Challenges and More in 2004
 
October 30, 2003
 
James M. "Jim" Norman- Ft Lauderdale

Hospitality is and remains a unique part of the real estate industry.  Year after year, the challenges facing those involved in it—owners, operators, franchisors, franchisees, lenders, investors and vendors—appear, evolve and reappear in new and more complex versions of old issues reborn and new issues, both foreseen and unforeseen.  This Alert identifies and describes some of the issues and concerns that can be expected to capture the attention of the hospitality industry and demand new solutions in the year ahead.  Some of the challenges will impact multiple disciplines within the industry.  No group in, or wanting to deal with, the hospitality industry can afford to sit back and hope all will work out, somehow.

Help, I Just Gave Away My Rooms. 

This year’s hero will be the company or person who figures out how to reclaim supply and pricing discipline without losing the considerable marketing reach of the Internet.  The Internet is here and it is not going away.  Baby boomers, “Gen Xers” and behind them, the “Gen Yers” love the power of the Internet and must be expected to use it more, not less.  Better distribution systems and greater management of those systems will be a priority for owners and for the brands.  The challenge will only become more intense as new affinity and frequency programs are unveiled.  Companies like American Express and Internet competitors like Expedia and Hotels.com will soon have their own frequent user programs designed to compete with similar programs already in place with every national brand.  Owners, and brands in particular, will need to develop a better strategy and a better communications system both within each company  and among companies (without running afoul of antitrust laws) to balance maintaining brand standards with maintaining occupancy.  Failure of the industry to respond here may result in Internet companies becoming “brands.”  If this happens, will independent hotels replace national brands?  Certainly not in the immediate future, but a long-term trend could emerge.     

Cash Is Still King. 

Money is power.  But it impacts the industry in many ways.  There is the obvious impact of owners needing to satisfy all of the needs and demands of the capital providers, whether that capital is equity or debt (and the many shades of each or a combination of the two).  But there is also the impact of more subtle factors such as the sponsorship behind ownership, particularly if development or repositioning is involved, and the underwriting of the brand.  Certainly there are certain assets in key markets that have developed their own “brand” awareness, and can withstand underwriting without a brand.  This class of assets can usually be relied upon to perform well with or without brand support.  There is a much larger pool of assets that simply must be branded in order to satisfy the Wall Street type lenders.  The recent growth of mezzanine loan programs of all stripes will not alter this very much.  2004 is not expected to be a year of significant RevPar growth (although some growth is expected), so there will continue to be the requirement that owners show solid cash flow consistently able to cover debt service, but achieving RevPar growth will be difficult when wholesalers control blocks of your rooms.

Is This Place Safe? 

For the most past, compliance with the USA Patriot Act is honored in the breach, and security at hotels within the continental United States is less rigorous than a Target or K-Mart trying to prevent theft.  To be sure, there are certain cities or certain assets that present a higher target profile, and have done considerably more to not only appear to be more secure, but in some cases, actually be more secure.  This is an area with a serious disconnect between the Office of the General Counsel, that spends its time worrying about compliance with laws and regulations, like the USA Patriot Act, but never even sees a guest, and the front line staff that is already preoccupied with processing check-ins and check-outs, welcoming guests, and putting out all of the daily fires that come with actually having to deal with and satisfy real people who come to the hotel.  Many brands and companies have not spent the time and money to understand the many new rules and regulations that came on line after 9/11, and even if they have at the corporate level, they have not gotten the word down to the line employees that should be executing corporate policy.  The international catastrophes in Bali, Jakarta or in the Middle East have not been widely discussed domestically and seem to have had little or no adverse impact on U.S. based hoteliers.  We remain only one incident away from driving the industry back down into the depths of despair, but we seem quite willing to ignore it, as if that might make the whole mess go away.  There are engineering and construction methods to prevent loss of life.  They are expensive to the point where 20% would be added to new construction.  Competitive pressures and the economic health of the industry make that an impossible standard.  Perhaps the more important question is whether the traveling public would like to check into a resort that resembled NORAD headquarters.

The Supply Dilemma. 

An oft-repeated quote on this subject is that,  “We are not overbuilt;  we are under-demolished.”  Much of the stock of the industry looks old and tired in many areas.  Yes, there are fewer capital projects.  Yes, there are hotels that drop out of brands, or drop through brand after brand until they finally land somewhere or with no brand.  But they do not seem to go away.  It is not being suggested that the hospitality industry can do anything about this segment of lower end product, other than to find new technologies and designs to dry up the demand for the older products. The market will take care of the rest.  In the limited service sector we expect to see new products brought on line that will allow a smaller number of people to manage a larger number of rooms. The same Internet-savvy customers, who will find the best rate on the Internet without ever accessing the brand’s own Web site, will probably not be offended by checking themselves in at a computer terminal—or won’t be when the technology allows this to work as well as airline kiosk check-in. It’s not here yet.   These same customers will also demand high speed Internet via broadband, not dial-up for free.  The days of not offering high speed Internet access or charging for it are just about over, if not over already in a market sense.

What Are the Lawyers Up To? 

The hospitality industry is no stranger to the courthouse, and that is not likely to change in 2004. Owners and operators will continue to disagree about their respective rights, obligations and operating practices in management agreements, and franchisors and franchisees will carry on their running disagreements about a range of issues, from territorial exclusivity to favoring company operated properties over franchisee operated properties.

We expect to see an appellate court opinion in the Woodley Road case in 2004.  That opinion will either motivate more claims based on an alleged breach of fiduciary obligations and federal and state anti-trust laws, or may make similar cases more difficult.  Most lawyers believe that the malpractice verdict against the law firm that represented Sheraton in that case will not change industry practices in anything like the way that the Woodley Road verdict did.  Industry buzz hints at management agreement structural changes that will make them more like franchise agreements than agency agreements.  Others suggest that we will see operating leases, modeled after the custom in many countries outside the U.S.  There are enough legal, tax and business pitfalls with all of these alternate arrangements that wholesale change is unlikely.  What is likely is that a few companies will try a new approach in 2004, probably in selected cases.  That, in turn, will have to be litigated before the industry can feel comfortable with any structure.

The key litigation issue will be the resolution of the extent of the fiduciary relationship between owners and operators.  From that will flow critical changes in operator disclosure and owner consent requirements with respect to fees, commissions and the sharing of rebates and similar monies.

Employment discrimination claims, with an increasing number based on “English only” requirements and alleged discrimination against Muslim and Arab employees in the aftermath of September 11, will continue, along with sexual harassment and hostile workplace cases.  Such is the nature of an industry with more employees per square foot than probably any other.

There’s More To Come.  

There are even more challenges ahead. Some have not been hinted at yet, but they will arrive during 2004.  Every hospitality player has a list of its own that is property, company and industry-niche specific.  The message for 2004 is that much more time must be devoted to fully vetting these issues and developing strategies to address them, at every level.  The economy is recovering—or is it?  What are the geographies and product types that will flourish?  Which will not fare so well?  How will Wall Street look at the industry as a place for its money?  There are no easy answers to these issues, there never are.  There is an opportunity to develop new paradigms through which to engage the issues and emerge from the pack through creative solutions. These solutions must first be filtered through the lens of current legal restraints.  Each issue that we will confront this year must be viewed in the context of current legal precedent, established through the courts; current legal and regulatory constraints, as established by federal, state and local legislative bodies; and current industry thinking as seen through the eyes of those who have spent years watching our industry develop and mature.  Opportunities should not be missed, nor challenges ignored in the hope they will disappear somehow.  Are you ready?

For more information, e-mail Jim Norman at jim.norman@hklaw.com or call toll free, 1-888-688-8500.