backThe Saudi Arabian hospitality market is evolving rapidly, with a surge of new hotel and branded residence developments driven by Vision 2030 and increasing investor appetite. As asset owners and investors seek to capitalize on these opportunities, negotiating fair and balanced hotel management agreements (“HMAs”) is critical to maximizing returns and maintaining control over their assets.
This article marks the launch of our “Mastering Hotel Deals in the Kingdom of Saudi Arabia” series, where we provide asset owners and investors with strategic insights into key aspects of negotiating HMAs with international hotel operators in the Kingdom of Saudi Arabia. Each article in our series will explore a fundamental topic—from the various fees involved to key performance tests and termination rights—helping stakeholders make informed decisions in their negotiations.
We begin with one of the most crucial aspects of any HMA: operator fees. While operators prefer to present their fee structures as customary market standard, the reality is that these fees are highly negotiable and can significantly impact the financial success of a hotel project. Understanding how to structure and negotiate these fees effectively is essential for owners looking to optimize profitability and manage their financial outlook for a project.
In this article, we break down the key components of operator fees, common pitfalls to avoid, and strategies for ensuring that fee structures align with owners’ long-term financial objectives.
Engaging Expert Advisors: A Critical First Step
Many investors in the Kingdom of Saudi Arabia acquire hotel assets as part of larger mixed-use developments, often through non-thematic real estate funds that invest in a wide array of asset classes. While these investors—whether institutional or private—may have deep expertise in real estate, retail, or commercial property development, they are not always specialists in hotel operations or aware of the nuances of HMAs. As a result, they can find themselves negotiating highly complex contracts without the necessary industry knowledge to secure the most favourable terms.
Given the intricacies of hotel management and operator fee structures, it is critical for asset owners, including real estate funds and institutional investors, to engage experienced legal counsel, owner representatives and financial consultants who specialize in hotel investments. These professionals play a pivotal role in ensuring that investors make well-informed, financially sound decisions when structuring HMAs. Their expertise includes:
- Conducting Feasibility Studies: A comprehensive market and financial feasibility analysis helps investors assess a project’s revenue potential, operating costs, and anticipated profitability within the context of the broader mixed-use development. For real estate funds, these studies are crucial in determining whether a hotel asset will deliver the targeted returns for stakeholders.
- Assessing Operator Proposals: Hotel operators typically present fee structures that reflect their standard models, but these are often negotiable. Legal advisors with a strong understanding of industry benchmarks can critically evaluate proposed fees to ensure they align with the owner’s financial objectives—especially when investments are structured through funds with specific yield expectations. In our experience, engaging with our clients at the early stages of the term sheet negotiations enables us to add significant strategic value in shaping the key terms of a transaction.
- Structuring Optimal Fee Arrangements: Experienced consultants and legal advisors help balance base fees, incentive fees, and additional operator charges, ensuring that the financial arrangement aligns operator compensation with actual hotel performance rather than simply rewarding the operator at the owner’s expense. This is particularly important for real estate funds managing multiple assets, where ensuring consistent and predictable returns across the portfolio is a priority.
By embracing expert legal guidance in HMA negotiations, asset owners and investors can move beyond simply avoiding pitfalls and instead actively shape agreements that drive profitability, ensure financial clarity, and foster a strong, mutually beneficial partnership with their operator. This proactive approach is essential for effective real estate funds management aiming for consistent and predictable returns across their portfolio.
Empowering Successful Project Asset Management: The Advantages of Expert Negotiation
For asset owners and investors, proactively engaging with legal advisors with expert guidance offers significant financial and operational advantages. The specialized advice of experienced legal professionals empowers investors to navigate negotiations with operators effectively and establish a strong foundation for the long-term profitability of their asset. Some key benefits of seeking expert support include:
- Establishing Fair and Sustainable Fee Structures: Rather than accepting potentially limiting “standard” or “market” fee structures, expert legal advisors can help owners propose and negotiate compensation models that genuinely align with the operator's performance and the owner's investment goals. This ensures a balanced approach where both parties are incentivized for success and the long-term financial health of the hotel project is prioritized.
- Developing Financially Sound Fee Arrangements: Instead of relying on fee structures based solely on revenue, expert financial consultants facilitate the creation of comprehensive financial frameworks for owners to model different fee scenarios. These frameworks accurately reflect the complexities of hotel operations and ensure the owner's profitability is protected, even with long-term considerations. This proactive approach avoids unforeseen financial burdens and fosters a more resilient investment. For instance, an incentive fee based solely on revenue rather than gross operating profit (GOP) can result in an operator being rewarded even when the hotel is unprofitable.
- Ensuring Transparency and Clarity in Costs: Expert legal advisors bring invaluable experience in identifying and thoroughly evaluating all potential operational costs and charges, including system fees, brand marketing fees, reservation fees, and technical service fees. Advisors with experience in hotel investments ensure these costs are clearly defined, reasonable, and benchmarked against industry standards, preventing unexpected financial expenses and maximizing the owner's returns.
- Creating Aligned Incentive Structures for Optimal Performance: By working with experienced legal advisors as primary negotiators, owners can establish performance-oriented fee structures that effectively incentivize the operator to prioritize both revenue generation and cost control. This alignment of interests, often tied to achieving Gross Operating Profits (GOP), Net Operating Income (NOI) or other profitability metrics, fosters a collaborative environment focused on maximizing the asset's overall success and long-term value. This alignment encourages operators to focus on both revenue generation and cost control, ultimately benefiting the owner.
- Harnessing Competitive Dynamics: Savvy asset owners and investors recognize the significant value in strategically leveraging competitive dynamics when selecting hotel operators. Engaging experienced owner representatives and legal counsel empowers them to proactively solicit proposals from multiple high-calibre hotel brands, fostering a competitive environment that yields more favourable financial terms and operational structures. This proactive approach ensures investors are presented with a range of compelling options, leading to informed decisions and maximizing the potential of their asset.
- Ensuring Long-Term Flexibility: Forward-thinking owners prioritize long-term flexibility within their hotel agreements. By collaborating with expert legal advisors at the initial stage of a transaction, they can proactively incorporate crucial elements such as well-defined termination rights, clear performance benchmarks, and strategic renegotiation clauses. This foresight ensures the agreements can adapt to evolving market conditions and allows owners to take decisive action if performance expectations are not met, safeguarding their investment and ensuring long-term success.
Breaking Down Operator Fees: Key Components and Owner Considerations
Unlike traditional lease or franchise models, HMAs are dynamic, performance-based service contracts. As such, operators do not assume the financial risk of the hotel’s operations rather they are paid a series of fees tied to revenue and, in some cases, profitability. Engaging with expert legal advisors is crucial for owners to align the operator's financial rewards with the actual success of the hotel, incentivizing effective management and driving profitability.
While operators often present initial fee structures as seemingly non-negotiable or standard across the industry, proactive owners recognize the significant opportunity to shape these arrangements to better align with their financial objectives and optimize profitability. By gaining a thorough understanding of the various fee components, owners can strategically negotiate terms that enhance control over operational costs and align operator incentives with their own financial objectives. Below are the principal fees and payments typically encountered in HMAs:
- Base Management Fee: Typically calculated as a percentage of gross revenue (not profit), base fees globally usually range between 2% and 4% with slightly lower percentages of between 1% and 3% typically seen in Saudi Arabia and the wider Middle East. Understanding this benchmark empowers owners to negotiate a percentage that appropriately reflects the market and the hotel's specific characteristics, ensuring a fair and sustainable partnership regardless of short-term profitability fluctuations.
- Incentive Fees: Calculated as a percentage of Gross Operating Profit (GOP), incentive fees are a powerful mechanism to motivate exceptional performance. Tiered structures, often featuring increasing percentages as profitability targets are exceeded, create a clear alignment of interests. For instance, paying no incentive fee unless GOP exceeds a certain threshold (e.g., 20% or 30%) and scaling up to a fee of 9–10% as profitability improves—although regionally, the scaled incentive fee usually starts at 5%. Where no incentive fee is paid below a certain threshold, this ensures that the owner receives a minimum return before the operator earns its incentive fee, otherwise known as “owner’s priority return (OPR)”. Although not always accepted by operators, an OPR acts as a vital risk buffer and is increasingly used in negotiations to protect owner interests.
- Technical Services Fee: Paid to the operator for essential pre-opening services in connection with hotel design and development, this fee typically ranges from USD 300 to USD 2,000 per key depending on the operator. Payment is often staggered over time, and in some cases, owners may negotiate a refund upon successful and timely completion of the hotel.
- System and Technology Charges: These include fees for brand-wide services such as reservations, marketing, loyalty programs, and technology platforms—often 2–5% of room revenue. Owners should assess the real value these services deliver and negotiate caps or performance-based structures where appropriate.
- Key Money: A one-off capital contribution made by the operator to secure a management opportunity. While historically uncommon in the region, key money is now more frequently offered in competitive markets. Owners who carefully consider the long-term implications and potential trade-offs associated with accepting a key money proposal can leverage this capital to fuel growth and secure a strong, mutually beneficial partnership.
Laying the Groundwork for Stronger Negotiations
Operator fees are among the most impactful and most negotiable elements of any HMA that allow owners to shape the financial success of a hotel project. Understanding how they function, what benchmarks exist, and how to structure them effectively is essential for owners seeking to maximize value from their hotel investments in Saudi Arabia.
Looking ahead, in our next article, we’ll turn to another critical area of HMA negotiation: termination rights and performance tests. These provisions serve as the owner's ultimate safety net, ensuring that they have meaningful recourse if the operator underperforms or fails to deliver on agreed benchmarks. We’ll explore how to craft enforceable and commercially viable termination triggers, what performance metrics to look out for, and how to retain long-term flexibility in your HMA.