Generally considered as a reward for performance, designed to motivate management to control operating costs and be more mindful of profitability. Typically charged as a percentage of GOP or AGOP and often scaled within bands of percentage GOP.
Depending on the geographic market and segment typically in the range of 5.0% – 15.0% of GOP/AGOP. From time to time regional study summaries are produced by hotel consultants giving indicative fees in specific regions.
Understanding Market Value?: No two hotels are the same, no two markets are the same, no two operators or brands are the same, and the environment is continually changing, more recently in emerging markets to the advantage of the owner. Operators are usually extremely tight-lipped regarding fee conditions accepted in an HMA attaching confidentiality clauses and stressing that each deal is unique. A typical developer approach is to poll several operators and chase the lowest fees or test preferred operators with low counter offers. Such a strategy can be time-consuming, lose focus of the bigger picture or the most appropriate operator/brand and leave value on the table. Engaging a well-informed hotel consultant with in-depth knowledge of HMA deals on your market should help ensure you achieve the optimal agreement balanced for your needs.
Incentive Fee Structures
The structure of incentive fees can vary widely in complexity, the three basic structures are:
Fixed Percentage: Incentive based on a simple static percentage of the GOP or AGOP, usually in a range between 6.0% and 10% depending on the base fee (with a low base fee incentive can significantly exceed 10%), the market, property characteristic and operator strategy.
Sliding Scale: In most markets today probably the most common form of incentive fee typically with between three and five levels of percentage GOP or AGOP threshold whereby the fee is increased in increments on the higher usually with levels in a range between 0% and 15%.
For example: If %GOP is 0% to 19.9%, the fee is paid at 0% of the amount of GOP. If %GOP is 20% to 39.9%, the fee is paid at 7% of the amount of GOP. If %GOP is over 40%, the fee is paid at 10% of the amount of GOP.
Owners Priority Return: The purest form of owners priority return while common in North America is still rare in EMEA whereby fees are calculated only after owners return on capital, such fees would be 10-30% of the remaining cash flow. Still unusual in emerging markets but more accepted in developed EMEA markets is where the incentive calculation remains fixed or scaled as above, but the operator will only be paid in a given fiscal year once a priority return threshold is reached. The incentive fee is subordinated to a predetermined amount of cash flow usually based on the levels of the owner’s initial debt service or a percentage of the project cost. Most often when the threshold is not met, then the fee is deferred to future years, but in some cases may be forfeited entirely.
Incentive Fee Discussion Notes
The Balance of Base & Incentive Fees: Assuming base at 3% total revenue and incentive at 10% on GOP, where GOP is 40%, traditionally the operators expected fee income between base and incentive was split approximately 50:50, with a slight lean towards incentive. An owner’s primary concern is that the operator fees do not impact on their ability to service debt and since incentive fees are closer in the income statement to cash flow to the owner, then it is more aligned and shifting the balance of these fees in favour of incentive should be a priority, other conditions enabling.
Calculating AGOP: As with owners priority return, in general, the more established the market, the further down the income statement an operator may be prepared to consider the calculation of the incentive fee. This is in part because the lower in the income statement generally, the less control the operator has over the costs/deductions. In most emerging markets calculation of incentive would typically be based on GOP. Since AGOP has no fixed definition, the discussion and clarification come down to what are the adjustments to GOP. Generally accepted as AGOP deductions are the base fees, but operators are then reluctant to include items for which they have little or no control. Such entries include FF&E fund, property insurance, property taxes, land rent and capital charges of the asset.
Creative Incentive Fees: With the various threshold levels, optional fee calculation points of the income statement, potential to use past operating results as a base, consideration of the trading environment such as market penetration, and adjustments through the duration of the HMA the hybrid scope for the calculation of incentive fees become almost endless. Nevertheless, it should not be forgotten that it is an ‘incentive fee’, it needs to be easy enough for the managers of the hotel to understand and calculate, should not skew the incentive away from the performance of the hotel and most of all must remain achievable. Incentive fees that turn out to be unattainable can have the opposite effect entirely, especially if the operator is only then able to achieve a base fee.