Negotiating Contracts in Tough Times

5th April 2010 (Last Updated April 5th, 2010 18:30)

A significant slowdown in hotel development has seen major players competing like never before, but Accor’s Christian Karaoglanian and Starwood’s Bart Carnahan believe that opportunities remain. They tell Phin Foster about the challenges of negotiating contracts during a downturn.

Negotiating Contracts in Tough Times

While the global hospitality industry may be reeling from record drops in RevPar and an ongoing lack of access to credit, many hotel operators can at least console themselves with the thought that things could have been much worse.

The trend to shed real estate and embark on asset-light strategies was already evident sometime before the bottom fell out of the market and was driven more by the prices being realised for property portfolios and an abundance of buyers than a strategy of risk aversion brought on by gathering financial storm clouds.

Nevertheless, this shift away from ownership in favour of focusing growth on management and franchise contracts had removed a major area of exposure from balance sheets by the time the scale of the crisis became clear. As we start to take tentative steps towards recovery, however, the environment for securing new contracts and keeping the development pipeline flowing has shifted quite dramatically. According to Lodging Econometrics’ 2010 EMEA Construction Pipeline Outlook, pipeline counts have now declined 22% by projects and 23% by rooms since their Q2 2008 peak and are expected to fall further. Europe recently saw its sixth straight quarter of decline.

This all means that the same number of operators are competing for the attention of a dwindling number of properties and, for the first time in a long time, many owners are in a position of strength at the negotiating table. Operators might be forgiven for feeling squeezed by these circumstances and the temptation to cut fees and accept unfavourable conditions in order to stimulate growth must be strong.

“In terms of securing new assets you’re right to say the world’s a much more difficult place that it was a few years ago,” acknowledges Accor’s chief development officer, Christian Karaoglanian. “There’s certainly more competition among operators, but I’d also say that owners are struggling to get better bottom line and are looking to choose who they go into business with more carefully than ever.”

The advantages of being an established global player in a market where risk aversion has become the norm is not lost on Bart Carnahan, SVP of acquisitions and development, EMEA, at Starwood. The brand strength at the disposal of the American hospitality giant offers some counterbalance to owners with increasingly demanding agendas.

“Sure they’re pushing hard,” he explains, “but if you have good value in your brand and can demonstrate a longstanding ability to deliver then you can create at least as much push-back. The playing field is certainly narrowing. Owners are looking to find partners in hotel companies with those strong brands, but equally importantly they want to be sure that the people with whom they’re going into business will be right beside them whatever the condition of the market.”

The small print

“What we’ve maintained is a sense of our brands and the need to protect their integrity, living up to the expectations of the owners who’ve already committed to us. “

Karaoglanian negotiated his first contract 25 years ago in Jeddah; owner and operator are still together to this day. Despite insisting that the negotiation process “hasn’t seen a dramatic change since the collapse of Lehman Brothers”, he does admit that certain clauses have become more significant than they once were. Some aspects certainly received less attention before,” he begins. ‘We’ll now request a non-disturbance clause, for example. The banks aren’t always happy with this but, with properties going bankrupt, it is far more important on our side than it was two years ago. We’ll also resist any termination on sale clause because it makes the duration totally uncertain. Now that operators aren’t generally the buyers, it is also up to us to demonstrate that a property with a brand attached is not necessarily a more difficult asset to sell.”

These are not always demands that can be met, however, and Accor’s CDO admits that adopting a one-size-fits-all approach to contract negotiations is rarely a good idea. “We have to address it on a project-by-project basis,” he explains. “Sometimes it makes more sense to accept clauses we don’t like, but it completely depends on the strategy. Accor couldn’t accept such terms in France, for example, where we’re already the market leader and can feel confident that new opportunities will arise. In a new territory where we’re trying to get a foothold, perhaps some conditions are more tolerable. I never say ‘never’. It is a question of balance between take and give.”

But one mustn’t give too much away in the pursuit of growth. The dangers of deep discounting are well established in the minds of operators, following on from experiences of previous downturns, and there is also a general acceptance of the need to maintain some level of restraint over the terms offered to developers and owners.

“Hotel companies can go one of two ways in the current market,” Carnahan says. “Some may look towards doing deals for the sake of doing deals, dropping fees, terms and requirements in order to build quickly; you can certainly get a lot of traction that way. What we’ve maintained is a sense of our brands and the need to protect their integrity, living up to the expectations of the owners who’ve already committed to us. We’ve really pushed on terms, not because we’re hard guys who want to be difficult but because short-term, illconceived contracts don’t do anyone any favours.

We’ve therefore retained our fee and term integrity. There are various ways we can tweak the deal in order to make the process function better and a lot of work goes into being creative – if it’s a strategic asset we might talk about the possibility of capital in the form of key money, for example. It’s important to be as flexible as possible, but you have to understand the parameters within which you’re working and stick to them.”

Local knowledge

Getting the balance right can be challenging and may vary regionally. Despite the global downturn, Karaoglanian believes that Accor has been able to improve the quality of its contracts in the Middle East over the past few years, for instance.

“Perhaps our guys weren’t so sure of their strengths before and the fact that we’ve started to develop a network out there provides them with more confidence,” he muses. “After all, this is always a question of people. Relationships lie at the heart of whether we succeed or fail. The management contract is a marriage. You see a lot of couples getting divorced who should have never got married in the first place, but we hope to be able to tell before anything has been signed whether this is somebody we can live with for a long time or if there is trouble on the horizon.”

A closer screening of “fiancés” is also well in evidence at Starwood. “Everybody has had to revise who they do business with,” says Carnahan. “I can’t say we go for any particular ‘type’, but there were a lot of opportunities we might have gone full steam ahead at back in the boom years that we’d now take a much harder look at. It’s something we’ve always been good at, but we’ve had to raise our game.”

“This is always a question of people. Relationships lie at the heart of whether we succeed or fail. The management contract is a marriage. “

The interpersonal nature of securing successful contracts is deeply embedded within the organisation and Starwood has been busy over the last few years getting its people into key markets so as to provide the genuine local knowledge that can sometimes be lost to a global player.

“It’s been one of the best moves we’ve made from a growth and development standpoint,” Carnahan believes. “Placing our people at the very heart of a region is critical. It’s all very well for me to enter a market and talk about how successful we’ve been elsewhere, but if you don’t have someone there, speaking the language and making connections, then you simply won’t have the same level of penetration. Local knowledge has to lie at the very heart of a successful development strategy and securing the best terms.”

A major slowdown in cross-border real estate purchases only adds to its importance. The changing makeup of those entering the property market brings new challenges and breeds a degree of uncertainty in what is already an uncertain market, but it may also result in an easier operating environment over time.

“The shift towards private equity has slowed and most of those players have disappeared,” Karaoglanian observes. “They were always extremely keen on termination on sale and that’s why we didn’t do a huge number of deals with private equity even when they were at their peak. There’s a new generation coming in and we are looking towards what new investment funds will do. High net-worth individuals and institutional investment funds are also emerging – we’ve done several deals with an AXA investment fund and Invesco. These players do seem to be in it for the longer term, which works for both parties.”

Carnahan is equally hopeful in regards to what he has seen thus far. “We used to have conversations with investors, urging them not to sell a property prior to it even being finished,’ he begins. “If you’ve made a deal with Party X, the last thing you want to do is find yourself working alongside an entirely new partner almost immediately. Those conversations have become much easier because buyers now seem to be there for the long-haul. Those are the kind of partners Starwood wants to be with – they care about the business and are not interested in the quick-flip.”

With demand still outstripping supply, the next big question is what will happen on the distressed property market. “That’s the piece I’m certainly curious about,” Carnahan agrees. “There are people waiting in the wings who will be very interested in picking up assets at attractive prices, They will then want to link up with the big players and that is an area where we certainly stand to gain.”

Those independents that are also still suffering may also be looking to jump on the brand bandwagon. With new development having ground to a virtual halt in traditional markets, conversion is a major growth opportunity for larger operators.

“At around 25%, Europe is still under-penetrated by branded properties,’ Karaoglanian observes. “Life has become more difficult for independent owners and there is a lot of opportunity there, particularly with a non-standardised brand such as All Seasons. You can have the most efficient manager in the business, but without the sales force behind him you still won’t fill your hotel. Being able to plug into our booking system and the economies of scale a major player provides; that’s looking very attractive right now.”

Although pipelines continue to struggle, the message appears to be that big is beautiful within the current market. Owners may be negotiating harder than they once were, but perhaps larger operators have even more to offer now than they did previously. For now at least, the balance of power remains finely poised.