Hotel management contracts have emerged over the years as the prevailing business model arrangement in the hospitality industry. However, they remain largely unknown in the hotel investor community and even more so outside that circle.

Management agreements consecrate the principle of the separation between the hotel’s ownership and operational management. This separation, now globally considered as a best practice, was led by shareholders who were not comfortable being under the obligation of holding two roles simultaneously: a real estate investment with its relatively low return on invested capital and a services business with its dynamic and ever changing requirements.

Most importantly, these agreements are long term strategic partnerships between an owner, whether individual or legal entity, and an operator.

The selection of the operator is often a difficult learning process, especially for new hotel owners who often struggle for the optimal approach to identify the right partner or often the ‘right deal’. Nothing could be further from a good and sound long term arrangement than a ‘good deal’, when the latter is being considered in its transactional nature. Because appointing an operator is about choosing a partner, the cultural fit is of the highest importance.

Dubai’s hospitality landscape presents one of the highest prevalence of management agreements in the GCC. It reflects the sophistication of the hotel ownership structure of what could be considered the backbone of Dubai’s hospitality industry.

After some teething problems, it allowed the creation over the years of long and solid partnerships that has served Dubai relatively well and allowed it to weather some stormy passages due to regional and global challenges.

On a regular basis, JLL and a law firm partner conduct a survey on management agreement contracts over the world and the 2014 exercise illustrate the difference between current practices in mature and emerging hospitality markets.

In line with the new and much improved stance of the stock market and the investment community worldwide towards real estate as an investment option, an increasing number of operating groups have put their balance-sheets to use in order to secure the targeted assets. In this regard, mature markets have been the focus with operator equity contributions of up to $5 million evident in 20 per cent of the contracts analysed for the survey.

This compares to just 8 per cent of contracts in emerging markets and represents a marked change from previous surveys when hotel operators were refraining from taking any part due to the development risk.

Clauses in a management contract which restrict an owners’ exit, either the range of prospective purchasers or timing of sale, are those which could most significantly increase or decrease total returns for an owner. Termination fees have become more complex as operators seek greater compensation for a reduction in tenure, reflecting the importance of non-terminable contracts or alternatively a contract that locks in compensation upon termination.

While overall the proportion of hotel management contracts which allow the owner to terminate at any time without cause or upon sale has reduced over the past decade, JLL’s 2014 survey highlights divergent trends between mature and emerging markets. Termination upon sale was permitted in almost half of the contracts analysed in mature markets but only 15 per cent of contracts in emerging markets.

This shows the value that is being attached to liquidity and market transparency in today’s financial markets.

It should be noted that growth in third-party operating companies in mature markets is adding to the competitive pressures for hotel operators. These companies can often offer more commercially attractive agreements with shorter and more flexible terms (thereby enabling ease of exit), as well as incentivised fees which are profit-linked or subordinated to an owner’s priority return.

Third-party operators will affiliate with a variety of hotel brands for marketing and distribution which is spurring more operators to adopt franchise models as they look to aggressively grow brands over the coming years.

The writer is Head of hotel advisory for the Middle East and Africa at Jones Lang LaSalle.