The pitfalls of hotel rentals

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Viability's Guy Wilkinson writes a monthly column for Hotelier Middle East Magazine. This article originally appeared in December 2011.
For more information about Viability, please visit http://www.linkedin.com/company/2347942 or http://www.viability.ae/

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The pitfalls of hotel rentals

  1. 1. 24COMMENT The pitfalls of hotel rentals Viability director Guy Wilkinson ponders the merits of rental or lease plus revenue share models, and questions whether they would ever enable the hotel operator tenant to make any money Well, the answer is that historically, this was quite a common business model. Prior to the Gulf real estate boom of 2002 to 2008, rents were much more reasonable, and the sums involved in these kinds of deal made a lot more sense. Many of the hotels that are still rented are done so on the basis of rents agreed many years ago, with fixed increases independent of trends in the wider property market, that have allowed COLUMNIST them to remain viable. Rent deals are also popular in n my job, I come across an in- particular GCC locations, Makkah I creasing number of hotel own- ers or developers who are look- ing for a tenant to rent their properties. They’ll be asking for, say, US $3-4 million a year for a in Saudi Arabia being arguably the most prominent, where the highly- seasonal pilgrim market with its reduced brand-reliance makes rent deals more logical. decent-sized four-star hotel, which The large global brands will they expect to receive in the form hardly ever accept a rental deal in of four cheques, payable in ad- If an owner has their heart set on renting,Viability’s Guy Wilkinson suggests they stick to the residential market. this region, but there are scores of vance. As simple as that, just the ‘invisible’ or ‘white-label’ opera- same as you or I renting an apart- tors who will happily do so, and ment or villa, only the sums are a also some mid-market chains. bit more frightening! However, my company has just OWNERS LOVE THE RENTAL MODEL undertaken a study to test the via- THE OWNERS’ VIEW BECAUSE IT GUARANTEES THEM REGULAR bility of a lease plus revenue share Look at it this way. Under the terms deal in a prominent GCC capital of a management or franchise con- FIXED CASH FLOWS with a looming oversupply prob- tract, which are the most com- lem and an intensifying rate war, mon methods under which luxury and I can tell you that the would-be hotels are operated in our region, while the owner may still be the one plus profit share approach being tenant realistically had no hope of the owner not only has to incur the to fit out the hotel, it is typically the proposed in theory, the profit share making any money. costs and risk of building the hotel, tenant-operator who takes all the becoming something like an incen- The previous tenant-operator but he also has to foot the bills for risk after that by paying the rest of tive fee. In most cases, the lease plus had been kicked out in disgrace fitting it out, equipping it, staff- the pre-opening costs. revenue share is almost as onerous after becoming deeply indebted. In ing it and then setting the ball roll- It is also the tenant who, once the on the operator as a simple lease. such circumstances, the onus is on ing with a major wad of working hotel becomes operational, then has While hotel owners theoreti- the owners to accept a rent that pro- capital. And all this in return for to desperately peddle as fast as he cally stand to make more money by vides a win-win situation for both only the vaguest of commitments can to make enough money to pay entering into management or fran- parties. Otherwise, if their hearts on the part of the contracted oper- the ongoing operational costs — chise agreements, because their are set on renting, then better con- ator to try and make a profit for above all, that sword of Damocles properties’ profit potential is (hope- vert the hotel into residential apart- the owner — and that, only if trad- hanging over his head, the quar- fully!) a lot higher than the asking ments, rather than to expect opera- ing conditions are perfect and there terly rent instalment. rent, in reality they love the rental tors to perform miracles. HME are no legally extenuating circum- A common variant on the rental model because it guarantees them stances like pesky recessions to deal model is the lease plus revenue or regular fixed cash flows. with. In reality, almost the entire profit share approach, under which investment risk lies with the owner, the base rent is reduced and the WHICH OPERATORS RENT? Guy Wilkinson is a partner of Viability, a which is traditionally why he gets owner gets a share of the total rev- So are there, I hear you asking, specialist hotel and real estate consulting firm to keep the bulk of the profits. enues or profits. I am sorry to say management companies crazy in Dubai. Email him at guy@viability.ae Now under a straight rental deal, that I have only heard of the lease enough to take on hotel leases? December 2011 • Hotelier Middle East www.hoteliermiddleeast.com

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