Proudly flying a brand’s flag is something hotel owners and brands strive for, of course. In fact, it’s been one of the safest bets for an asset as the flag can bring reservation power, loyalty members, brand recognition, operating support and lender comfort. Essentially, all the things that make a hotel easier to finance, market and, ultimately, sell.
But precisely how much is that branded pennant worth nowadays, especially as franchise fees rise, PIPs get more expensive and brand standards become more demanding?
“It is getting harder and harder for brands to justify their all-in fees of sales, marketing, royalty, transaction, frequent guest, etcetera,” says Evan Weiss, co-founder, COO and principal of LW Hospitality Advisors. “Most PIPs post-2020 are 40 to 50 percent higher than they were just a few years ago, and there is no measurable decline in these costs in sight.”
This has led some owners to face an uncomfortable possibility: what if the safest bet is no longer the best use of capital?
A flag too heavy to fly?
Recent financing activity suggests some owners are willing to ask these hard questions. Kapstones recently secured a $175 million guidance facility backed by five hotels across Florida and Texas, with plans to transition the assets from third-party flags into its own proprietary Kompose and Kozy concepts.
For many owners, deflagging enters the conversation when an asset is already at an inflection point. A renovation is due. A PIP is looming. A refinance is approaching. A sale is being considered. A hold strategy is getting re-examined.
In other words, whenever ownership is being asked to spend, refinance or recommit. It’s then that the flag often gets scrutinized in today’s high-cost environment.
Nate Siehr, co-founder of the Big Key Group, a developer focused on branded residences, condo hotel projects and hospitality-backed real estate, categorizes this type of discussion as an economic deflagging.
“Economic deflaggings occur when an owner concludes that the costs of affiliation no longer justify the value received,” he says.
Siehr believes that most sophisticated owners aren’t asking whether they can afford the franchise fees, but whether the net RevPAR premium generated by the affiliation exceeds the total cost of affiliation after accounting for fees, required capital expenditures and operational constraints. Most include an additional analysis on whether the brand is delivering sufficient revenue premiums, loyalty contribution, distribution power, operational support and consumer trust to justify its fees, brand standards and capital requirements.
“If the economics no longer align with the owner’s investment thesis, a change in affiliation – or independence – may become attractive,” Siehr continues.
Weiss adds that any decision should also take the competitive set, competitive landscape and overall positioning, management and quality of the asset into consideration to determine whether the supply, demand and operating environment make sense to go independent, down-flag, up-flag or simply stay the course.
Oftentimes, the final answer is just as varied as the assets.
“We are seeing the deflagging conversation arising in all asset types,” Weiss says. “The issue is much more situational.”
It can depend on the asset’s age, required PIP, capital expenditures, sale and location, for example.
“In other cases, re-flagging, down-flagging, or affiliating vs. branding are all being discussed to add value, reduce capital outlay and increase upside over a hold period,” he adds.
When the flag comes down
Siehr cautions that the deflagging calculation can’t be based on cost savings alone. Owners must also weigh what that flag is bringing to the asset for the price it charges.
“The value proposition extends far beyond the use of a name on the building,” he notes.
That’s because brand companies provide access to powerful reservation and distribution platforms, loyalty programs, revenue management tools, digital marketing systems, information technology infrastructure, global and continental sales organizations, corporate account relationships, food-and-beverage expertise, operational support resources, quality assurance programs, performance benchmarking and extensive consumer marketing platforms.
“When an owner chooses to deflag, the relevant question is not simply how much fee expense can be eliminated, but rather how much revenue contribution, operational support, and infrastructure must be replaced – and at what cost,” he continues. “One common misconception is that deflagging automatically produces significant cost savings.”
While the total cost of affiliation for many major hotel brands often ranges from about 9 percent to 13 percent of room revenue, according to Siehr, those fees aren’t simply profit to the franchisor. Instead, they fund a broad range of systems, services and capabilities that many owners would otherwise need to replace independently.
Weiss sees those replacement costs as the biggest risks for owners considering deflagging, particularly as the shift often leads to higher commissions to online travel agencies, increased marketing expenses, larger sales-office costs and potential affiliation costs elsewhere. Owners also have to determine whether the demand and rate once supported by the brand can realistically be replaced through reinvestment and additional operating spend.
Then there’s the financing aspect.
“Lenders are typically downside focused, while investors look toward the upside,” Weiss adds. “Thus, their risk tolerance is quite different. It is much more challenging to finance an independent hotel flag as the lender is not paid for the upside or savings of a deflagging.”
There are also instances where money isn’t the primary motivator behind a deflagging. In these scenarios, the minds of the brand and hotel owner may not be meeting. Or, at least, they aren’t anymore.
Siehr refers to this as a strategic deflagging.
“Strategic deflaggings occur when either party determines that the asset no longer aligns with the long-term positioning or direction of the brand, regardless of near-term economics,” he says. “Not all deflaggings are signs of distress; many are deliberate portfolio management decisions by sophisticated owners and brand companies.”
There is also vision-driven independence where an owner or developer has a unique vision that simply doesn’t fit within an existing brand framework. This can occur when owners or developers possess an intimate understanding of a particular market or submarket, enabling them to recognize shifts in consumer behavior before they can be reflected in broader brand strategies.
“As consumers become increasingly experience-driven and, in some segments, more brand agnostic, opportunities can emerge for highly differentiated independent hotels that would be difficult to execute within traditional brand standards,” Siehr continues.
These, too, carry risk. Independent hotel owners must sacrifice the benefits associated with major brand affiliation while assuming greater responsibility for creating awareness, generating demand and delivering operational excellence.
Nevertheless, they can be successful, Siehr believes, if a differentiated vision is supported by investor conviction, aligned with the risk tolerance of the ownership group and responsive to evolving consumer preferences. When this happens, independence can create meaningful value, allowing these hotels to achieve pricing power and market premiums that may not have been possible within a conventional brand structure.
Whether the deflagging conversation is economic or strategic, the most important part of any flag-flying partnership is that both parties see and hear the other as they work toward a common goal. If that fails, the flag is bound to falter.
“Successful brand relationships create value for both parties,” Siehr says. “When that mutual value creation no longer exists, deflagging often becomes the natural outcome.”