Hotel management fees on the rise

U.S. hotel owners paid management companies 8.9 percent more to operate their properties in 2005 than they did in 2004.This is according to the recently released 2006 edition of Trends in the Hotel Industry published by PKF Hospitality Research (PKF-HR), an affiliate of PKF Consulting.

This increase in management company compensation occurred during a year when hotel revenues grew just 8.8 percent, and profits jumped 15.5 percent.

“Typically, growth in management fee compensation correlates closely with growth in hotel revenues,” said R. Mark Woodworth, president of Atlanta-based PKF-HR. “With total management fees in 2005 growing at a greater pace than total revenue, it is clear that many management companies also were able to earn incentive management fees. In fact, 40 percent of the hotels reporting payment of an incentive management fee in 2005 did not report one in 2004.”

“The good news for hotel owners is that the incentive fees appear to have been justly earned,” Woodworth noted. “The growth in profits from 2004 to 2005 was 4.1 percentage points greater for those hotels that paid an incentive fee versus those that did not.”

Put a different way, while hotel owners paid an additional $400 per available room in incentive management fees in 2005, the increase was more than covered by the $2,280 per available room rise in profits. Profits are defined as income after management fees, property taxes, and insurance, but before capital reserves, debt service, rent, income taxes, depreciation, and amortization.

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Management fees is just one of the 200 discrete hotel revenue and expense items captured by PKF-HR for its 2006 Trends in the Hotel Industry report. The 2006 report marks the 70th annual review of U.S. hotel operations conducted by PKF. This year’s sample draws upon year-end 2005 financial statements received from more than 5,000 hotels across the country.

Base vs. Incentive Fees

Hotel management fees typically consist of two components—a base fee and an incentive fee. More often than not, a base fee is charged as a percentage of total revenue. In addition, a growing number of management contracts now include an incentive fee that is paid to the management company once a certain profit threshold is reached. The amount of the incentive fee is usually based on a percent of the profits. “Incentive fees are designed to make management more conscious of the bottom line,” Woodworth said. “After all, the owner earns his or her return-on-investment from the profits, not the revenue.”

Of all the hotels that participated in the PKF-HR Trends survey, 54.7 percent reported paying management fees in 2005, but only 11.1 percent paid an incentive fee. For those that did pay management fees, 61 percent of the dollars went towards a base fee, while the remaining 39 percent was paid out for incentive fees. Based solely on the sample of properties that paid an incentive fee, the base fee portion grew 6.4 percent from 2004 to 2005, while the amount paid for incentives fees grew a healthy 56.2 percent.

Other Management Costs

“The 8.9 percent rise in management fees was one of the largest increases among any single hotel operating expense in 2005, a situation that was duly noted by most owners,” Woodworth said. “Because of the sharp rise in fees, many owners are starting to scrutinize all dollars paid to the management company.”

In addition to the base and incentive fees, management companies are frequently reimbursed for such expenses as training costs, accounting fees, marketing services, and travel by company executives. “These charge backs and reimbursables are typically spelled out in detail within the management contract. However, the expenses are located throughout the income statement and often hard to identify,” Woodworth commented. “This creates some angst between owners and operators.”
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