Story

I spent an hour on a fund call about one word in the management agreement

I'm passive in a couple of things and I read documents for a hobby, so when a sponsor I follow opened a hotel fund I got on the diligence call.

I expected an hour about markets and travel demand. What I got was fifty minutes about the hotel management agreement, and specifically the word termination.

The sponsor's position was that if the operator underperforms, the owner needs to be able to replace them without paying a fortune. The manager's standard form gave them a long term with limited termination rights and a fee if the owner cut it short. There was a performance test in there, two consecutive years of missing both a budget threshold and a competitive index, and one of the investors on the call kept asking what happens in a year when the whole market is down. Everybody misses budget in a bad year. Does the index test save the operator, or does the owner still get to walk?

The sponsor said that's exactly why the index test exists, and that's exactly why the negotiation matters. Then he said something I wrote down, which was that in hotels you're not buying a building with a lease, you're hiring a company and hoping you can fire them.

I still don't know if I'm investing. But I understood for the first time why people say hotels are operationally intensive. It isn't the building. It's that the income depends on people making decisions every day and you're several steps removed from those decisions.

8 replies

brandonlee36Passive

Small portfolio here and the same thing scaled down. My property manager was fine until she wasn't, and getting out of that agreement took a lawyer and four months. Multiply by a hotel and I can see it.

samantha_ruizAU4APRO6

@canton the two consecutive years part is the bit I'd push on. A bad operator gets two years to eat your returns before the test even fires. Did anyone ask about a shorter cure period?

ryanmck27SC2C

I'm studying for a license and honestly the management agreement stuff is more interesting than anything in my course materials. Where does someone even read a sample of one of those?

priya_n21PO1C

This is the exact reason I stay away. I want income without a second job, and a fund whose whole risk is whether they can fire a manager sounds like a second job I'm paying someone else to have.

tylerbrooks9PassivePRO5

@marlow I don't think that's unreasonable. Hotels reprice every night. Everything I'm drawn to is the opposite of that.

raj_mehta14CapitalPRO6

Mostly confused as usual, but is the fee for early termination something the buyer of the hotel later inherits too? Or does it die with the sale?

sonia_alvarez Get yoursPRO6

@vellum depends entirely on the agreement and whether the lender required anything. Some management agreements survive a sale, some can be terminated on transfer, and there's usually a subordination piece where the lender has its own rights if it takes the hotel back. That's document specific and worth a lawyer's read, not a forum read.

monica_tran3SF4CPRO6

The other side of it, from five years running a service business. Owners who can fire you easily are not always the owners who get the best work. The good operators walk from those deals. @canton did the sponsor talk about who they'd actually be able to attract with the terms they wanted?