high-end assets, due maybe to a union issue or other unique situation.
He doesn’t, however, see that happening in the case of mixed-use projects, with hotel, residential and multiple food and beverage facilities. restaurants. “Hyatt has a long-standing history of running big properties in major markets like Hong Kong and Tokyo, where there’s probably a different owner profile that relies on the brand.”
Noting, for example, that the Grand Hyatt Hong Kong has seven restaurants, Hanson added, “It gets to be very cumbersome and complex, as we as talked about before, that's where I think we can really add value.:
Hamilton noted that hotel owners are becoming more sophisticated in their knowledge and reasoning on third-party hotel management. “They have the tools to measure what's going on in their buildings, and that visibility has led to the conclusion that third-party managers can do some things better and more focused on their assets (than brand managers),” he said.
Unlike brand management companies with hotel interests nationally, hotel owners want a hotel manager focused on their assets, Hamilton suggested. “Our business model lends itself better to that self-contained, revenue generation machine, to being personalized to an asset. So we're finding that the major owners, the REITs, private equity are aware of those benefits, and we have some pretty good case studies that show where we've been able to move the needle on the costs,” he added.
Hanson noted that key money has allowed Hyatt to solidify a brand in a particular hotel's presence in a certain market. “We've got a view that we're really good at some things, and maybe there's some things that we can do better on. But on those issues we feel strongly (about), where we've got a brand in a location that we feel has a history or a kind of a legacy of excellence, those are the kind of deals that we add significant value to.
“When we look at statistics on some of our most iconic brands, like the Park Hyatt and Grand Hyatt in some great markets, our ability to execute in those markets translates into a broader network effect across the whole system, which benefits third-party managed hotels,” he continued.