Very often we have been involved in conversations with clients asking for direction about the required processes for the appointment of management companies. This is a very blurred path for less experienced developers regarding timing or involvement of consultants. Often management companies would suggest getting themselves involved in very early stages. However, this could lead to costly mistakes. But just as often, developers will think of involving management companies too late, which, again, will lead to costly mistakes. So, when should they be involved?
Operator too early
Too early involvement of operators very often leads to issues related to the feasibility plan. Quite often developers involve management companies at a very early stage, thinking that they will give all the direction to the design team and they will somehow work on the feasibility model. This mistake leads to two issues:
Operators will not take the risk of suggesting an inappropriate business model or business positioning. They will ask for the developer to involve consultants to advise them. Operators merely look after their own brand, the suitability of the brand given the market and the project characteristics. Yes, it is true that Operators may provide financial projections but only at advanced stages of HMA negotiations. Developers need to work out the feasibility model themselves and discuss it with the Operator as part of the tendering process.
Operators are agents. They will need to be selected based on a proper tendering model and based on certain criteria and a proper strategy. Involving the operator too early, will mean that the tendering was not done correctly, since the business model is not clear, the expected investment cot is not clear and the anticipated design features are not issued yet. How can a developer select an operator if they are unable to explain (or show them) what they are building? How can the developer compare the different brands to judge their suitability for the project if the developer has not yet defined a solid feasibility and design base?
Loss of negotiation power. Developers should always try to “seduce the operator” to ensure there is a high level of interest from the management company. Remember that the commercial terms offered and negotiated are highly subject to operator interest in the project and in the developer partnership. If the business model is well set, if the concept design is good, if the proposed list of consultants is excellent, then the developer will have a much higher chance to obtain much better commercial terms.
Operator too late
Involving the operator in a late stage of the development is one of the most common mistakes developers make. Developers sometime seem to wake up and ask for an operator only just before construction commences or when the lending institution denies financing because of the lack of a third party operator. The reality is, after the design has been finalized, there are very few changes that can be done and in the majority of cases, or, better, in all cases, the operators bring enormous value during the design stage. So, why would the developer forfeit that value, even if they still must pay for it?
In several cases, the operator will not take a project unless certain changes are made to meet the brand standards. Adjustments in later design stages, are, as expected, very costly and could lead to large delays in construction.
MOU signed but terms not well understood
This is a problem that is linked to inexperienced developers. Since the MOU is “not binding”, several developers rush into signing the MOU just because they think it will be possible to renegotiate later on, once a professional consultant comes on board or when a more senior team takes over. The reality is, if you do not negotiate the MOU properly, two things will happen:
Professional operators will not take you seriously. If you are failing on the basic steps of organising negotiations, operators will know that your team is not professional enough for carrying out the project. As a result, the fee and terms will be much more in favour of the operator, in order for them to justify the extra risk in doing business with an amateur. Why should the developer pay more just because you they are not organized?
Operators will not renegotiate the terms at latest stages, they will always use the “we already agreed in the MOU” line which the developer will never be able to properly combat. In addition, as everyone can imagine, the developer has already lost the best position in the negotiation, since they cannot claim that they have other options because the MOU is not binding, except the fact that the developer will no longer be able to talk to other operators. So, don’t sign an MOU too early!
TSA signed too early
TSAs are contracts that allow operators to be engaged in the design review (and later, pre-opening). Some operators accept to enter into a TSA first and after into the HMA. Some developers think that it is a good idea to sign the interim TSA first, to get the operator involved, in order not to delay the design and construction process while waiting for the HMA to be finalized. The reality is, operators could lock the developer in a very weak negotiation position if the TSA is signed and partially paid before properly negotiating the commercial terms. Other operators will then no longer be a possible option because the developer will not want to lose the initial payment already made under the TSA, so, the developer negotiation position will be seriously compromised.
In summary, a real estate developer should always have a very clear understanding of the process of engagement of partners or consultants. The operator is not a short term consultant, they are engaged for 15 years contracts, much longer than the designer, project management or construction company. The process of appointing them should be very carefully managed to avoid very expensive mistakes.