‘Entire contract landscape will change’

Brightcove Video

The current virus outbreak will lead to a change in the “entire contract landscape”, this week’s In Focus broadcast, hosted by Hospitality Insights, heard.

Theodor Kubak, head of hospitality, Arbireo Capital and co-founder HAMA Europe, said that risk would have to be spread more equally in the future between the different parties involved in the hotel stack.

Kubak said: “The entire contract landscape will change. Not only the franchise agreements but also management and lease agreements. There will be a more equal spread in responsibilities. After the lawyers have looked at how to mitigate the situation there will be a change in how to look at insurance, at fees, at FF&E reserves and in the terms in general.”

Describing the present situation in the sector he said: “If you talk to most asset managers they are in fire fighting mode, talking with the owners and the owners are discussing the respective issues they have with the banks. The owners have responsibilities. They are acting as custodians to their investor and therefore they have to think of their abilities to protect the respective investment. If the owner is PE and has a management agreement behind them it is a different role, however it is important for all parties involved to have an equal share in suffering. Try to get all the parties involved and share the burden.

“We are all in this together and we can overcome the present situation.”

The growth of franchising and with it independent management companies has become a feature of the sector, with HVS commenting that franchising represented a significant portion of the European portfolios of the biggest four groups in Europe. Franchised rooms accounted for approximately a third of Marriott's portfolio (although it reports Europe, MEA and South America as an aggregate), approximately half of Accor's and Hilton's European portfolio, and the majority of IHG's European portfolio.

To highlight the increasing importance of this operating model, in the five years to 2019, the portion of franchised properties has increased from 37% to 48% for Accor and from 32% to 51% for Hilton.

Richard Bursby, partner, Taylor Wessing, told us: “So where does the buck stop? The allocation of risk and reward has always been a key issue in HMAs and franchise agreements, with decisions based on a combination of various factors including bargaining position and risk appetite but always predicated on underlying assumptions about the range of likely economic outcomes.

“COVID-19 is the mother of all Black Swan events, it is so off the chart that few if any commercial contracts provide for such a set of circumstances as the ones we have now. Future contracts will likely seek to address this. However, the challenge will be allocating risk in such a seismic event, and the Black Swan you provide for will probably not be the Black Swan that lands.”

Looking to alleviate some the pressure on the relationships within the hotel stack, many were looking to government bailouts. Kubak said:  “Governments have put some safety nets over not only our industry but over the entire economy but we must be very careful how to view these because the safety net is only valid for three to six months or however long this situation might last. Then it will be interesting to see what the government is willing to do to protect the longevity of these businesses.”

Bursby saw a larger role in the future for government, commenting: “Insurance is often seen as a solution, but insurers are rapidly excluding COVID-19 risk from their policies. In the past, governments have stepped in to offer cover (terrorism for example) where insurers have withdrawn and this is the most likely solution here in our view.”

Bursby was referring to Pool Re, which was set up in 1993 by the insurance industry in cooperation with the UK government in the wake of the IRA bombing of the Baltic Exchange in 1992. Syndicates which offer commercial property insurance in the UK, with membership of the scheme affording them a guarantee which ensures that they can provide cover for losses resulting from acts of terrorism, regardless of the scale of the claims.

 

Insight: The shifting pull of power in the sector has been a source of ongoing fascination to us observers, with the common complaint being that those pesky brands got all the glory and all the fees with none of the pain and risk. The brands would occasionally protest that they were the glowing sign over the door and really, they took all the reputational risk.

But reputational risk isn’t really a thing to the investor sinking their millions into a hotel and there was much gnashing of teeth over fees, particularly in the recent drive to direct bookings, which many owners have objected to. The round of M&A also caused some letter writing, as owners found themselves part of a much larger beast, with less love to go around and more suspicion that maybe as no many guests which might have been hoped to come through the door have been delivered.

Now no-one is getting much in the way of fees, revenue or anything else to put in the plus column. It cannot be fair that owners have to take the hit. The brands have been pulling away from participation, but just sitting back and watching the fees roll in is not going to endear them in operator selection. As the hotel sector became more of a mainstream asset class, it had been hoped that it was possible to invest without getting your hands dirty. That is clearly not possible. It’s time for everybody to dig in.