WinHotels / Short-Term Lodging (Passive Hold)

Subordinating the affiliate management fee below the pref is worth negotiating for

Consider a 110 key select service hotel near a regional airport, $23M capitalization, $8.1M equity raise. An investor coming in for $400k is often large enough to get a conversation with the sponsor and small enough to have no illusions about control. A first draft of terms on a deal like this often has a familiar shape. The manager is a sponsor affiliate, charging a 3.5% base fee on gross revenue plus a 1.25% asset management fee on invested equity, both payable from operating cash before the 7% preferred return. On a typical base case that is roughly $290k a year of affiliate compensation sitting ahead of investors. A worthwhile set of asks in that position, and terms worth pushing for over several weeks of negotiation: Leave the base management fee where it is, since payroll makes that one hard to move. Subordinate the asset management fee to the pref in any quarter where distributions are not paid in full, letting it accrue without interest and become payable only from sale proceeds after investors get their pref current. Raise the incentive fee hurdle from a percentage of gross revenue to a NOI-based test, so the sponsor earns the upside fee off profit rather than volume. And add a quarterly reporting package with a STAR report competitive index included, not just a P&L. The NOI-based hurdle is typically the hardest point to win and the most valuable one to hold onto. In a downside scenario, RevPAR coming in about 7% under model on a soft corporate travel quarter and a competitor's renovation reopening would push distributions to partial. With the asset management fee subordinated, that deferred amount is often most of the difference between a partial distribution and none at all. A sponsor that has already signed other investors on the original terms may resist amending for everyone. If pressed hard enough by an investor willing to walk, a sponsor with a tight raise will often amend across the board rather than lose the close, which says something about how much room they actually had. Securities and partnership terms like these are a lawyer's job, and legal review earns its fee on points exactly like these.

wendy_park48 CU1BPRO 17

Answer

samantha_ruizPassivePRO

Vellum, it costs them exactly when it hurts most, which is why it's worth having. In a good year they get paid on schedule and nothing changed. In a bad year the property keeps $101k it would otherwise have sent out, and if the deal ends badly they may never collect it. That's the definition of taking risk alongside you.

Fathom, the part I'd flag for anyone copying this is that the base fee is where the real money is and you left it alone. 3.5% of gross on a 110-key select service is what, $290k a year against maybe $8.3M of revenue? Over a seven year hold that's $2M to the affiliate and none of it moved. You bought a $101k deferral and a better incentive definition. Both good, both small next to the line you couldn't move.

Which is fine, and it's the honest scoreboard. The reason your year two worked isn't the fee terms. It's that the property still covered debt service at 7% below model, which means the debt was sized conservatively at the start. If that same RevPAR miss had happened at a 1.25 going-in coverage, your $101k deferral would have been a rounding error against a cash sweep. The subordination bought you the margin between partial and zero. Original underwriting bought you the margin between partial and default.

samantha_ruizPassivePRO

5 replies

derekj19ServicePRO

The incentive fee change is the interesting one to me from the operations side. Paying a manager off gross revenue means the fastest way to earn more is to sell rooms cheaper. Moving the incentive to NOI at least makes them care what the last twenty rooms cost to fill. Did they push back on the definition of NOI, and where did the reserve deduction land?

derekj19ServicePRO

ryanmck27CapitalPRO

Five weeks of two lawyers for a $400k position. What did that cost you all in, and would it have penciled at $150k?

ryanmck27CapitalPRO

raj_mehta14 PF4BPRO 10

Subordination is worth examining closely in practice. If an asset management fee accrues without interest and only gets paid from sale proceeds after the pref is current, the question is whether that is real money to the manager at all, or a structure that costs them nothing if the deal works and everything if it does not.

raj_mehta14 PF4BPRO 10

hannah_west29 SS2APRO 16

Keystone's last paragraph is the whole thread. Fathom, what was going-in DSCR and was the debt fixed? Because if it was fixed and sized at 1.5 or better, the real question is whether the fee terms got negotiated or whether the deal was already conservatively capitalized and the fee terms were a bonus.

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hannah_west29 SS2APRO 16

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