Picking the lock: The cruciality of key money in hotel deals

You’ve got to spend money to make money. It’s an old adage, but one gaining new attention in the hotel space as global brands shell out big bucks to secure deals.  

Key money, at its most basic, is a payment made by a hotel operator or a hotel brand to a hotel owner to secure a management or franchise agreement. And though there are caveats to it, its attractiveness to owners is that it serves as a kind of self-amortizing loan that, if conditions are met, like the life of the agreement is satisfied, doesn’t need to be paid back. (This is sometimes referred to as a “burn-off” provision, where if the agreement is terminated before the burn-off period, the operator or franchisor is usually due back the remaining key money.) For brands or management companies, key money can be a deciding factor between getting a deal and not getting a deal.  

Sound like a bribe? It’s not far from off; but in an era of higher interest rates that has choked off new development, activated conversions and created cracks in the capital stack, key money, which typically doesn’t exceed more than 5% of the total deal cost, acts as a highly effective inducement. After all, who is going to turn down free money (some strings attached)? 

“Key money is being used more frequently at present,” said Sean Hennessey, founder of Lodging Advisors and a clinical associate professor at the Jonathan M. Tisch Center of Hospitality at NYU. “It is particularly important to help secure new unit growth.” 

Hennessey noted that though key money, historically, was used more by operators to secure management contracts, he is now seeing more franchisors willing to pony up cash to secure their brand name on a building and the attendant franchise fees that come with it. When brands offer key money, he said, they usually ask for deal terms they might not otherwise get, such as a longer contract term or narrower performance termination rights.  

“The marginal cost of bolting one more management contract or one more franchise onto an existing system is minimal; therefore, hotel companies can offer key money and still enjoy a profitable arrangement,” Hennessey said. 

Sonesta International Hotels, which both manages and franchises some 1,100 hotels across 13 brands and eight countries, has selectively used key money as a growth vehicle. As Brian Quinn, chief development officer, attests, key money is a carrot used to motivate an owner: If two companies or brands are similar, all things being equal, an owner may elect to select the one that is willing to deploy key money.  

In his estimation, the swell of key money was borne out of the pandemic and has now carried over through the last 24 months or so. “Demand for lodging is raging, but the cost to build new is high,” he said, citing supply-chain issues and inflation and the ensuing interest-rate hikes by the Federal Reserve to try and tamp everything down. “One way to smooth some of that out is with the brand or the operator providing key money. It’s basically an investment in lieu of fees,” Quinn said. “You write a check at the start of the process of the contract, then you amortize it over the term of the contract, and you’re basically earning less than you would each year as the key money sort of burns off, but it’s fresh capital to get put into the project that accelerates the property improvement plan or reduces the debt or equity component.” 

Fast and Furious 

It’s a bricks-and-sticks race and global brands are now the main competitors vying to win the favor of owners. This is especially true as supply growth has remained restrained and brands home in on hotels that are either up for relicensing or have changed hands.  

“The competition for conversions has become very frothy,” Quinn said. And though distinguishing a brand promise through systems, messaging, positioning and standards matters, key money doesn’t hurt.  

Sonesta isn’t the only brand house leveraging key money for growth; in fact, the bulk of lodging companies are. On a recent earnings call, Marriott International CFO and EVP of Development Leeny Oberg said that key money is involved in some form or fashion in around a third of Marriott deals. “Over a number of years, we’ve seen a bit more key money across more tiers,” she said. In similar fashion, during Hyatt Hotels Corp.’s Q3 earnings call, CEO Mark Hoplamazian made mention that on some deals, “we will deploy key money or invest in the capital stack of the hotel.” 

A Baird Equity Research note put out last summer indicated the rise in key money being put out by the brands, specifically: “The deal environment is competitive, and the global hotel brands are spending more money to win new contracts or maintain existing ones.” 

Baird highlighted the slowdown in new supply and transactions as chief culprits for the increase in key money and, since publicly traded companies, such as Marriott and Hilton, are judged on Wall Street by their ability to add to new hotels to their systems, accretion is needed by any means necessary. “Spending has increased and is likely to remain elevated due to the slowdown in both new-construction activity, particularly domestically, and transaction activity; therefore, fewer deals are available, which is negatively impacting net unit growth,” it noted. “Brands are providing an increasing number of financial incentives to owners/developers in order to win conversion or development deals.” 

Though Marriott said it deploys key money on around 33% of deals in its pipeline, Hilton, as noted in the Baird note, commits key money on only around 9% of hotels in its development pipeline. And while it’s reasonable to think that key money is dispersed on deals in the luxury or upper-upscale space, there has been a spate of key money deployment in lower chain scales.  

Consider Choice Hotels International. Baird noted that Choice’s total spending in 2023 was 21% of gross fees, but the composition has shifted, “from more notes receivables and equity method investments pre-pandemic to more key money spending recently.” Meanwhile, Choice competitor and one-time acquisition target Wyndham Hotels & Resorts’ net key money spending in 2023 represented 9% of gross fees, a high mark for the company. As Baird pointed out, Wyndham’s key money spend increased since the company’s 2018 spin-off, its recent focus on higher-fee-per-room hotels and to trigger growth in its Echo Suites extended-stay brand. Executives have also noted that the increase in key money spend in 2023 was an attendant result of Choice’s hostile takeover bid.  

At the same time, the competition for conversions has made key money a defensive play as brands look to ward off birds of prey. “It’s become so fierce that you’re seeing key money being used to defend existing assets,” Sonesta’s Quinn said. “If you have a marquee asset and it’s at the end of the contract, or there’s a there’s an out, the competition is going to come in with key money.” 

Other times, key money is used to expand, especially a brand’s footprint, and particularly in the higher-end segments, which can have a resultant halo effect. Sonesta, for example, has two hard brands in the luxury/lifestyle space in Royal Sonesta and The James; they are two brands that Quinn said Sonesta could deploy key money to build out.  

Mo Money, No Problems 

Hotel owners now find themselves in an enviable position where key money can come from not only brands, but also from management companies, which traditionally have been a source of key money. But even operators agree: Hotel owners getting attached to a management company just because of the provision of key money is not a winning strategy. If the operator is a dud, in the end, the upfront dollars are not worth it. 

“The operator is of unique importance,” said Mike “Woody” Woodward, EVP and chief growth officer of Atlanta-area management company HVMG. “The difference between good and bad operators can really impact a hotel.” 

Brands play a major role in the success of a hotel—providing and driving large-scale marketing, loyalty programs and distribution; an individual hotel’s P&L is driven by its manager and the various day-to-day levers it pulls to not only generate revenue but contain expenses. And as Woodward put it, when it comes to key money, “If you are an owner enticed by it and if you’re a first-time operator, it could be a very tricky situation that you may not understand until it’s too late.”

Brands may have more incentive to deploy key money since the terms they receive in exchange could turn out to be more lucrative, from the length of the deal to the percentage of royalty fees. Conversely, management contracts are typically constructed with shorter-length terms.  

In some instances, Woodward warned, an owner should eschew key money out of unanticipated consequence. “It may be there’s key money involved, but then the owner wants to sell the property and that money has not burned off over a certain period of time and now they have to repay it,” he said. “It’s educating those owners on what [key money] really entails.” 

Of the 10 or so deals HVMG did in 2024, only one involved key money and the decision was made because the hotel was going through a major renovation and it helped finish out the capital stack. “It was the right thing to do and ensured we were both married to the project,” Woodward said.  

Rob Smith, CEO and president of Denver-based management company Stonebridge Companies, has a somewhat cynical view of key money. In his estimation, key money can create an unnecessary tension within the owner/operator relationship. “Key money,” he said, “has strings attached and we want our owners to be in love with our performance and not married to our HMA.” 

For this reason, Smith maintains that key money coming from the brand is more practical than key money coming from a management company. “It is more advantageous [for] owners from the branding perspective,” he said. They want to have a long-term brand agreement and if funds are needed in the capital stack, it is a great way monetize the branding strategy.” Of course, it’s no free lunch: key money oftentimes comes with not only higher royalties, but less ramping time of fees that allow the property to stabilize and mature.  

Hotel brands are in a competitive race for brick-and-mortar and what can amount to free money is very often a deciding factor in who wins. For owners, having a strong brand is not only good for business, it assists in getting better traditional lending terms and can be equally good when it’s time to sell: Though some buyers like the idea of an unencumbered asset that they can put their imprint on, a strong, cash-flowing encumbered brand can be a no-brainer—one less thing to worry over. 

Key money aside, Smith pointed out that in the triad relationship of owner, brand and operator, “The best scenario is to have a long-term agreement with the brand as this provides stabilization and a performance-based relationship with the operator.”  

And though key money may be having its moment in the sun, it’s not always needed or wanted. “In my experience, developers and owners will use their negotiating leverage to get hotel companies to compete against each other,” said Hennessey. “Some well-capitalized owners still avoid key money if they can get better contractual terms without it.”