Introduction
In the last decades there have been great changes in the Israeli hotels industry. In terms of demand, we are witnessing a huge growth in incoming tourism[1] and an uprising in the industry revenue. Due to the growth in the hotel industry, there is increasing competitiveness between the operators in the field, highly professional level of the players in the market, and an expanding variety of types of lodgings available for the public such as rich technology “business” hotels, “spa” hotels, international franchise brands to attract specific clients, Airbnb, “capsule” hotels and more.
Despite those changes, when we examine the legal-contractual aspect in the engagement between hotel owners and hotel operators, it is surprising to see that even though the tourism industry is blossoming and the hotel industry is rapidly changing, the legal infrastructure in Israel has remained almost the same.
Thus, most of the business engagements made between the players in the hotel industry in Israel are based on lease agreements, even though there is another commercial contractual option for this business engagement: engaging in a management agreement with a hotel management company.
In this article we will briefly review the main differences between engaging in a management agreement and engaging in a lease agreement, and we will attempt to map out the advantages and disadvantages embodied in engaging in each one of these agreements.
Some background: In a global aspect, until 1949, hotel owners were also the managers of the hotel. Between 1949 and 1963 there were mostly transactions based on lease agreements, while only in 1963, Hilton International has made the first hotel management transaction in Hong Kong. Ever since then, most of the transactions in the hotel industry in the United States and in Europe are based on management agreements, while in Israel, as stated, the parties prefer to engage in lease agreements[2].
Hotel Management Agreements
A management company in the hotel industry is a company that specializes in management of hotels. Such company will manage the hotel for the owner of the property in exchange for pre-agreed management fees, while all incomes and expenses will be imposed on the owner of the property. Namely, the management company is nothing more than the long and professional arm of the property owner, acting in complete transparency and with minimum commercial and financial risks.
In this framework, the parties will prepare a management agreement which will impose most of the liability, both legal and commercial, on the property owner. The agreement will greatly emphasize the creation of a balance between an effective and profitable management incentives mechanism, while leaving full control via transparency and control mechanisms to the property owner.
In the framework of creating the sensitive balance, the author of the management agreement must assimilate mechanisms in the agreement, which will balance the risks and interests of both parties. Thus, for example, in most cases the management agreement provides a mechanism, that on the one hand grants the management company incentives to increase sales revenues and minimize expenses, and on the other hand enables the property owner to terminate the agreement when the management company causes losses, or its conduct is improper.
When one party wishes to engage in an agreement with a management company it must be aware that this a complex legal-commercial relationship, which requires understanding the material difference between an engagement in a management agreement and the engagement in a hotel lease agreement. Among the considerations the parties face in the engagement of a property owner with a management company, the following advantages and disadvantages are evident:
Advantages:
1. A significant part of the profits belongs to the property owner when the hotel generates significant profits.
2. Complete transparency with regards to the hotel activity.
3. Management companies are usually professional and efficient companies with seniority in activity in the field, a fact which grants great security in the establishment of a new hotel.
4. The management companies usually bear a recognized and reputable name. An international name of a management company such as “Hilton” will necessarily attract foreign tourism and regular customers of the chain.
5. To the management company, there is a low risk in engaging with the property owner, whereas even in case the hotel is not profitable, the management company will earn a fixed and pre known amount (in the form of percentage from the revenue).
Disadvantages:
1. To the property owner, inasmuch as the hotel is not profitable or when the operation is not efficient, the fixed payment to the management company will continue to be paid, while in some cases the property owners could suffer losses.
2. There is concern from the problem of asymmetrical information: the management of the hotel via an external management company could create gaps in information between the management company and the property owner, thus creating disputes between the parties and damaging the effectiveness of the management.
3. There is concern for the existence of the “principal-agent problem” according to which the management company, while acting as the agent of the property owner, will act to promote its own interests while damaging the property and/or the property owner.
Hotel Lease Agreements
With a hotel lease agreement, the hotel company rents the property from the property owner and operates the hotel as independent unit, separate from the property owner. This way, the hotel company (the lessee) reserves all incomes from the hotel and pays fixed rent (usually In addition to a certain percentage from the sales revenue).
Namely, this is the conduct of a regular business in the property of another, while regulating special aspects which exists in the hotel industry. In Israel, as stated, apart from hotel management companies which could be counted on one hand, the parties will prefer to conduct themselves as independent units, separate from one another, via engaging in lease agreements with property owners. These are some of the advantages and disadvantages of this type of engagement:
Advantages:
1. The property owner gains industrial stability and an almost guaranteed economic income. The owner earns the fixed rent. It is often agreed that the owner will also earn a percentage of the sales revenue / profits of the hotel.
2. The hotel company, on its part, will bear all profit and losses, and all legal and commercial liability pertaining to the management of the hotel, the positive and the negative.
Disadvantages:
1. Even in cases where the hotel is extremely profitable, the property owner will not enjoy the full fruits of the success. In addition, he is not exposed to all internal data of the business, so that the advantages of making use of this high value data in the future will not be available to him – whether he chooses to enter an alternative lessee in the future, and whether he chooses to manage the hotel via a management company.
2. The management company (the lessee) will not be granted guaranteed economic security. The management of the hotel in the absence of business certainty will make it difficult for it to grow and expand in short periods of time as would have been possible had it engaged in a management agreement while entering fixed and known amounts consistently.
To Summarize
As we can see, there is a great difference between hotel management agreements and hotel lease agreements and there are advantages to both ways. The engagement of a property owner with a management company which has proven management capabilities, a resume and a target audience, may suit a property owner who has knowledge and experience in the hotel industry, who would be interested in creating a professional hotel and increasing his chances for success. On the other hand, a property owner who would be interested in minimizing his exposure to risks and would be interested in industrial peace, such as a management company which will have at its side all risks and chances for success, will prefer to engage in a hotel lease agreement.
Thus, it seems that the choice between the aforementioned options is a business commercial choice, however this choice must be made on the basis of a full and detailed contractual agreement, which will grant the parties with the piece for a healthy and fruitful business engagement throughout the engagement lifespan.
[1] The Central Bureau for Statistics, press release, “Entrance of Visitors to Israel, December 2019”, (published on the Bureau’s website, 06/01/2019).
[2] Michael Evanoff , The Center for Hospitality Research, Cornell University, “The International Hotel Management Agreement: Origins, Evolution, and Status”, 2016.