Exploring Hotel Lease Agreements in Challenging Economic Times

By Guy Stehlik, CEO, BON Hotels

For hotel owners, entering into lease agreements with an operator can be an appealing option as it allows them to transfer the operational responsibilities to the operator while retaining ownership of the property.

In the midst of a challenging economic climate in South Africa, characterised by load shedding, sky-high inflation, and climbing interest rates, the country’s investment appeal has come under scrutiny, with some referring to the country as a ‘failed state’. Magda Wierzycka, co-founder and CEO of Sygnia Ltd, recently went as far as stating that South Africa has become ‘irrelevant’ from an investment perspective.

Hotels, in particular, are facing significant pressure, leaving hotel owners in search of viable options for their properties. Traditional avenues such as hotel acquisitions have become less attractive to investors due to the prevailing uncertainties in the country. There is apprehension surrounding the forthcoming elections and the potential future of post-election South Africa. Moreover, the deteriorating electricity situation, inflation, and a government that frequently makes missteps add to the challenges. In all honesty, it would be considered questionable for anyone to contemplate buying or developing a substantial hotel in South Africa at present.

I believe that one potential solution to address some of these challenges could be found in hotel owners and hotel operators sharing the risk through revenue share and lease agreements. If structured correctly, these agreements have the potential to be a viable alternative for hotel owners in this context.

Navigating the Unique Nature of Hotel Lease Agreements

A hotel lease is a contractual agreement between a hotel operator and the property owner, in which the operator leases the property and assumes the day-to-day operations of the hotel from their own resources. Unlike management agreements or franchise agreements, in a lease arrangement, the operator takes on 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 appealing option as it allows them to transfer the operational responsibilities to the operator while retaining ownership of the property. It enables them to alleviate the concerns associated with the immense challenges of independently running a hotel. Similarly, hotel operators are attracted to the prospect of higher returns and increased control over operations.

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

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

Unlike other businesses, hotels have a significantly longer gestation period before becoming profitable, requiring patient capital from investors. It takes approximately four to five years for a new hotel to reach 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 favorable 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 ones.

Furthermore, considering the South African risk landscape for businesses, with challenges such as electricity, changes to labor regulations, and water shortages, it becomes apparent why the risk can be too great for an operator.

Striking a Balance: Lease Terms for Hotel Operators

A balanced approach that incorporates realistic commercial terms, such as a combination 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 crucial to achieving mutually beneficial agreements. Personally, I am not aware of many hotel operators who possess the legal or commercial expertise to structure these agreements, which is why professional assistance and legal input are essential.

The reality

is that successful lease agreements require meticulous attention to detail, which is often overlooked amidst the excitement surrounding a new hotel entering the market. Conducting thorough building surveys, maintaining essential facilities, and addressing staff takeover before the lease commences are critical steps. There should be absolutely no ambiguity regarding maintenance responsibilities between the lessee and lessor, and these must be clearly outlined in the agreement. It is also vital to consider different lease types and structure them with a legal expert experienced in the hospitality industry and its nuances.

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

The Outlook for Hotel Owners

In the face of a challenging economic climate, hybrid and bespoke hotel lease agreements present a different option for South African hotel owners who may be at their wit’s end, especially those who may have been disenchanted by previous hotel management or franchise agreements.

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