Skin in the game: sliver equity helps align owner, operator interests - news

NATIONAL REPORT--There are several advantages management companies gain when they invest in the properties they manage. But coming up with investment capital and owners agreeing to the investment are keys to sliver equity, or a management's partial ownership of a hotel it operates, becoming a reality.

Many people in the industry want to see management companies in line with ownership, and sliver equity does that, according to Thomas Prins, principal of Gemstone Hotels & Resorts, which has 12 properties in its portfolio.

"Sliver equity ties things up and it becomes more difficult to terminate the management company," Prins said. "The only hindrance is if an owner needs to terminate the management company. It becomes complicated."

Sliver equity ties management companies to the future of the property and provides an ownership perspective, according to Bruce Kinseth, v.p. of Kinseth Hospitality, which has 28 hotels in its portfolio.

"You have a vested interest," Kinseth said. "We like to be owners of real-estate. That's where we think the best place is for our capital. I don't see any drawbacks to having sliver equity."

The financial risk is the only drawback, according to Tom Conran, managing director of Richfield, which has about 30 hotels in its portfolio. Not all management companies are capitalized well enough to put sliver equity in deals.

"Owners would like to know that management companies are in line with their objectives," Conran said. "Sliver equity makes everyone feel a lot better. When management companies have skin in the game, owners know that when they hurt, you hurt, when they prosper, you prosper."

Kinseth Hospitality has sliver equity in 10 hotels.

"We have no problem with third-party management," Kinseth said. "[But] we like to have ownership of the property.

"We're not doing any massive projects," he said. "Most investments are between $200,000 and $600,000. We look forward to doing bigger properties in the 200- to 400-room range."

Mike Marshall, president of Marshall Management, which has about 20 properties in its portfolio, said the company has sliver equity in three of the hotels it manages and two that are under construction that it will manage.

"We could not buy the hotels on our own, so we put together an investment group," Marshall said. "We put up the cash next to other owners. The management company itself doesn't have any equity, but the principals do. It's a personal investment that benefits the management company.

"We're choosy about where we're putting our personal investment," he said. "There are instances where we told owners it won't work. Many owners feel if we do put money into a deal, we'll keep a closer eye on it, whereas we run every hotel the same. It does happen with other [management companies]."

Kinseth said his company doesn't give special treatment to the hotels it has sliver equity in.

"I don't have time to think about, 'Do we own this one or that one?'" he said. "It's impossible to send that message to the operational team. We don't go over the ownership structure with them."

Kinseth said some owners don't want third-party managers to have sliver equity because ownership might need to light a fire under management or have to buy the management company out. Other owners want the management company to have sweat equity in it because owners would be less prone to fire a partner.

Marshall said his company is involved with a new build in which the owner doesn't have hotel experience and the lender required a management company to have equity.

"Lenders want management companies to have a piece of equity, especially newbies to the industry," he said.

Prins said sliver equity isn't critical.

"Sliver equity is a psychological thing," he said. "We don't have buckets of cash [to invest in properties].

Prins said Gemstone's mission is to have sweat equity, which means putting resources into a hotel at the management company's risk. Sweat equity is different than sliver equity, but it's still a way to align management companies with owners.

Conran said Richfield has several sliver equity initiatives to place in hotel real-estate. He said there are fewer management opportunities today than in the past because of the number of hotel management companies that own, making the pool smaller.

"People want to align with fewer rather than more for a lender to feel stronger because underwriting is more stringent," he said. "Whether you have money in it or not, we align core competencies."

Prins said there was a point in the hotel industry's past when management companies rarely had part ownership.

"The Apollo [investment funds] of the world said management companies needed to be more aligned with ownership," he said. "This happened during the mid-1990s."

Marshall said the only way to gain wealth is to have a piece of ownership in something that will appreciate in value. He said that of all the management companies that have sliver equity in hotels, half of the actual companies have the investment and the other half are individual principals of the companies.

"I've gone into certain deals and felt it was going to be a home run and offered money and got turned down, but still offered to run the property," he said. "I've been turned down more than I've been accepted. It depends on the temperament of the owner."

Pros and cons of sliver equity to management companies

Pros

* return on equity

* secures management contracts

* have less micromanaging from ownership

* control company's future better

* long-term continuity

Cons

* having to come up with the capital

* can deploy money differently to grow the management company

* risk of losing cash and tarnishing company's reputation if it partners with the wrong owner

Source: H&MM research

jwalsh@advanstar.com

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