The Sovereign Fund of Egypt (TSFE) has just announced that the conditions booklet for the overhaul of Mogamma El-Tahrir will be made available “within hours”. TSFE will give prospective private sector partners a few months’ window to purchase the booklet and submit their bids on the project, which is anticipated to see the Mogamma transformed into a multi-purpose building, including a hotel/apartment-hotel portion, and other parts used for commercial and administrative purposes. Ayman Soliman, TSFE’s CEO, has also announced that the fund is next planning to propose the land where the headquarters of the dissolved National Democratic Party used to stand, near the Egyptian National Museum, for creative private sector development. The announcements come amidst news related to the creation of a company or real estate investment trust (REIT) by TSFE for the management of its newly transferred real estate assets.
These are only some of the assets owned by the Government of Egypt that are currently under refurbishment or development. A large part of the portfolio falls under the umbrella of the Egyptian General Company for Tourism and Hotels (EGOTH), the Holding Company for Tourism and Hotels (HOTAC), the Holding Company for Construction and Development, and generally the Ministry of Public Business Sector (MPBS). MPBS itself is currently overseeing the refurbishment or re-development of iconic buildings and hotels, such as Shepeard Hotel on Nile Corniche in connection with which the ministry has recently signed a management contract with an international operator, Intercontinental Hotel on Opera Square which is planned to be re-built as 5-star business hotel, Steigenberger Hotel Ras Elbar, Steigenberger Tahrir Hotel, and Marriott Menahouse Hotel, which have all been recently refurbished, as well as the to-be built Four Seasons Hotel Sultana Malak planned to be inaugurated in Luxor in 2024.
We have yet to see the planned schemes for the repurposing of the Mogamma, but as of recently, the State’s aim for similar assets has been to maximise the profitability of those buildings tendered for private investment. Hotel Management Agreements, separating the hotel ownership and operations, have been the go-to business model, as opposed to hotel lease and franchise.
A Hotel Management Contract is an agreement between a management company (called the “operator”) and a property owner, whereby the operator assumes the responsibility of managing the property on behalf of the owner, in return for a fee, according to the specific terms negotiated with the owner.
According to HVS surveys, HMAs have in the past couple of decades been the general trend of key global operators in the Middle East, although hybrid schemes (such as “manchise”, which is a hotel management agreement with the option to convert into a franchise) are gaining ground.
HMAs raise a number of specific issues, which are typically the subject of lengthy negotiations, and others which are fairly standard. Below is an overview of the salient points you would normally come across when negotiating these agreements. Points you should be mindful of when negotiating hotel financing are addressed in a separate post.
Term. The initial duration of the HMA typically lasts between 15 and 25 years (in Egypt, recent practice has shown terms between 30 and 50 years). The higher the market positioning of the hotel, the longer the initial term may be negotiated by the operator. Renewals tend to occur in multiples of 5 or 10 years with at least 6-months’ written notice.
Fees. The operator’s management fees should be structured in a way to encourage it to maximise the hotel’s financial performance. Fees are usually split into a base fee calculated as a percentage of gross operating revenue (historically, a flat fee ranging from 2% to 4%, but shifting towards a scaled-up base fee model), and an incentive fee based on a percentage of the hotel’s operating profit (historically, a flat fee ranging between 8% and 10% of the gross operating profit (GOP), but shifting towards a scaled fee based on the GOP or adjusted gross operating profit (AGOP, calculated by deducting the base management fee from the GOP). As hotel owners become more sophisticated, the payment of the incentive fee becomes tied to the owner’s rights, such as the owner’s priority return (whereby the incentive is only paid to the operator after a certain amount or percentage of the initial capital investment has been achieved for the owner, and possibly becomes deferred if the priority return is not achieved in a certain year), and the operator’s minimum guarantee (which is a financial guarantee by the operator to pay a certain amount of money to the owner if it fails to reach the GOP determined in the HMA, typically capped between 4% and 7% of the total revenue).
Key money. Is a financial contribution from the hotel operator to the owner’s costs of investing in the development of the hotel, which is typically paid in return for higher operator’s fees and/or longer HMA term. Unlike minority equity stakes of the management companies, this does not entitle the operator to any equity share in the asset.
Performance tests. Allow the owner to monitor the performance of the operator and to terminate the HMA if the latter failed to meet the agreed performance criteria after a period of build-up between 3 to 4 years on average. Two types of tests are typically used for this assessment: the revenue per available room (RevPAR) and the gross operating profit level for an operating year, both between 85% and 95% on average, with a right to cure allowing the operator to make a compensation payment to the owner in case the operator fails to pass the performance test. The right to cure is generally limited to a certain number of times during the term of the agreement.
FF&E and capital expenditure. Hotels normally create a fund to raise capital (usually a percentage of gross revenue) for the regular furniture, fixtures and equipment replacement. Routine capital improvements are usually funded through the FF&E reserve, but not discretionary capital improvements which target the generation of more revenue and profit, are carried out during significant hotel renovations, and require the owner’s approval and additional funding.
Purchasing contracts. Owners are increasingly focused on the optimisation of their assets’ performance and, in externally financed operations, lenders also must ensure that owners are able to monitor the competitiveness of the operator’s purchasing agreements and any discounts or benefits received by the operator, so they can be priced in the owner’s budget.
Selection of key personnel. Typically, hotel staff are employed by the owner; however, the operator has the responsibility for hiring and training them. The owner’s approval should be required for the hiring of certain key management positions. Owner’s approval is also typically required for long-term outsourcing contracts or deals exceeding a specified amount.
Non-compete. The owner will want to limit the ability of the operator to be involved in other hotels which could compete for the business of the owner’s hotel. The operator will want to negotiate down the area of protection (AOP) by reducing its duration and size (usually, in these negotiations, the higher the market positioning of the hotel, the bigger the radius of the AOP).
Termination. If the operator defaults under the HMA or fails to meet the agreement’s performance test requirements, the owner would want to have the right to terminate the agreement without incurring any liability. The owner may also want to reserve the right to terminate the agreement without cause, but in this case the operator would most likely negotiate a termination fee equivalent to the anticipated return over the remaining period of the HMA. Owners also tend to negotiate the right to terminate the HMA in case of change in control of the operator, especially if acquired by a competitor of the owner. Ensuring a smooth transition on termination or expiry of the HMA is paramount.
In effect, the goal when negotiating HMAs is to avoid areas of uncertainty and conflict and establish trust by producing a balanced draft. Aligning owner’s and operator’s interests and goals is key, as it allows each party to focus on its side of the business while profits are maximised for both parties’ interest.
If you would like to discuss the points to look out for in HMAs, please reach out to Ahmed Mostafa at email@example.com.
Update: TSFE has just announced that it all details have been made available to interested developers and that the agreement with the preferred developer is expected to be concluded by end of Q3 2021.