Franchisors are requiring franchisees to upgrade their properties to unprecedented levels. It’s happening in every market segment, from premium to economy—and it’s causing serious financial challenges for owners and their lenders.
Franchisors want owners to upgrade so hotels stay fresh and competitive and maintain brand equity, while franchisees are concerned about (1) how easily they will get funding for the required renovations, and (2) if and when they will get a return on their investment. For their part, lenders worry about loan-to-value ratios.
The problem is simple to explain, but it will be more complicated to solve. Let’s examine how we got here, then consider how we can manage our way to acceptable solutions.
Five trends contribute to shaping today’s situation:
• Financial crisis: 2008 to 2012 brought business slowdown, economic hardship and little access to capital. Franchisees were unsure about the future and postponed routine renovations; franchisors understood and agreed to delayed improvements; and, for lenders, lending standards changed dramatically.
• Expiring franchise licenses and bank loans: There was an explosion of 15- and 20-year licenses when all major franchisors introduced limited-service brands during the late 1980s and early ’90s. Asian-American hoteliers, who had avoided full-service hotels, suddenly flocked to the limited- service category.
Many of these licenses, some of which were extended for two or three years during the financial crisis, are expiring now. Also expiring are shorter 10-year licenses that became popular in the early 2000s. Typically, bank loans are tied to the length of the franchise license, so companion loans to these expiring licenses are also expiring.
• First-generation Asian-American hoteliers are retiring: Increasingly, American-born and -educated children are taking over the businesses started by their immigrant parents in the late 1970s and early 1980s. The older generation doesn’t want to take on new debt as they are retiring, while younger owners typically don’t have the financial strength to assume significant debt on their own.
• Brand companies are different: Franchisors that formerly operated as family businesses are now owned by private equity or hedge funds. Most are public companies facing pressure from Wall Street for immediate growth and profitability—pressure that trickles down to franchisees. Relationships and results that were viewed for the long run are now evaluated on short-term financial performance.
Franchisors can grow revenues with more and bigger properties, more brands and more fees from existing properties. However, more properties take time—through conversion, construction or introduction of new brands—and it’s a strategy limited by competitive saturation.
Growth for franchisors is easier and quicker through renovations that enable hotels to charge a higher ADR or perhaps to move up a brand notch with a new entry fee. Often, this strategy comes with a “take it or leave it” approach: The owner can get the renovations done or get out of the brand—and getting out can mean paying liquidated damages of as much as 24 to 36 months in franchise fees.
• Changing guest profile: With Millennials becoming a key target travel group, franchisors are changing traditional decor and amenities to a more creative, “funky” scheme that gives branded properties the look and feel of independent, boutique lifestyle hotels.
There are bold and bright paint colors, large padded headboards, upgraded bedding, quartz bathroom counters and a 42-in. flat-screen television in every guestroom. There are also architectural changes such as walk-in showers and contemporary exterior canopies.
These “back-to-the-box” enhancements typically require taking a hotel down to the sheet rock, so they are expensive. Costs can be $15,000 to $25,000 per room or more, which can total in excess of $1 million even for modest-size properties.
While smart financing is becoming more available, owners and lenders are asking if the magnitude of these mandated investments make economic sense. How long will it take to achieve a reasonable ROI?
The answer will vary by the strength of the brand, market and operator. However, the sad economic reality is that hoteliers who can afford the high initial costs will survive, while those that can’t afford to upgrade will either go out of business or be forced to downgrade to a lesser brand.
Clearly, our industry is currently being pushed by the pain of mandated renovations—yet pulled by the possibilities of progress. So how can we resolve these conflicting pressures?
To franchisors, I say remember that franchising is a people business—your relationship is with the person, not with the box. Develop a renovation plan that is customized and sensible for the brand and the property, but also for the economics of the hotel—and do it with the franchisee’s involvement.
Think about what’s good for both of you and think outside the box, literally. For example, consider a PIP that converts some rooms for Millennial travelers and some for Baby Boomers. Perhaps, designate certain floors or wings of the building for certain types of travelers.
This is similar to having some rooms for the disabled, certain floors for women travelers or having a dual-branded hotel on the same site.
If a franchisee simply can’t accommodate any version of a flexible renovation, then the franchisor should arrange a soft landing in another brand—without any punitive liquidated damages. Owners who have been loyal to a brand for years deserve some special consideration, especially if you want them and their families to continue with your brands.
To franchisees, I say understand the rationale of the franchisor: You must keep your product fresh to stay competitive and to enable RevPAR increases. Of course, you must also balance how much is spent with how much that spending is worth.
Remember that bankers are more than just lenders—they can also be important advisors. The bank wants you to maintain ongoing financial health, which means helping you avoid any economic stress that might cause default on your loan or franchise license.
So, communicate with your banker early and often when you have questions about difficult financial business decisions such as a property renovation.
Never withhold your franchise fees. Some owners mistakenly think this provides some sort of bargaining leverage, but it actually threatens your license, your loan and your credibility. Similarly, avoid hard money lenders—their high rates will put unacceptable pressure on your cash flow.
Finally, franchisees should build a cash reserve for future franchise upgrades and changes. It’s not “if” but “when” renovations will be required.
I’m confident that franchisors and franchisees can come to mutually agreeable answers that avoid costly lawsuits, especially if we are all guided by the business philosophy of automobile executive Lee Iacocca, who is considered one of the greatest CEOs of all-time: “I never made a deal of any lasting value unless the other guy felt he won something, too.”
Nitin Shah is chairman & CEO of Embassy National Bank, which is a community bank located in the Atlanta suburb of Lawrenceville. He also owns hotels and commercial real estate as president of Imperial Investments Group, and is a former chairman of the Asian American Hotel Owners Association.
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