CREDITS I am indebted to Dr. Johan R. Edelheim of Southern Cross University Lismore, for the foundation of these slides. Dr Johan R. Edelheim (PhD)Lecturer, Hotel and Resort ManagementSouthern Cross University, Coffs Harbour CampusPersonal researcher page: http://works.bepress.com/johan_edelheim/ Asset Management
Previous topic: • The maintenance plan • Maintaining the facility • Maintenance planning • Maintenance processes • Refurbishment / renovations / obsolescence
Today’s Schedule • This week: • Appraise the economic factors that influences the hospitality industry; • Define asset management in more than one way; • Distinguish the importance of asset management to both owners and operators; • Compare current issues in the negotiation of management contracts • Next topic: Risk Management
Readings for this topic • Reading 5.1; Powers, T & Barrows, CW 2006, ‘Forces Shaping the Hotel Business’; • Reading 5.2; Bridge, D & de Haast, A 2004, ‘Asset management’; • Reading 5.3; Schlup, R 2004, ‘Hotel management agreements: Balancing the interests of owners and operators’; • Reading 5.4; Eyster, JJ 1997, ‘Hotel management contracts in the U.S.: The revolution continues’.
Economic Forces (BOR 5.1) 1 (2) • Cyclicality in the Hotel Industry • Contraction / Expansion • Peak / Through • Special Events • Expansion of major brands • Increasingly segmented room products
Cyclicality in the Hotel Industry • Business cycles are not regular, predictable or repeating cycles like phases of the moon. Their timing changes unpredictably. But all cycles have some things in common. Every cycle has two phases: • A contraction, which is a slowdown in the pace of economic activity; • An expansion is a speed-up in the pace of economic activity; • And two turning points: • A peak, which is the upper turning point of a business cycle where an expansions turns into a contraction; • A through again is the lower turning point of a business cycle, where a contraction turns into an expansion • Exceptions to the peak/through is for example in times of special events in the regions – such as the Olympics, or World Cup Football • Other ‘illogical’ expansions in times of economic downturn in a market can be attributed to major brands filling gaps in their network of hotels, or developers seeing a gap in a specific segment’s offerings, such as a ‘no-frills’ hotel in a market saturated by 3-5 star hotels.
Economic Forces (BOR 5.1) 2 (2) • Securitisation and Hotels as Investments • Cost of capital • Financing mix • Capital structure theory • Hotel Investment decision: Financial; Real estate; Operating • Mixed use developments – trend of the future? • CMBS Commercial Mortgage Backed Security & mezzanine financing – both Debt finance/ REIT / Public fundingReal Estate Investment Trust ‘ paper-clipped’ to management companies IPO (initial public offering) – Equity finance
cost of capital • is related to the opportunity cost of using money to invest in new projects. If, for example, an investor has $100 of cash that can be invested in any way possible – the first calculation that always has to be done is the ‘risk-free return’ on investment. As a general rule no project should be undertaken where the rate of return is less than the cost of capital – as the opportunity cost for the money then has been wasted
Financing mix • refers to the proportion of equity versus debt used to finance a project • The financing mix is constantly more complicated and the capital structure theory aims at finding ‘the optimal capital structure [in order to] minimise the composite cost of capital.
Mixed use development • a building core with a range of different users; shopping centres, hotels, f&b arcades; movie theatres, offices, residential apartments, even governmental services such as libraries, schools, etc
Definition of Asset Management 1 (4) • Bridge and de Haast (2004): …the safeguarding of a hotel’s or group of hotels’ earnings, earnings capacity and value through correct product and service definition, selection of the appropriate operator, setting of strategic and operational goals and monitoring and adjusting those goals in the light of changes in both the operating, debt and investment markets (2004, p. 255).
Definition of Asset Management 2 (4) • Vazquez Winkler (2003): The concept of “asset management” basically consists of an exhaustive follow-up of management performed by hotel operators in benefit to the hotel owner (or, where applicable, the loan companies), with the main objective of maximising the value of the asset and therefore the value of the investment (2003, p. 17).
Definition of Asset Management 3 (4) • Williams (2005): A comprehensive, fully integrated strategy, process and culture directed at gaining greater lifetime effectiveness, value, availability, profitability and return from production and manufacturing assets
Definition of Asset Management 4 (4) • Rushmore (1994): • The service of assisting hotel owners • in realising their investment goals. • The asset manager acts as the owner’s agent • or representative to ensure that a hotel • is acquired for a reasonable price; • is then operated properly during the period of ownership; • and ultimately is disposed of at an appropriate time and price
What is Asset Management ? • Based on real estate management • In the financial services industry (APTECH Engineering Services, 2001)
What is Asset Management? • Real estate: The oversight of the day-to-day management of real estate property and the responsibility for maintaining and preserving the physical asset • Finance: The process of managing client investments • Isn’t the hotel operator also the asset manager? • You would think so ! But…. • Most operators don’t think like owners • (or don’t know how to think like owners) • Operators have a conflict of interest • They like spending the owner’s money…… • Asset management = conflict management • The asset manager works for the owner • The principal task of the asset manager is to align the interests of owner and operator (in the best interest of the owner…..)
What is the role of the Asset Manager ? • The hotel asset manager is both the chief engineer and navigator of a ship that must arrive at its destination with the greatest economy of resources yet at the highest possible speed: • Chief Engineer: hands-on, requiring both technical and personal skills • Navigator: strategic, requiring management and planning skills • The Asset Manager has a dual role: • The oversight of operations and the physical asset • The management of the capital investment
Role of the Asset Manager • Monitor ongoing financial performance • Actual performance vs. budget and previous years • Compare performance against competitive hotels • Monitor the competitive market • Track occupancy and rate trends • Monitor supply and demand changes • Monitor the asset • Maintenance and capital investments • Legal and OH&S compliance • Support and review the budgeting process • Set positioning and benchmarks against competition • “Negotiate” with operating company • Advise ownership about management issues • Review general operator performance and spot problems • Any other issues that require attention
Typical Tasks • Understand the ownership and management structure of the hotel and the working relationship between the two entities • Meet with senior executives of the management company to establish a working relationship • Review monthly reports provided by management and assess performance against the agreed operational goals • Visit the hotel on a regular basis and meet with the hotel management team • Report to the owner on a regular basis regarding salient issues • Provide strategic planning advice,acquisition and disposition services and other services as required
Typical Tasks Read and fully understand the management contract! • Meet with the corporate-level representatives responsible for the management of the hotel • Review to ensure that the they are effectively managing, marketing and maintaining the hotel • Report related to the management and financial performance of the asset
Behind the scenes of hotels… • Management contracts • Base fee • Incentive fee • Services and charges • Terms and conditions • Capital Expenditures • FF&E provisions • Sinking funds • Ownership structures • Private owner • Institutional owner • Strata titled (income distribution systems) • Banks (administration) • Operating structures • Owner operated • Management agreement • Lease agreement • Franchise agreement
Typical Tasks • Advise ownership about investment strategies • Strategic review in light of owners objectives • Create, maintain and enhance value • Monitor the investment community • Track comparable sales prices • Track cap rates, financing terms etc. • Select and manage operator(s) and consultants • Select management company • Retain other advisors and consultants (contractors, lawyers etc) • Negotiate and administer contracts • Negotiate management and other contracts • Monitor compliance with contracts • Approve and monitor capital expenditures • Create long-term capital expenditure plan and annual budget • Review and approve capital expenditure requests
“8 What’s of Capital Asset Management” • What is in the building portfolio? • What are the existing physical and functional conditions? • What changes are required to correct existing conditions? • What will the changes cost (both now and in the future)? Continued… http://www.vfa.com/productsandservices/assessment_services.htm?mtcPromotion=mv>YST
“8 What’s of Capital Asset Management” • What are the priorities? • What information can be used to strengthen funding requests? • What is the optimal allocation of facilities dollars? • What metrics/benchmarks/reports can be used to measure success? http://www.vfa.com/productsandservices/assessment_services.htm?mtcPromotion=mv>YST
Operating structures Owner operator Multiple Owner /Chain Lease contract Management Contract Franchise contract
Management Contracts • Most wide-spread in the quality hotel sector (Schlup 2004, p. 331) • Owner bears most of economic risk • Control of costs • Remedies of underperformance • Goal of owner long-term success – goal of operator shorter-term success • Equity contribution • Compliance with standard • ‘Ownership’ of guests • Category one or two Mgmt contract
Management Contracts • Control of costs: • Management fees 1.8% gross revenue, 6.9% gross operating profit – average term 19 years initially • Group charges – have to be specified beforehand what is accepted • Budget – to be approved and negotiated together • Control of GM • Right to seel hotel asset • Remedies of underperformance • Stand-aside fee • Guarantees • Right to terminate • Ownership of guest refer to the ownership of guest data produced at the property. Both owner and operator interested in the IP after their ways part. • Category one – supplies the whole management structure and brand name (such as Hilton, Hyatt, Sheraton) • Category two – supplies management structure – but no brand name – rather utilises strong franchised brands
Franchise contracts • Favourably viewed by banks and other lending institutions • Services offered: • Operating procedures • Technical assistance • Marketing • Encroachment provisions • Franchise fees • Initial fee • Monthly fee • Advertising fee • Training fees • Increased segmentation of market Stutts 2001
Franchise contracts • Ops procedures – • Manuals updated regularly • Training programs • Standards • Cost saving suggestions • Purchasing • Technical assistance • Site location / selection • Architectural design • Purchasing • How to display brand / logo • Marketing • Logo on consumables • Reservation system • Integrated advertising • Franchisor sponsored advertising for select regions or types of properties • Encroachment provisions: • kilometre range between franchisees – high occupancy for certain might override this clause • cannibalisation compensation • Equity investment • Computer upgrades – demanded by franchisor • Initial fee up to US$ 50.000 • Monthly fees often fixed plus % of room sales between 3 and 6.5%
Asset Management • Physical assets – the largest single asset category on the balance sheet of many organisations • Investment manager’s role: ‘Maximise return on investment… at a level of risk acceptance’ – simple • Obsolescence at some stage • preservation & adaptation • Facility Equilibrium Fagan & Kirkwood (1997)
Asset Management • Physical assets portion large – emphasis on their management relatively low • Investment manager’s role simple – why is not the same type of thinking applied on facility or asset managers? • All facilities are in need of maintenance, all facilities will at some stage become obsolescent – different types of maintenance needed. • Facility equilibrium refers to the level of maintenance needed to maintain the facilities at a constant level from year to year. This cost increases for each year, but is always lower than if no management structure would be in place, in which case occasional capital expenditures would bring the facilities up to required level for a short time, before dilapidating again
Strategies for Asset Management • Facility Condition Assessment (FCA) • Facility Inventory – data standards; two hierarchies – space & systems • Facility Evaluation – life-span; deficiency categories • Analysis, Forecast and Reports • Ongoing FM • Facility Condition Index (FCI) Fagan & Kirkwood (1997)
Strategies for Asset Management • Data standards are simply categories or fields which describe elements and their measurement units for the evaluation of condition and performance • There are fields for naming each room, building or campus and describing their usage, size, and department to which each belongs • Building systems include envelope,; interior construction; heating; ventilation; air-con; plumbing; electrical; telecom • Systems are sub-divided into single component and groups of assemblies • Utilise existing data sources – link different elements to legal acts available for different components • Compare life-span to available sources, auditing depreciation or other accepted system • Deficiency categories – find suitable categorisation, be aware of downfalls in numerical ranking • Forecast: • Facility Renewal Forecasts • Facility Condition Index ( the ratio of the cost to correct all deficiencies identified to the current replacement value of the facility) • Optional funding scenarios
Tutorial activities • 1. How does the hotel business react to the business cycle? Explain why hotel building continues after demand turns down. • 2. What does securitization mean? How is it affecting the hotel business? • 3. What have been the major effects of securitization on competitive conditions in lodging? • 4. What to do the acronyms CMBS, REIT, C corp, and IPO stand for? To what to does each of them refer? • 5. What is mezzanine financing and what are some of its advantages? • 6. What are the hazards of public ownership? • 7. How does RevPAR differ from ProfPAR? • 8. What are the main elements of a hotel investment decision? • 9. Has segmentation contributed to encroachment? What are the effects of encroachment? • 10. Why did hotel management companies come into existence? • 11. What is the importance of asset management to lodging owners?