WinHotels / Short-Term Lodging (Passive Hold)

Subordinated the affiliate management fee below the pref, which mattered in year two

110-key select service hotel near a regional airport, $23M capitalization, $8.1M equity raise. I was in for $400k, which was big enough that they'd talk and small enough that I had no illusions about control.

The first draft had the usual shape. Manager was a sponsor affiliate, 3.5% of gross revenue base fee, plus a 1.25% asset management fee on invested equity, both payable from operating cash before the 7% pref. On their base case that's about $290k a year of affiliate compensation sitting in front of me.

What I asked for, and what I got, over about five weeks of back and forth with their counsel and mine:

Base management fee stays where it is at 3.5%, because they wouldn't move it and I understood why. The manager has payroll.
Asset management fee, the $101k one, gets subordinated to the pref in any quarter where distributions aren't paid in full. It accrues without interest and is payable only from sale proceeds after investors get their pref current.
Incentive fee hurdle raised from 9% of gross revenue to a NOI-based test, so they earn the upside fee off profit rather than volume.
A quarterly reporting package with STAR report competitive index included, not just a P&L.

Number three is the one they fought hardest and it's the one I'd keep.

Year two, RevPAR came in about 7% under model on a soft corporate travel quarter and a competitor's renovation reopening. Distributions went to partial. Roughly $101k of asset management fee deferred instead of leaving the property, which was most of the difference between a partial distribution and none at all.

What nearly broke it. Two other LPs in the raise had already signed subscription documents on the original terms, and the sponsor didn't want to amend for everyone. I said I'd pass. They amended for everyone rather than lose the close, which told me something about how tight their raise was.

Securities and partnership terms are a lawyer's job, and mine earned his fee on this one.

Answer

1samantha_ruizAU4APRO6

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.

5 replies

2derekj19SB1B

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?

1ryanmck27SC2C

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

4raj_mehta14CapitalPRO6

I'm still learning what subordination actually means in practice. If the asset management fee accrues without interest and only gets paid from sale proceeds after the pref is current, is it real money to them at all, or did they give you something that costs them nothing if the deal works and everything if it doesn't?

-1hannah_west29 Get yours

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, I'd want to know whether you negotiated the fee terms or whether you just picked a deal that was already conservatively capitalized and the fee terms were a bonus.