Hospitality OpCo Investments: Opportunities and Challenges

At this year’s Americas Lodging Investment Summit (ALIS) in Los Angeles, the sun was out, the discussions outside of the Starbucks at the JW Marriott were upbeat, and everyone was looking for their next deal. One theme that surfaced in our conversations at ALIS was the desire among some investors to acquire an ownership stake in the operating companies (OpCos) managing their hotel assets. This concept is hardly new; however, at a time when revenue growth in certain segments of the hotel industry remains muted, sophisticated investment managers and professionals increasingly are exploring ways to enhance returns for their investors. For some investors, real property ownership alongside OpCo investments represents another opportunity to drive profits.

The Case for OpCo Investments: Financial and Strategic Upside

One direct benefit of investing in an OpCo is the potential for increased financial returns. A hotel owner holding an interest in an OpCo gains access to a share of the fees that flow to the operator (i.e., base management fees, incentive management fees, and, when applicable, construction management fees).

Beyond financial returns, OpCo investments can provide enhanced visibility into, and influence over, the strategic decisions affecting an underlying real property — effectively reducing potential structural tensions between operating companies and property-owning entities. A seat at the OpCo table means direct insight into the revenue drivers management teams analyze day in and day out — from occupancy trends and market dynamics to rate strategies and distribution channel performance. This also puts equity holders closer to the people actually running the business, enabling real dialogue with the operators and talent who shape performance. Partial ownership in the OpCo also creates a more direct line of sight into the capital requirements of the operating business itself — helping investors anticipate and plan for any additional funding needed to grow and sustain operations. When the OpCo develops valuable intellectual property (IP) — whether proprietary technology, data systems, or operational tools — an equity stake in the OpCo positions the hotel equity holder with better opportunities to deploy that IP across its broader portfolio, while also opening the door to additional revenue streams through licensing arrangements with third parties. OpCo investments are more than a fee-based earnings play; they are a pipeline strategy for future real estate acquisitions. Partnering with best-in-class operators that operate on behalf of other owners provides access to professionals with superior asset-level expertise, deep institutional relationships across the hospitality ecosystem, and early visibility on assets prior to formal marketing activities.

While OpCo investments can be good for investors, operators also benefit beyond the infusion of equity capital. There is a brand-building dimension for operators worth considering in today’s segmented hotel market: an equity investment can provide the OpCo with the capital and platform it needs to scale its operations, strengthen its industry reputation, and cultivate long-term brand value.

The Challenges: Risks Hotel Owners Must Weigh

Hotel equity holders must consider concentration risk in determining whether to invest in an OpCo. By investing in both the real property and the entity operating it, the hotel equity holder is effectively doubling down on a single business ecosystem. Investing in both the real property and the OpCo managing it does not, in and of itself, limit an investor’s ability to build a diversified portfolio — capital can still be deployed across a range of assets and geographies. The more precise concern is correlation: when a specific hotel asset underperforms, the OpCo managing that property is likely to struggle as well.

Exit timing misalignment is another risk to consider with OpCo investments. Hotel equity holders often operate under mandates requiring positions to be liquidated within a defined window — typically three to seven years — while operating partners, content to keep collecting management fees, typically do not have comparable requirements. The result is a structural mismatch: when the time comes to exit the real property, the equity holder may be required to divest its OpCo stake as well. This mismatched exit timing may lead to reduced returns (or no returns due to a lack of liquidity) on the sale of the hotel equity holder’s interests in the OpCo. This may be mitigated if the hotel equity holder can invest in the OpCo via a separate vehicle that does not include an obligation to liquidate within a defined time frame (or at least not the time frame applicable to the real property investment capital), but whether this option is available will depend on the nature of and restrictions on the hotel equity holder’s capital.

The regulatory framework for operating companies may also present challenges. Certain jurisdictions impose detailed disclosure requirements on the underlying investors and control parties of operating companies to obtain liquor licenses and other operating licenses. Due to the multitiered nature of some investment funds, these disclosures can be problematic and may necessitate further structuring advice and support. Further, in certain jurisdictions, if an investor exercises a certain level of control over an OpCo that manages union hotels, there can be meaningful risk of so-called “union accretion” — a concept under US labor law pursuant to which an investor’s non-union hotels may be added to an existing collective bargaining unit without a representation election.

Finally, investments in the OpCo can complicate the decision to terminate a management agreement. When a hotel owner holds interests in an OpCo managing multiple properties, the prospect of terminating a single agreement may damage the broader relationship with the operator. This could lead a hotel owner to retain the operator and suffer reduced returns in circumstances in which termination would otherwise be the obvious decision.

Conclusion

For hotel owners that understand the complexities and challenges associated with operating companies, OpCo investments may present opportunities to improve returns for their investors. Before investing in an OpCo, hotel equity holders should consider the following:

• Valuation discipline: Ensure the capital invested in the OpCo is deployed at a justifiable valuation. The enthusiasm of a broader deal should not obscure the need for rigorous, independent underwriting of what the OpCo is actually worth.
• Technology and differentiation: Take a hard look at the operator’s technology stack. The question is not simply whether the manager uses technology, but whether that technology is genuinely differentiated — and whether it can drive measurable value for the hotel owner’s assets.
• Capital obligations: Understand what the ongoing capital commitments to the OpCo can and should be. An equity stake rarely is a one-time investment, and unplanned capital calls can erode the returns that initially made the investment attractive.
• Intellectual property rights: Assess whether the OpCo is developing — or is likely to develop — proprietary technology or other valuable IP. If so, negotiate for the right to deploy that IP across a broader portfolio, and explore whether licensing arrangements can create additional fee streams over time.
• Union matters: Given the potential for significant costs and operational impacts across a broader hotel portfolio, carefully assess what entity is the “employer” of hotel employees for labor law purposes, whether that entity already has unionized operations, and what level of operational control the investor will have in the OpCo.
• Exit structure: Consider whether it makes sense for both parties to decouple exits between the real property and the OpCo from the outset. A forced concurrent sale of OpCo interests can result in a drag on returns — and it is far easier to negotiate flexibility up front than to unwind a rigid structure mid investment.