I am indebted to Dr. Johan R. Edelheim of Southern Cross University Lismore, for the foundation of these slides.

Dr Johan R. Edelheim (PhD)Lecturer, Hotel and Resort Management

Southern Cross University, Coffs Harbour CampusPersonal researcher page:

http://works.bepress.com/johan_edelheim/

Asset Management

The maintenance plan Maintaining the facility

Maintenance planning Maintenance processes Refurbishment / renovations / obsolescence

This week: Appraise the economic factors that

influences the hospitality industry; Define asset management in more than

one way; Distinguish the importance of asset

management to both owners and operators;

Compare current issues in the negotiation of management contracts

Next topic: Risk Management

Reading 5.1; Powers, T & Barrows, CW 2006, ‘Forces Shaping the Hotel Business’;

Reading 5.2; Bridge, D & de Haast, A 2004, ‘Asset management’;

Reading 5.3; Schlup, R 2004, ‘Hotel management agreements: Balancing the interests of owners and operators’;

Reading 5.4; Eyster, JJ 1997, ‘Hotel management contracts in the U.S.: The revolution continues’.

Cyclicality in the Hotel IndustryContraction / ExpansionPeak / ThroughSpecial EventsExpansion of major brandsIncreasingly segmented room

products

Business cycles are not regular, predictable or repeating cycles like phases of the moon. Their timing changes unpredictably. But all cycles have some things in common. Every cycle has two phases:

A contraction, which is a slowdown in the pace of economic activity;

An expansion is a speed-up in the pace of economic activity; And two turning points: A peak, which is the upper turning point of a business cycle

where an expansions turns into a contraction; A through again is the lower turning point of a business cycle,

where a contraction turns into an expansion Exceptions to the peak/through is for example in times of special

events in the regions – such as the Olympics, or World Cup Football

Other ‘illogical’ expansions in times of economic downturn in a market can be attributed to major brands filling gaps in their network of hotels, or developers seeing a gap in a specific segment’s offerings, such as a ‘no-frills’ hotel in a market saturated by 3-5 star hotels.

Securitisation and Hotels as Investments Cost of capital Financing mix Capital structure theory Hotel Investment decision: Financial; Real

estate; Operating Mixed use developments – trend of the future? CMBS Commercial Mortgage Backed Security

& mezzanine financing – both Debt finance/ REIT / Public fundingReal Estate Investment Trust ‘ paper-clipped’ to management companies IPO (initial public offering) – Equity finance

is related to the opportunity cost of using money to invest in new projects. If, for example, an investor has $100 of cash that can be invested in any way possible – the first calculation that always has to be done is the ‘risk-free return’ on investment. As a general rule no project should be undertaken where the rate of return is less than the cost of capital – as the opportunity cost for the money then has been wasted

refers to the proportion of equity versus debt used to finance a project

The financing mix is constantly more complicated and the capital structure theory aims at finding ‘the optimal capital structure [in order to] minimise the composite cost of capital.

a building core with a range of different users; shopping centres, hotels, f&b arcades; movie theatres, offices, residential apartments, even governmental services such as libraries, schools, etc

Bridge and de Haast (2004):

…the safeguarding of a hotel’s or group of hotels’ earnings,

earnings capacity and value through correct product and service definition, selection of the appropriate operator,

setting of strategic and operational goals and monitoring and adjusting those goals

in the light of changes in both the operating, debt and investment markets (2004, p. 255).

Vazquez Winkler (2003):

The concept of “asset management” basically consists of an exhaustive

follow-up of management performed by hotel operators in benefit to the hotel owner (or, where applicable, the loan companies),

with the main objective of maximising the value of the asset and therefore the value of the investment

(2003, p. 17).

Williams (2005):

A comprehensive, fully integrated strategy, process and culture directed at gaining greater lifetime effectiveness, value, availability, profitability and return

from production and manufacturing assets

Rushmore (1994):

The service of assisting hotel owners

in realising their investment goals.

The asset manager acts as the owner’s agent

or representative to ensure that a hotel

is acquired for a reasonable price;

is then operated properly during the period of ownership;

and ultimately is disposed of at an appropriate time and price

Based on real estate management In the financial services industry

(APTECH Engineering Services, 2001)

Real estate: The oversight of the day-to-day management of real estate property and the responsibility for maintaining and preserving the physical asset

Finance: The process of managing client investments Isn’t the hotel operator also the asset manager?

You would think so ! But…. Most operators don’t think like owners

(or don’t know how to think like owners) Operators have a conflict of interest

They like spending the owner’s money…… Asset management = conflict management

The asset manager works for the owner The principal task of the asset manager is to align the interests of owner

and operator (in the best interest of the owner…..)

The hotel asset manager is both the chief engineer and navigator of a ship that must arrive at its destination with the greatest economy of resources yet at the highest possible speed: Chief Engineer: hands-on, requiring both

technical and personal skills Navigator: strategic, requiring management and

planning skills The Asset Manager has a dual role:

The oversight of operations and the physical asset The management of the capital investment

Monitor ongoing financial performance Actual performance vs. budget and previous years Compare performance against competitive hotels

Monitor the competitive market Track occupancy and rate trends Monitor supply and demand changes

Monitor the asset Maintenance and capital investments Legal and OH&S compliance

Support and review the budgeting process Set positioning and benchmarks against competition “Negotiate” with operating company

Advise ownership about management issues Review general operator performance and spot problems Any other issues that require attention

Understand the ownership and management structure of the hotel and the working relationship between the two entities

Meet with senior executives of the management company to establish a working relationship

Review monthly reports provided by management and assess performance against the agreed operational goals

Visit the hotel on a regular basis and meet with the hotel management team

Report to the owner on a regular basis regarding salient issues

Provide strategic planning advice, acquisition and disposition services and other services as required

Read and fully understand the management contract!

Meet with the corporate-level representatives responsible for the management of the hotel

Review to ensure that the they are effectively managing, marketing and maintaining the hotel

Report related to the management and financial performance of the asset

Ownership structures Private owner Institutional owner Strata titled (income

distribution systems) Banks (administration)

Operating structures Owner operated Management agreement Lease agreement Franchise agreement

• Management contracts– Base fee– Incentive fee– Services and charges– Terms and conditions

• Capital Expenditures– FF&E provisions– Sinking funds

Advise ownership about investment strategies Strategic review in light of owners objectives Create, maintain and enhance value

Monitor the investment community Track comparable sales prices Track cap rates, financing terms etc.

Select and manage operator(s) and consultants Select management company Retain other advisors and consultants (contractors, lawyers etc)

Negotiate and administer contracts Negotiate management and other contracts Monitor compliance with contracts

Approve and monitor capital expenditures Create long-term capital expenditure plan and annual budget Review and approve capital expenditure requests

1. What is in the building portfolio?2. What are the existing physical and

functional conditions?3. What changes are required to

correct existing conditions?4. What will the changes cost (both

now and in the future)?Continued…

http://www.vfa.com/productsandservices/assessment_services.htm?mtcPromotion=mv>YST

5. What are the priorities?6. What information can be used to

strengthen funding requests?7. What is the optimal allocation of

facilities dollars?8. What metrics/benchmarks/reports

can be used to measure success?

http://www.vfa.com/productsandservices/assessment_services.htm?mtcPromotion=mv>YST

Ope

ratin

g str

uctu

res

Owner operator

Multiple Owner /Chain

Lease contract

Management Contract

Franchise contract

Most wide-spread in the quality hotel sector (Schlup 2004, p. 331)

Owner bears most of economic risk Control of costs Remedies of underperformance

Goal of owner long-term success – goal of operator shorter-term success Equity contribution Compliance with standard ‘Ownership’ of guests

Category one or two Mgmt contract

Control of costs: Management fees 1.8% gross revenue, 6.9% gross

operating profit – average term 19 years initially Group charges – have to be specified beforehand what is

accepted Budget – to be approved and negotiated together Control of GM Right to seel hotel asset Remedies of underperformance Stand-aside fee Guarantees Right to terminate Ownership of guest refer to the ownership of guest data produced

at the property. Both owner and operator interested in the IP after their ways part.

Category one – supplies the whole management structure and brand name (such as Hilton, Hyatt, Sheraton)

Category two – supplies management structure – but no brand name – rather utilises strong franchised brands

Favourably viewed by banks and other lending institutions

Services offered: Operating procedures Technical assistance Marketing

Encroachment provisions Franchise fees

Initial fee Monthly fee Advertising fee Training fees

Increased segmentation of marketStutts 2001

Ops procedures – Manuals updated regularly Training programs Standards Cost saving suggestions Purchasing Technical assistance Site location / selection Architectural design Purchasing How to display brand / logo Marketing Logo on consumables Reservation system Integrated advertising Franchisor sponsored advertising for select regions or types of

properties Encroachment provisions: kilometre range between franchisees – high occupancy for certain

might override this clause cannibalisation compensation Equity investment Computer upgrades – demanded by franchisor Initial fee up to US$ 50.000 Monthly fees often fixed plus % of room sales between 3 and 6.5%

Physical assets – the largest single asset category on the balance sheet of many organisations

Investment manager’s role: ‘Maximise return on investment… at a level of risk acceptance’ – simple

Obsolescence at some stage preservation & adaptation

Facility Equilibrium

Fagan & Kirkwood (1997)

Physical assets portion large – emphasis on their management relatively low

Investment manager’s role simple – why is not the same type of thinking applied on facility or asset managers?

All facilities are in need of maintenance, all facilities will at some stage become obsolescent – different types of maintenance needed.

Facility equilibrium refers to the level of maintenance needed to maintain the facilities at a constant level from year to year. This cost increases for each year, but is always lower than if no management structure would be in place, in which case occasional capital expenditures would bring the facilities up to required level for a short time, before dilapidating again

Facility Condition Assessment (FCA)1. Facility Inventory – data standards; two

hierarchies – space & systems2. Facility Evaluation – life-span; deficiency

categories3. Analysis, Forecast and Reports4. Ongoing FM

Facility Condition Index (FCI)

Fagan & Kirkwood (1997)

Data standards are simply categories or fields which describe elements and their measurement units for the evaluation of condition and performance

There are fields for naming each room, building or campus and describing their usage, size, and department to which each belongs

Building systems include envelope,; interior construction; heating; ventilation; air-con; plumbing; electrical; telecom

Systems are sub-divided into single component and groups of assemblies

Utilise existing data sources – link different elements to legal acts available for different components

Compare life-span to available sources, auditing depreciation or other accepted system

Deficiency categories – find suitable categorisation, be aware of downfalls in numerical ranking

Forecast: Facility Renewal Forecasts Facility Condition Index ( the ratio of the cost to correct all

deficiencies identified to the current replacement value of the facility) Optional funding scenarios

1. How does the hotel business react to the business cycle? Explain why hotel building continues after demand turns down.

2. What does securitization mean? How is it affecting the hotel business?

3. What have been the major effects of securitization on competitive conditions in lodging?

4. What to do the acronyms CMBS, REIT, C corp, and IPO stand for? To what to does each of them refer?

5. What is mezzanine financing and what are some of its advantages?

6. What are the hazards of public ownership? 7. How does RevPAR differ from ProfPAR? 8. What are the main elements of a hotel investment

decision? 9. Has segmentation contributed to encroachment?

What are the effects of encroachment? 10. Why did hotel management companies come into

existence? 11. What is the importance of asset management to

lodging owners?