Co-authored by Hector Medina
Summary
- Owners need to understand the true cost of up-front payments for their resort or hotel property
- While key money may seem like a way to offset initial costs, the negatives outweigh the positives
For many resort and hotel owners, especially those working feverishly to launch a new property, the prospect of receiving an up-front incentive payment from a branded operator often seems too good to pass up. Unfortunately, the financial promise implied by key money is also usually too good to be true. While a cash infusion may seem like a great deal at the start, the numbers often don’t add up in the end.
The scenario generally goes like this: a resort or hotel property under development, or one seeking to change its operational approach, is offered an up-front financial incentive to select a particular management or franchise partner.
Within the operating contract, this key money can be structured in a variety of forms, and it can best be described as a hybrid loan, an equity contribution, or a sunk cost payment tied to the management fees to be collected throughout the life of the agreement. Because it amortizes over the course of the contract, the incentive will likely not have to be repaid — unless the contract is terminated early.
This third option is the most prevalent among hotel chains interested on closing a management deal with a particular hotel project due to its size, location and strategic value, i.e. increasing brand’s footprint in popular resort destinations, allowing members to earn and redeem points at this property.
At the end of the day the goal for an owner should be focusing on the operator/brand that offers the highest long-term profitability for the project and not on the economic power behind the operator. Many brands offer key money as a way to “buy” (close) a deal that is strategic to them, but this may not be the best option for the owner. Of course, the allure of key money for owners and investors is easy to understand. Ramp-up costs for new or converted properties can be steep, and up-front cash can offset the initial financial burden.
Key money may also serve as a symbolic bridge between owners and their management partners, implying a level of confidence and shared commitment that may, upon closer examination of the contract terms, not actually exist.
For management teams and brands, promising an incentive is often the only route into markets or hospitality segments where they lack the experience and expertise to compete. This is particularly true in the Caribbean region, where new resort development is challenging, providing fewer opportunities for new management organizations to enter the picture.
But beneath the myths and easy promises of key money, there’s a much more complex financial reality. Here is a closer look what it all could mean for your resort or hotel property:
Quick Cash vs. Long-Term Profitability
To some extent, key money is similar to a payday advance. While the incentive offered by an operator or franchise may provide some initial financial freedom to ramp up operations, it comes with restrictive strings attached.
Higher fees, hidden restrictions, and a longer contract term typically accompany management contracts that start with cash incentives. As a result, key money can have a direct, negative long-term impact on your resort’s profitability, weighing down the balance sheet with fees, and tying your property — through penalties for early withdrawal — to a partnership that may not ultimately succeed.
Promises vs. Proven Occupancy and RevPAR
Your property’s long-term profitability will also suffer if your management partner offers key money at the expense of investing where it really matters: driving occupancy and revenue.
While up-front cash implies a commitment to financial strength, real commitment to your property’s sustained success is a lasting exercise – one that requires the ability to consistently bring guests through the doors. For new properties, achieving strong occupancy quickly is a particular challenge.
Instead of financial promises in the form of incentives, you should look for a management partner that invests in building a distribution network that will deliver travelers week after week via multiple channels, including online platforms, partnerships with airlines, and, for resorts in key vacation regions like the Caribbean and Mexico, coordinated charter flights. Profitability depends upon the kind of proven experience and access to vacationers that up-front cash can’t buy.
Expectation vs. Experience
One myth of key money is that it binds property owners and investors more closely with their operator or brand. The up-front monetary contribution creates an expectation of good things to come. In reality, experience and a proven track record are indicators of future accomplishments than an early payday.
In fact, franchisors and operators will often suggest key money to ease a hotel or resort owner’s concerns about a lack of direct experience, even though there is no monetary substitute for measurable results. A good example of this can be found in the growing and increasingly profitable segment of all-inclusive resorts.
As traditional European Plan operators with little experience in the all-inclusive arena look to compete in already-crowded markets, they may use key money to gain traction. But all-inclusive resort management is a unique skill gained over time – one that requires an understanding of how to effectively reduce costs while exceeding guest expectations.
So, how can resort owners and investors decide whether key money should be part of the management contract with an operator or brand? Our experience at ALG suggests that the answer is in the numbers.
For instance, ALG serves 3.2 million annual passengers, including 2.3+ million in the Mexico/Caribbean region, through its vacation brands. Our partnerships with airlines provide our travelers with more than 130 weekly winter flights. We offer the largest network of direct flight charters to the Caribbean and Mexico.
These kinds of numbers must play a part in the decision-making process.
In other words, delivering occupancy and revenue over time requires an investment by hotel and resort operators that can be measured by past results, by the number of distribution channels in place, and by the quantity of travelers served, which equate to increased demand for the owner’s resort property.” Ultimately, the real metrics of potential profitability should outweigh a simple up-front percentage payment in the contract.
Previous
