Thought leadership.

Exploring Hotel Lease Agreements in Challenging Economic Times: A Promising Path for South African Hotel Owners

In the midst of a difficult economic climate in South Africa, characterised by load shedding, sky-high inflation and climbing interest rates, the country’s investment appeal has been called into question with some calling the country a ‘failed state’. Magda Wierzycka, co-founder and CEO of Sygnia Ltd, recently went as far as saying that South Africa has become ‘irrelevant’ from an investment perspective.

Hotels, in particular, face immense pressure, leaving hotel owners searching for viable options with their properties. Traditional avenues such as hotel acquisitions have become less attractive to investors due to prevailing uncertainties in the country. There’s anxiousness around the forthcoming elections and what a post-elections South Africa could potentially look like. Added to this is the worsening electricity situation, inflation and a government constantly scoring own goals. So, if we’re honest, we know that anyone would probably need their head read if they were considering buying or even developing a substantial hotel in South Africa right now.

I believe that a one potential solution to some of these challenges could well be found in hotel owners and hotel operators sharing risk in the form of revenue share and lease agreements. If structured correctly, these agreements are potentially a viable alternative for hotel owners here.

Navigating the Unique Nature of Hotel Lease Agreements

A hotel lease is a contractual agreement between a hotel operator and the property owner, where the operator leases the property and takes over the day-to-day operations of the hotel for its “own pocket”. Unlike a management agreement or franchise agreement, in a lease arrangement, the operator assumes greater control and responsibility for the business while the property ownership remains with the owner.

For hotel owners, entering into a lease agreement with an operator can be an attractive option as it allows them to transfer the operational responsibilities to the operator while retaining ownership of the property. It allows them to shed the worries that come with the extreme challenges of self- running a hotel. Similarly, hotel operators enjoy the prospect of higher returns, and increased control of operations.

So, why are there so few hotel leases in Africa?

Many hotel owners and developers typically propose and then expect to apply traditional commercial property terms to hotel lease agreements without considering the unique nature of hotels as commercial entities. This inevitably places unnecessary pressure on hotel operators and their livelihoods, not the mention heightening the risk for hotel owners’ lease agreements.

Unlike other businesses, hotels have a far longer gestation period before they become profitable, requiring patient capital from investors. It takes around four to five years for a new hotel to hit its first “normal” year of trading, whereas other commercial properties, such as shopping centres or offices, generate immediate traction for the property owner.

Although there is a desire among hotel operators to sign leases, the terms must be favourable and tailored to suit the unique commercial needs of hotels. Smaller hotel operators, in particular, often cannot afford the stringent conditions imposed by typical commercial leases, such as 20 or 30-year lease durations, exorbitant lease guarantees, and annual escalations. Despite being the preferred choice for many hotel owners, these lease conditions are often not feasible for most operators, let alone the smaller operators.

Add to this the South African risk landscape for businesses with challenges like electricity, changes to labour regulations, water shortages, and you’ll understand why the risk can be too great for an operator.

Striking a Balance: Lease Terms for Hotel Operators:

A balanced approach incorporating realistic commercial terms, such as a mix of fixed and variable rental components, can mitigate risks for both parties. Engaging hotel lease specialists and ensuring differentiated terms based on the unique requirements of hotels is essential for achieving mutually beneficial agreements. Personally, I don’t know too many hotel operators who are either legally or commercially savvy enough to structure these agreements, which is why professional assistance and legal inputs are essential.

The reality is that successful lease agreements require meticulous attention to detail, which, through my personal experience, is often forgotten in the hype and excitement of a new hotel joining the fray. Conducting thorough building surveys, maintaining essential facilities, and addressing staff takeover before the lease commences are crucial steps. There should be absolutely zero grey areas for maintenance responsibilities between lessee and lessor and these must be clearly outlined in the agreement. It is also essential to consider different lease types, and structure these with a legal expert who is experienced in hospitality and its nuances.

All things remaining equal, hotel owners can potentially benefit from lease agreements by receiving a share of increased revenue generated by operators. This at least offers a way for owners to generate income even when the property is underperforming. Operators, in turn, gain greater focus and motivation to manage leased properties effectively, resulting in improved management, marketing, and revenue generation. A balanced approach should strike a fair balance between operator responsibilities and property owner benefits.

The Outlook for Hotel Owners?

In the face of a difficult economic climate, hotel lease agreements in hybrid and bespoke form offer a different option for South African hotel owners who may be at their wits end; particularly those hotel owners who may have been disillusioned by previous hotel management or franchise agreements.

Mid-market corporate hotels in corporate locations, in particular, hold significant potential to BON Hotels in the lease market, driven by their overall resilience to adverse market conditions, cross-segment appeal and government support. I challenge hotel owners to consider strategic leasing partnerships with us at BON and in doing so, potentially help revitalise their owned hotel businesses.

By Guy Stehlik, CEO BON Hotels

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