Hotel management contracts typically include two primary components of compensation for the management company—a base fee and an incentive fee. The base management fee is generally derived as a percentage of total revenue. In addition, owners may pay the management company an incentive fee once they reach a designated profit threshold. The incentive fee is designed to make management more conscious of the bottom line since owners achieve their returns and pay their debts from profits, not revenue. Given the extreme changes in revenue and profits during 2020 and 2021, CBRE Hotels Research analyzed concurrent management fee changes. As a significant expense, management fees impact the cash flows of hotel owners. Similarly, management companies are dependent on the management fees they earn, so huge changes in hotel performance impact their profitability. To gain a better understanding of recent management fee trends, we analyzed the performance of 1,027 hotels that reported paying an annual management fee from 2019 through 2021 for CBRE’s annual Trends in the Hotel Industry survey. In 2019, before COVID, the hotels in the research sample averaged 155 rooms in size, with an occupancy of 75.6 percent and an average daily rate of $175.94. During 2019, management fees averaged $1,835 per available room, or 2.8 percent of total revenue.
Total hotel revenue for the hotels in the research sample declined by 61 percent from 2019 to 2020. Facing this dramatic decline in revenue, management was able to cut expenses by 44.3 percent during the year. However, with revenue falling greater than expenses, earnings before income taxes, depreciation, and amortization (EBITDA) dropped by 107.2 percent. EBITDA is frequently the profit measure used to determine if a management company earns an incentive fee. A decline in EBITDA greater than 100 percent implies that owners had to pay their debt service out of their own pockets, and no funds were available to provide a return to investors.
With revenue declining by 61 percent, we observed a 55.3 percent drop in base management fees during 2020. At the same time, the 107.2 percent decline in EBITDA triggered the 88.3 percent fall-off in incentive fees. In 2020, only 4.1 percent of the hotels in the research sample earned an incentive fee. This compares to 10.8 percent in 2019.
During 2020, all property types posted a decline in management fee expenditures. The declines in management fee payments exceeded 60 percent at full-service, convention, and resort hotels. Conversely, the fall-off in management fees at extended-stay properties was just 41.1 percent.
Increases in 2021
The recovery of the U.S. lodging industry began in earnest during the spring of 2021 and flourished during the summer. Unfortunately, the surge of the COVID Omicron variant muted the pace of recovery during the latter part of the year. On an annual basis, total hotel revenue grew by 74.1 percent, while EBITDA surged by 837 percent.
Resort hotels posted the greatest gains in revenues and profits during 2021. In turn, resort properties paid out 192.7 percent more in management fees during the year.
The rise in revenues and profits enabled management companies to earn 98.1 percent more in management fees in 2021 compared to 2020. The 74.1 percent gain in revenue resulted in a comparable 74.8 percent increase in base management fees. Operators were rewarded for the great improvement in profits with a 631.9 percent increase in incentive fee payments. Indicative of the resilience of leisure demand, resort hotels posted the greatest gains in revenues and profits during 2021. In turn, resort properties paid out 192.7 percent more in management fees during the year.
The COVID recession has impacted the relationship between owners and operators, as well as some management contract terms.
Facing great financial stress, owners looked to their management companies for help with the burden, in many cases, in the form of temporary relief from certain financial obligations. Owners with larger portfolios were able to obtain a temporary reduction in base fees, or a waiver in their incentive fees. Conversely, some management companies helped their owners raise capital to better capitalize their operations. This afforded the management companies with the ability to cover payroll and other operating shortfalls.
Owners/operators not only faced financial stress, but the pressures of increasingly challenging day-to-day operations as well. Accordingly, we have observed owners with small portfolios give up property management and contract with a professional management company.
To further align the interests between both parties, owners have asked management companies to contribute in “key money.” (Key money is an upfront payment by a hotel operator to a hotel owner to enter into a hotel management agreement.) In addition, incentives are not only tied to the performance of the asset, but the owner’s return on investment as well. Termination provisions are becoming more favorable for owners. We are seeing owners gain the ability to terminate contracts without cause. It is uncommon for management companies to contract for more than five years unless they provide some key money.
When selecting a management company, owners are now looking for more than just the ability to supervise the day-to-day operations and achieve key performance indicators, and consider the following: The ability to manage renovation projects, implement advance purchasing systems, install new technologies, influence changes in brand standards, and recruit and maintain key property managers; the personality of management company leadership needs to match the owner, and ESG goals and values need to be aligned; experience with the subject property type and chain-scale; and experience with the latest IT, accounting, revenue management, digital marketing, and social media technologies.