Who Attracts Foreign Hoteliers to Local Cities?

In Japan, hotels are often run under a lease agreement between the owner of the hotel property and the hotel operator. When it comes to foreign hotels, however, things are handled very differently. For foreign hotels, operating under a management contract is the norm.

April 30, 2019

Get more revenue than under a lease contract

In the U.S.—a very influential player in forming global standards—hotel investment and development are divided into several functions, for example, owners, managers, and operators. In this example, the owner of a property and a hotel management company (often established by the property owner) first enter into a lease agreement, and then the management company and the hotel operator sign a management contract regarding the operation of the hotel. The operator provides its hotel brand and sales know-how, sends its executives, and even recruits hotel staff. It undertakes all of the practical tasks involved in hotel operation. Meanwhile, the management company receives all of the profits produced in the running of the hotel, out of which it pays a certain amount as operational fees to the operator. When a hotel is run under a lease agreement, the property owner gets about 70% of the hotel’s gross operating profit (GOP), and the remaining 30% is left for the tenant—the operator. In cases where there is a management contract, the management company bears certain business risks, including staff employment and variation in profits and losses, but can expect higher returns that match the risks, sometimes gaining as much as 90% of the hotel’s GOP. In countries other than Japan, using management contracts is common, and the management company, or property owner, keeps risks under control and receives a large part of the cash flow. This results in a higher overall property value for the hotel.

Local cities booming as foreign tourists increase

Only a few major developers have actively invited foreign hoteliers to Japan, mainly for redevelopment projects taking place in prime locations in urban centers. However, following an explosive increase in the number of foreign visitors to Japan, whose interests have spread beyond major cities to local cities, foreign hoteliers have started to seriously consider expanding their businesses into local cities. This means that we now see the chance to attract foreign hotels that will make eye-catching projects in local cities, but there are some issues: the abovementioned management contracts. “Under a lease agreement, which is the norm in Japan, operators handle everything involved in the operation of the hotel, and although owners have no say in their operations, they can earn regular income from fixed rent in the long term,” explains Takahiro Kawai of the JLL Japan Hotels & Hospitality Department, who has supported the entry of a number of foreign hoteliers into the Japanese hotel market. “However, when an owner establishes a hotel management company under a management contract, it needs to bear most of the risks pertaining to hotel operation. The operator may provide its know-how and human resources, but it will almost always receive a certain amount of operational fees. Therefore, an operator may not always share a mutual interest with the hotel management company, or the owner, on matters like cost reduction. If the owner is not savvy in hotel management, it will not be able to control the operator, let alone increase the property value of the hotel.”

Asset managers serve as watchdogs for the operator

Today, many Japanese major developers have expressed their intentions to join the hotel business, and, with their large-scale redevelopment projects, encourage foreign hoteliers to open their first hotel in Japan. Many have established their own hotel management companies or hired an asset manager who is familiar with hotel management, and are developing cordial relationships with foreign hoteliers in order to be fully prepared. However, in local cities, there are still areas untouched by these developers as a matter of course. Even if a foreign hotelier shows a desire to open a hotel in these areas, that desire may be dampened by the unfamiliar business practice of a management contract in which the owner has to bear certain risks in operation, and the project might fall through before it gets started. Another possibility is that the hotelier will prefer a Japanese operator that will handle things with a lease agreement—a style they are more familiar with. Kawai says that, behind the scenes, these cases are not surprisingly few in number. Those areas have failed to attract newsworthy foreign hoteliers, and only host Japanese “accommodation-only” hoteliers that lack novelty—they have missed chances to pursue upside risks.

What can be done to attract foreign hoteliers? The point of discussion is—in addition to the issue of a management contract—nothing else but how to have an operator perform to its full capability after signing a contract. In this regard, a hotel asset manager, hired as a watchdog for the operator, plays a key role. “Hotel operation is easily affected by external factors, and is regarded as a business that requires highly professional expertise and has highly volatile income among real property assets. Therefore, revenue may change substantially thanks to a management-savvy asset manager,” points out Kawai. A hotel asset manager monitors hotel management as a proxy for the owner, and keeps risks under control to maximize the hotel’s profit. Specifically, they supervise the operator, measures its performance, identify issues in the operation of the hotel, and find solutions to them.

In Japan, listed REITs (real estate investment funds) developers, and major real estate agencies involved in the hotel business hire their own hotel asset managers, but in local cities, you seldom find in-house hotel asset managers, even in prominent real estate agencies and local developers. The gap between foreign hoteliers that want to open hotels in local areas, and local areas that want to attract foreign hoteliers can be filled using the know-how of hotel operation-savvy experts that hotel asset management services can provide. Filling that gap may accelerate the business expansion of foreign hoteliers outside of major cities.