In the hospitality industry, delayed Property Improvement Plans (PIPs) have become a growing challenge for hotel owners. Rising interest rates, supply chain disruptions and financial constraints have forced many properties to defer these essential upgrades, leaving owners searching for creative solutions to keep their properties competitive.
Previously, we discussed why addressing delayed PIPs is critical to maintaining brand standards and guest satisfaction. In this article, we explore the rising trend of key money as a tool to manage PIP challenges, and we review how switching brands using key money can be an option worth assessing โif it suits an ownerโs unique circumstances.
The rise of key money
Key money, a financial incentive offered by hotel brands to secure franchise or management agreements, is gaining traction as a solution for hotel owners grappling with PIP delays. Typically representing no more than approximately 5% of the total deal cost, key money provides upfront capital that owners can use to fund renovations and improvements.
To remain competitive in todayโs crowded hospitality market, many brands are leveraging financial participation like this one to attract properties that are overdue on implementing PIPs or need operational repositioning. These contributions are particularly pronounced in the full-service and luxury segments, where brand competition is fiercest. In many cases, key money not only accelerates much-needed renovations but also helps offset rising costs driven by inflation and interest-rate hikes.
Key money provides immediate capital that can be used to address delayed renovations or reduce the overall debt or equity burden for a project. By structuring this investment as an advance that amortizes over the life of the franchise or management agreement, brands and owners find a mutually beneficial way to move projects forward. The heightened competition for conversions in the market has also led to the strategic use of key money to retain properties nearing the end of their contracts, ensuring they have an option to remain within the brandโs portfolio.
How it works
For hotel owners with overdue PIPs, switching brands with the help of key money is an option worth considering. Hereโs how the process typically unfolds:
- Negotiating key money with a new brand: The owner approaches a new brand that offers key money to fund the PIP requirements. In exchange, the owner agrees to transition the property to the new brandโs portfolio.
- Exiting the current agreement: To rebrand, the owner must terminate their existing franchise or management agreement. This often involves exit costs, such as liquidated damages or repayment of any previous key money received.
- Meeting the new brandโs PIP requirements: While the new brandโs key money might cover the overdue PIPs, additional upgrades may be required to align with the new brandโs standards, potentially increasing costs.
- Rebranding and operational transition: The property undergoes a rebranding process, which may temporarily disrupt operations but can also be an opportunity to reposition the property for better long-term performance.
When does switching make sense?
While the decision to switch brands and accept key money depends on individual circumstances, it may be worth exploring when the following conditions apply:
- Current brand relationship is unsustainable: If the existing brand agreement is no longer viable due to unresolved PIPs, underperformance, a deteriorated relationship or a lack of support from the franchisor, switching might be the best path forward.
- Financial viability: If the new brandโs key money and agreement terms have the potential to outweigh the costs of exiting the current agreement and completing the necessary PIPs, it may justify further consideration.
- Better market positioning: If the new brand aligns more closely with the propertyโs market and guest demographics, the rebranding could drive long-term growth and profitability.
- Access to additional resources: Some brands offering key money also provide marketing, operational and loyalty program support, which can enhance the propertyโs longโterm performance.
Considerations and risks
Switching brands and leveraging key money is a nuanced decision that warrants thorough review. Owners should carefully evaluate the following:
- Exit costs: Terminating an existing agreement can be costly, especially if it involves repayment of prior key money or penalties. These costs can impact on the financial benefits of making a switch.
- Alignment of standards: The new brandโs PIP requirements may differ significantly from the original brandโs standards. Owners must ensure the total cost of compliance is manageable.
- Long-term commitments: Key money agreements often come with extended contract terms and specific performance criteria, potentially limiting the ownerโs ability to adapt to future market conditions or pursue other opportunities. These longโterm obligations should be weighed against the ownerโs overall strategic and financial objectives.
- Operational disruption: Rebranding can lead to temporary revenue loss during the transition period. Additionally, loyal guests of the previous brand may need to be reโengaged, which can affect shortโterm performance.
- Reputation and relationships: Switching brands over key money might make it harder to negotiate clean exits or enter new agreements elsewhere. This is especially relevant in a closely interconnected industry like hospitality, where reputation and long-term relationships with brand operators matter significantly.
Key money is increasingly serving as a strategic tool for addressing delayed PIPs and repositioning properties in a competitive market. While this approach can present valuable opportunities, it is not a oneโsizeโfitsโall solution. Hotel owners must weigh the immediate benefits of key money against the longโterm implications of switching brands โincluding costs, commitments and operational impacts.
For hotel owners and operators navigating the dual challenges of overdue PIPs and rising costs, rebranding with the help of key money is an option worth exploring carefully. A wellโexecuted transition can unlock new opportunities and set the stage for future success, provided it is aligned with the ownerโs longโterm objectives and overall strategic vision.
This perspective piece was written byย Charvi Gupta, senior director atย Getzler Henrich & Associates, a middle-market corporate restructuring and operations improvement firm.ย
