MADRID—Long-term, fixed hotel lease agreements in Europe are being eased out in favor of variable contracts and management agreements as economic conditions affecting the industry force owners and operators to reassess, renegotiate and in some cases terminate existing contracts.
One recent example occurred when Spanish hotel operator Barceló Hotels & Resorts threw in the towel and announced it was terminating its lease to run 21 hotels with 2,800 rooms in England, Scotland and Wales under an agreement with Britain’s Puma Hotels Plc.
“We signed an agreement with Puma in 2007 when the economy was buoyant for a 40-year period, which was extendable,” Raúl González, Barceló CEO for Europe, the Middle East and Africa, said. “But over the passage of time, the agreement proved unsustainable because of the economic crisis, which began a year after the signing. We started negotiations in 2009 as we wanted to continue managing these hotels, but at a lower rent.”
“We were unable to reach a new agreement, and in the end we lost something like £10 million ($15.5 million) over the period,” he said.
And there will be further costs for the Spanish chain. Under the termination agreement, Barceló is to pay Puma £20 million ($31 million) in addition to a completion adjustment payment.
“Any chain which signed fixed rental agreements with owners just before the crisis is probably in trouble, and I understand there has been lots of renegotiating going on in Europe, especially in the more troubled markets like Spain,” González said.
“In the future, we’ll see fewer fixed rental agreements and more variable agreements,” he predicted, adding that Barceló, which owns or operates 142 hotels in 16 countries, hopes one day to return to the British market when the economy improves.
Pressure mounts as markets evolve
Industry sources said that economic conditions aside, a hotel asset and the surrounding market can change a lot over the average 20- or 25-year duration of a lease agreement, which can create disputes between owners and operators.
In response, most new lease agreements are variable in nature, which accounts for changes in rent to be paid to the asset’s owner. Others are being replaced with management contracts.
Lease models are typically based on a fixed payment or linked to revenue where the lease might include a guaranteed minimum payment with the lessee retaining operational control of the property for the term of the lease.
Under a management contract, the operator runs the hotel for the owner and is compensated through a management fee that usually consists of a base and an incentive element. The owner retains all profits after the management fee is paid but relinquishes day-to-day operational control.
“A lot of hotel companies, which entered into lease agreements in the heady days before the crisis hit, are going back to renegotiate,” explained Jeremy Hill, director and the head of hotels at London-based hospitality, retail and care consultants Christie + Co.
“And one of the obstacles to renegotiating a lease agreement is that the owners themselves are having their own debt concerns, so that’s a problem.”
Hill said that while there are still a few legacy lease contracts around, many big hotel companies now only will sign management contracts unless it is a very interesting market and a lease agreement is the only type available.
Owners also seek change
Another factor favoring management contracts is that lease agreements are listed as a liability on balance sheets, while the former are not, he said.
“I’d be surprised today to hear of a lease agreement based on the previous model being signed as they are an instrument of the past,” Hill said. “The conventional agreement now is a management contract.”
In many cases, it is the owners, and not the operators, who seek a change in the lease structure.
For example, Pandox AB, the Swedish-based hotel owner, which has 116 properties with 25,000 rooms in Scandinavia, Britain, Germany, Switzerland, Canada and the Bahamas, will assume management duties if an operator fails to meet financial expectations.
“We take over one or two hotels every year which are performing badly,” said Pandox CEO Anders Nissen. “And we are taking over three under-performing hotels in Germany. Some of the big chains just don’t keep their eye on the daily operations of the property.”
Although, lease agreements can be revisited and renegotiated to see if they’re still working, an owner generally gives up most of the control of the hotel to when entering a lease with a third party.
“You have to remember that it is always the owner who is running the biggest risk,” he added. “For a 300-room hotel in Barcelona, for example, the owner may invest €100 million ($123 million) and the operator maybe contributes €10 million ($12 million).
Pandox works with 20 brands such as Hilton, Hyatt, InterContinental, Crowne Plaza, Holiday Inn, Scandic, Radisson Blu, Park Inn by Radisson Hotels, Clarion, Quality Inn and Suits and Comfort Inn & Suites.
Approximately 70% of Pandox-owned hotels are operated under variable leases. The rest are franchises or owned operations.
“We like variable leases, and we were among the first to instigate these as we want to be active and not passive in the operations, to share both the risk and the upside,” Nissen said.