Hotel management agreement benefits. (An Advertising Supplement to the Los Angeles Business Journal: Corporate Expansion & Relocation).

Mixed-use projects are exploding. Cities from Los Angeles to San Diego, and from Burbank to San Francisco offer land and incentives to developers to build a hotel or make it part of their office or retail complex. Millennium Partners recently paired its luxury condos with Ritz-Carlton hotels in six locations. Meanwhile, Capital Pacific Holdings is planning to open a new St. Regis Hotel as part of its high-end residential golf community at Dana Point. And, Staples Center's developers are working feverishly to open a convention hotel in downtown Los Angeles. Indeed, hotels are popular components of these exploding mixed-use projects. And it's no wonder. They offer benefits to all involved. Cities want the tax base and economic boost hotels can bring. People want to live, work, shop and spend time in a complex where there is a hotel amenity. Hotels can maximize profitability density, facilitate financing, and appeal to a broader consumer market.

Developers in an unfamiliar setting

This trend to include a hotel in mixed-use developments puts many successful developers in an unfamiliar setting. Although they may have decades and hundreds of millions of dollars of project development experience, most developers are new to the world of hotels. This is a class of real estate where the hotel's operating business associated with the special-purpose real estate determines the value and success of the project. And the hotel industry has its own norms, customs, standards and players.

Most developers quickly learn that hotels are best run by professional management companies under the terms of a hotel management agreement. These are typically long-term agreements that may run for ten years, 20 years, or even longer, particularly with options. Under these agreements, the operators take an extraordinary amount of control over the asset -- which may work well in good times, but may be a financial and operating disaster when things turn sour, and difficult to fix under the typical long-term, "no cut" contract. They can also drastically restrict marketability of the hotel when it is time to sell.

Management Agreements make the difference

In full-service, first-class hotels, the terms of a hotel management agreement can add -- or take away -- 25% of the value of the hotel. It can make the difference between getting the hotel financed and having the hotel remain immovable on an architect's drawing board. It can be the difference between having a bidding frenzy of anxious buyers or only one or two casual bidders. It can mean the critical difference in the owner's ability to take a proactive role in maintaining the proper quality of the property and keeping attention focused on profitability.

According to Jim Butler, Chair of the Global Hospitality Group of Jeffer, Mangels, Butler & Marmaro LLP, "In the hospitality area, developers need more than just lawyers; they need lawyers who function more like consultants, particularly when it comes to the management agreement Butler continues, "However, assisting developers with identifying a brand and operator that will optimize value, quality and profitability for a specific project and market, as well as formulating a strategy and an issue list to attract several of the best operators is just the starting point. This is an area where even the most able developers may meet their match in negotiations."

This is contrary to most developers' intuition. They think that once Marriott or Hilton express an interest, they can relax. Butler says, "In our experience, we have found that it usually takes more than one operator to create a competitive situation to optimize your management agreement terms. We like to use an 'RFP process' -- a request for proposal, whether formal or informal. In this process, we start acclimatizing the operator to the key terms that we have identified with the client to optimize the value of the project. You have to soften them up a little."

An intricate but critical process

Think of a hotel management agreement as being similar to a very long-term lease, where the terms of the agreement will control the value of the real estate for years to come. In some ways, it is even more important, because the standard hotel management agreement comes with recourse to the owner for periodic improvements, operating shortfalls and the like. And in mixed-use projects, the proper maintenance of the hotel may be critical to the success and value of the remainder of the project.

Butler says, "Negotiating a successful management agreement is like a mating dance. If you are smart, you know where you want to go, but you still have to go through each step in a logical process or you can lose everything. And, you have to have stamina to stay the course."

How do you find out what "market" is?

According to Butler, although critical to the value of the hotel, the process of negotiating the management or franchise agreement is not rocket science. He comments, "It is just a matter of finding a lawyer who is in the game on a full-time basis and is willing to tell a client what her alternatives are and when to walk if there is no progress made. It also does not hurt if he/she has negotiated hundreds of agreements".

"Any lawyer worth her salt can understand the literal words in the agreement," says Butler. "The trick is knowing what the term should be, how the options work, what parts of the operator's fees should be subordinated and how deeply to owners' returns (and what they should be), debt service and operating costs. What termination rights should there be on sale, what voluntary buy-outs, what performance standards? Who is the employer of the hotel staff and why? How about non-compete covenants and solicitation or non-solicitation covenants? You only know what the market is if you work in the market on hotel management agreements day in and day out with virtually every operator and brand." he says.

Seeking a balance

Most developers just want a fair contract. They don't want to feel the operator has taken advantage of them, but they don't want to lose 25% of the value of their hotel either, so they have to know what points control the value of the hotel. Butler's Global Hospitality Group is one of the few groups in the country with hotel expertise who represents owners, investors, lenders and operators but has not been co-opted by the operators. Butler says, "We have a unique consulting and legal practice with more than $20 billion of hotel transactional experience in hundreds of transactions all over the world, representing owners, investors, lenders and a handful of operators who will also let us work for our developer and investor client base. We have resisted the temptation to represent operators who won't let us represent owners."

But the key is a fair contract for all -- one that balances the needs of all the parties and gets the deal done. Butler says, "Development deals are very tough in this market, but we are still getting them done. And the management agreement is a critical part of the financing and feasibility of the project."

Jim Butler and the Global Hospitality Group at Jeffer Mangels Butler & Marmaro are internationally-acclaimed as the "premier hospitality practice in a full-service law firm." Acting more like consultants than just lawyers, in the hospitality field, Butler and his team of more than 50 lawyers specialize in helping developers with their first hotel experience in mixed-use projects and caution even the most experienced developers that the "right" management agreement can add, or subtract, more than 25% of the value of the hotel, make the critical difference in obtaining financing and determining the profitability of the project.