Hotel financing - the pros and cons of management agreements versus franchises

At the CREFC "Financing Hotels in Europe" panel discussion on Friday 29 March, lenders and investors discussed their preferences for the way in which hotels are managed and operated. The comparison focused on the pros and cons of operating under a hotel management agreement with a hotel operator and obtaining a franchise from a hotel brand and operating in-house.

For investors with the right expertise and resources not looking for fixed-income returns, their preference may well be to enter into a franchise agreement with a major hotel brand and operate the asset themselves. That gives them the maximum flexibility to optimise operations and boost revenues. Crucially, it also gives them the maximum control over costs, with the ability to rationalise costs in any downturn.

In contrast, the lenders on the panel agreed that a management agreement with a well-known and established hotel operator would be their preferred route. They offered a number of reasons for this, but principally:

- the management agreement gives the lender more predictability of the revenue. This is the key driver for lenders but is at odds with investors who are seeking to maximise revenue via franchise arrangements.

- particularly relevant if the hotel is newly developed, the lender can rely on the operator to have and maintain proper systems, for example for bookings and payments.

We know of course that there are several lenders in the market who will lend on hotels operated under a franchise but their pricing will reflect what they consider to be the increased risk factors. If the investor is well established and has a track record of expertise in carrying out operations itself and a presence in the market which allows them to exert control on the brand, lenders are generally able to get comfortable with the franchise arrangements. However, for those investors who do not yet have that proven track record in operations, it seems that entering into a management agreement with an established hotel operator will give them the greatest flexibility to obtain finance.