Lessons from the pandemic for hospitality asset owners

What are some of the operational changes within the hospitality sector that you expect will endure post the pandemic?

There have been many operational changes within the hospitality sector as owners and operators battled for survival during the pandemic, but a large proportion of these changes may warrant a return to status quo once the pandemic is under control.

These include the reduction of staff-to-room ratio across all categories of hotels, limits in housekeeping/turndown services, and the absence of buffet breakfasts that were adopted at the onset of the pandemic.

I expect the return to status quo will be relatively faster for luxury and upper upscale properties, while budget and economy hotels may be able to explore avenues to hold on to some of the operational efficiencies that were discovered over the last two years.

A stripping down of services, such as daily housekeeping and turndown service, and providing them as an optional, chargeable add-on for guests, may be something that we see in the coming years.

The industry may look at budget airline carrier models to learn how this was done successfully within a similar, yet different, industry. From a regional perspective, however, the implementation of such a model may pose challenges, particularly due to the unavailability of part-time resources, which is essential for success.

In Dubai particularly, one promising trend that I expect will continue is the re-emergence of F&B outlets within hotels as a major revenue driver.

The performance trajectory of hotel-based F&B outlets in Dubai has been an interesting one. Pre-2009, F&B outlets in the emirate bucked all industry trends accounting for over 50 percent of a property’s total revenues, while in international markets they typically accounted for only a 25 percent to 35 percent share.

Following the global economic crisis, this trended downward with revenues across outlets in Dubai declining and approaching industry norms to generate between 30 percent to 35 percent of total property revenues. Against this background, owners (propelled by operators) decided to treat their F&B outlets as leased spaces settling for the surety of fixed rental incomes with negligible operational costs.

While this may have appeared a prudent choice at a time of declining revenues, recent years have seen restaurants leverage the power of social media and influencers to generate significant footfall and revenues.

Additionally, the onset of the pandemic and the resulting limited options for entertainment saw the burgeoning of restaurants as the ultimate “experiential” outlet for a large proportion of the residential population.

At present, only a handful of properties in Dubai have been able to leverage social media traction and the power of influencers to generate revenues, which has resulted in their F&B departmental contribution to overall revenues crossing the 50 percent threshold.

This is an opportunity for incremental revenue generation available across all hotels and I would expect that both owners and operators will begin to re-assess their F&B space utilisation to tap into this potential.

Travellers are increasingly deciding on their itinerary and choice of outlets based on their endorsement and popularity on social media, even before they arrive to the country. Therefore, the availability of F&B outlets within a property that have an established social media following (think trending hashtags, influencer appeal, etc.) could well assist these travellers on making it their choice of accommodation, giving the property a competitive edge while simultaneously accentuating room revenue.

Owners who are currently settling for a lease income should reflect on the fact that they are potentially sitting on a space that could generate annual revenues between AED45,000 to AED55,000 per cover if the right brand, concept, and marketing are in place.

If a restaurant operator is willing to lease the space for AED3-4 million, this typically translates to about 5-7 percent of the total revenues they would expect the outlet to generate. Owners must do the math, assess the capabilities of their hotel operator to build and market viable concepts, and then arrive at the decision to lease or operate.

How has the owner-operator relationship been affected due to the pandemic? Are there any changes to the typical hotel management agreements (HMA) terms you would expect to see going forward?
While most hotel asset owners in the region have commended the operators for their quick action to putting in place cost saving measures in response to the pandemic, the era has cemented one unassailable fact into the minds of the owners – that they bear the entire brunt of the risk in the investment.

While this was always understood to be the case, the pandemic has pushed this reality prominently to the forefront. A realignment of the risks and rewards to the operator and owner is anticipated to become even more of a mainstay in HMA negotiations going forward.

The dominant fee structure for HMAs in the region is that the operator earns a base fee, plus an incentive based on hotel profitability. In addition to the base and incentive fee, the HMA also provides for payment for a variety of operator-provided services (system reimbursable charges).

From an owner’s perspective, this essentially means that all costs incurred by the operator to market and sell rooms or services at the property is reimbursed back to the operator, while still getting paid a guaranteed base fee regardless of the property’s performance.

Contemporary HMAs in the region have seen base fee come down from the historic average of 2.5 percent to 3 percent to between 1.5 percent and 2 percent of total gross revenues. Going forward, owners will be looking to reduce the guaranteed fee pay-out even further and tie the operator’s payment almost entirely to the profitability margins achieved by the asset under their management.

Historically, incentive fees have been based on achieving a certain threshold of profitability, measured as income before fixed charges. A sliding scale is often employed with the incentive fee pay-out increasing upon achieving higher operational margins.

In future HMA negotiations, the focus for owners will largely be on reducing the base fee and aligning incentive fee to be based on cash flows after an owner’s priority return is achieved. Under such an arrangement, where the incentive fee payment is subordinated to the owner’s preferred return (typically around 8 percent to 12 percent return), operators would command a higher share of the remaining cash flows as incentive payment ranging anywhere between 10 percent and 30 percent.

A management fee structure based on cash flows after the owner’s priority would shift the focus from the property’s P&L to the cash flows generated by the asset, thus ensuring that operators are cognizant of any CAPEX investment requested of owners, while at the same time being laser-focused on maximising operational efficiencies.

There has also been recent chatter in the industry on the benefits of moving away from a hotel management agreement to a franchise model of operations. However, a decision to move to a franchise model will need evaluation of various quantitative and qualitative factors.

A franchise model will make sense from a financial perspective only if the owner has in-house capabilities or access to third party service providers to run the property at a much higher operational efficiency than an operator.

The franchise model typically requires a fixed initial fee (either a lump sum fee or calculated on a per room basis) followed by a percentage share of the total rooms revenues generated by the property. Any sales and marketing contribution for the property at the brand level will need to be separately reimbursed to the operator.

A fee is also charged for being part of the reservations system of the brand. While franchise models are significantly more popular in North America, it may not prove a better alternative to HMAs for assets in this region given the current operational environment and dynamics.

This article was originally published in Arabian Business.