Lease, management or own operation: what a buyer really buys

Two hotels of the same size in comparable locations can differ in price by a third without the difference being visible on either house. It follows from the contract under which they are run.

What a buyer actually acquires is a stream of payments together with a precisely described amount of work and risk. How much of each falls to him is decided by the operating structure, and it is decided long before anyone talks about price.

Under a lease you buy a payment, not a business

Under a lease a tenant runs the house on his own account and pays the owner a rent, so that revenue, staff, cost of goods and occupancy remain his affair. The owner receives an amount that is written into the contract.

For an investor this is the quietest form, because the return can be planned, the administration stays lean and the operating risk sits with the tenant. Banks and buyers accordingly value leased houses as a rule with the lowest risk premium.

That is paid for with a ceiling: if the house runs outstandingly well, the surplus stays with the tenant, and even under a turnover rent, where the payment rises with the business, the owner receives only a share of it.

What matters is in any case not the level of the rent but how far it can be carried. A rent that eats up almost the entire operating result of the tenant is back on the negotiating table after the first weak year, which means one has bought a payment that will be disputed again within a foreseeable period.

Worked example. A house with 80 rooms pays 1.1 million EUR in rent per year. If the tenant earns an operating result of 1.6 million EUR before rent, he retains a buffer of 500,000 EUR, and the rent cover, which is to say the ratio of result to rent, stands at around 1.45. If he earns 1.2 million EUR, cover falls to 1.09 and the next winter decides the fate of the contract. At the same rent there are therefore two very different investments.

The remaining term is part of the purchase price

A lease with twelve years to run and one with three years are two different products, even if the amount is identical.

The short contract forces the buyer to price in a successor, which is to say a renegotiation, possibly a search for an operator and certainly an investment in the house. The long contract ties him for years to a tenant he did not choose.

Examine termination rights, options, indexation and the question of who owes which maintenance, because the division between structure and fabric on the one hand and the interior on the other decides your spending over the next ten years.

Under a management agreement the result is yours, the bad one too

Under a management agreement an operating company runs the house for the account of the owner and receives a base fee on turnover and an incentive fee on the operating result. Everything else, from the staff to the energy bill, runs through the owner.

The whole of the upswing therefore belongs to you, and a good year lands in full in your accounts, a bad one just as much.

This form demands attention, because you need a budget that you understand, monthly figures that you can read and someone who sits opposite the operator as an equal. Where a management agreement is signed and the accounts are then looked at once a year, the owner in effect has an administrator with no counterpart.

For the valuation this means a higher expected return at a higher risk of fluctuation. Buyers who are confident in this form often pay more for the same house than a pure lease investor, because they are entitled to apply a different result.

Own operation is a profession

Own operation is the third form and the one most often underestimated, because here the owner runs the house himself, with his own staff, his own brand and his own responsibility.

Economically this is the form with the greatest leverage, although what is involved is a business with an entry in the land register and not a capital investment. Anyone who comes from the property world and takes over a running house in own operation takes over rosters, collective agreements, hygiene rules and a workforce that is getting a new boss.

There are good reasons for it, because family businesses, houses with a handwriting of their own and small units for which no tenant could be found often run better in own operation than under any brand. That decision should however be taken because one wants to run the business, and not because no tenant happens to be available.

The operating structure decides who pays for renewal

Over the holding period an inconspicuous question has its say, namely who bears the investment when the house is no longer current after ten years.

A lease usually sets out a division under which the tenant renews furniture and equipment while the owner is responsible for structure, fabric and building services. Under a management agreement the owner carries both, because the operator acts on his account, and in own operation the question is answered from the outset.

Work this item through before the purchase, because renewing the rooms in a house with a hundred units is an investment decision with its own financing and not maintenance done on the side.

A franchise is a brand, not an operating structure

The franchise is often named as a fourth variant, which is misleading.

A franchise agreement governs the use of a brand together with its distribution system and standards, but it says nothing about who runs the business. A house can run in own operation under a third party brand, or be leased and still carry a brand.

For the buyer two questions therefore matter: what the brand costs, calculated on turnover and including distribution fees, and what investment it prescribes when the standard is renewed in three years.

Decide first which role you want to hold

Behind the three forms stand three different roles, namely that of the landlord, that of the entrepreneur with a service provider, and that of the entrepreneur. The mistake rarely lies in the choice of form but in buying one form and expecting the role of another.

Settle therefore before the first asset how much operational responsibility you want to carry, how much fluctuation your financing can absorb and whether you have someone who controls the operator. The operating structure follows from those answers almost by itself, and with it the kind of house that suits you.

In the end a hotel is only as good as the contract under which it is run. If you would like a specific house or a search profile assessed in this respect: confidentially, in a conversation.