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Archive for August, 2009

In the last posting we discussed the most popular form of “privatization” agreement that is in place at municipal golf courses in the U.S. – the all-encompassing full service management agreement. This is an agreement whereby the municipality pays a fee to a private company to operate a golf facility for the municipality, but the municipality still owns the revenue. An alternative to this agreement is the lease agreement, whereby the private company pays a fee to the municipality for operation of a municipal golf course while the operator owns the revenue.

The primary goals of an operating lease are to relieve the municipality of all operating concerns, to ensure a minimum rent payment to the municipality (or at least eliminate the losses), and to improve and/or protect the asset. An operating lease is similar to a management contract in that the lessee, like the management firm, hires all employees and is responsible for the day-to-day operation of the facility. The difference between the two is that the full economic risk of the operation is shifted from the municipality to the private company in exchange for the opportunity to earn higher revenues and profits than the municipality was able to generate. The lessee would be committed to pay the municipality a fixed rent, pay all operating expenses, supply equipment, and typically provide some capital for investment in the golf facility.

In exchange for incurring all operating expenses and at least sharing capital upkeep, the private lessee would receive most (if not all) of the revenue and pay the municipality either a flat payment (flat lease) or a percentage of revenue (percentage lease), in conjunction with a guaranteed minimum base payment. Leases have several advantages and disadvantages, including:

Advantages to Leasing

 

  • Burden of Risk. Leasing the facility to a private entity shifts the burden of operational risk to the lessee. This includes the risk associated with rapidly rising expenses, as well as downturns in rounds played and revenues. The only expenses remaining with the municipality will be those associated with administering the contract, oversight, and compliance.
  • Simplicity. The municipality would be relieved of the day-to-day responsibility in maintaining and operating these facilities. (As with all management options, the municipality should still have a person who has golf course expertise monitoring the operation and enforcing contract compliance).
  • Capital Improvements. Depending on the relative attractiveness of the business opportunity to the private sector, the lease terms could require (or at least incentivize) the lessee to make, or at least contribute significantly to, needed capital improvements.
    •Maintenance Equipment. The lessee is often responsible for providing maintenance equipment and golf carts.

Disadvantages to Leasing

 

  • Control. This lease option offers public agencies the least amount of control over the golf course operation, especially with regard to:
  •            Pricing. Unless specified in the lease, the lessee may seek free rein over golf fees, likely making the golf courses more expensive to the general public. If the lease has restrictions on raising fees, the lease option becomes less appealing to the private companies that may be bidding for the lease award.
  •         Quality. Unless the contract is carefully executed, the municipality would have little ability to regulate the quality of the operation, as long as the lease terms are met.
  • Profit Motive. This is closely tied to the control issue. If not carefully executed, a lease arrangement may directly conflict with the objective of providing an affordable, enjoyable recreation activity for residents, as private interests (including maximizing return) can often be in opposition to public interests (such as providing a community service).
  • Labor Issues. The lease could lead to public sector employees losing their positions at the golf courses, or at least face reductions in pay and/or benefits. However, given the localized expertise employed at golf courses, it is more than likely that most of the full-time golf employees would be retained by a private operator.
  • Revenue Constraint. As would be expected when one party shares a disproportionately low share of the risk, the municipality would receive less of the upside revenue potential than it would with a management contract. This is likely to be an issue only when the operator is very successful at growing revenues or creating new revenue centers.
  • Long Term. Leases are typically for a long term, especially if capital improvements are included in the lease terms. This makes it difficult to get out of the lease, should the municipality become displeased with the lessee’s operation of the facility.
  • Down Market. The lessee may be forced to cut maintenance expenses and/or raise fees if revenues do not meet expectations. Unexpected golf market downturns often lead to the lessee seeking to renegotiate terms.

Discussion
While leasing of public sector golf facilities was popular in previous decades, its popularity waned in the 1990s as golf revenues were increasing and public agencies began to see what they thought were large sums in golf revenue going to an outside vendor and not being reinvested in the facility. However, since the turn of the 21st century, leases are coming back into fashion for municipal golf facilities, particularly in 2009, with public sector budget challenges. Leasing out the golf operations shifts the burden of operating risk to the private vendor, eliminates large fiscal losses and, in some cases, provides a guaranteed revenue stream to public agencies. In most cases, the vendor will also contribute to, or even completely fund, capital improvements.

Although the appeal of turning everything over to an outside agency does have a lot of merit, especially in terms of transferring operational risk, we should note some downsides of this option. First, the municipality would have much less control over operational issues such as pricing. Secondly, it may be difficult to attract an acceptable vendor with lease terms palatable to both the municipality and the vendor. The public agencies that find trouble in lease agreements often have entered into agreements where one party is doing considerably better than the other. If the deal is too favorable to the municipality, the lessee may struggle, and the asset could suffer as a result. Likewise, if the deal is too favorable for the vendor, the municipality may be sacrificing much needed capital. So it is clear the contract terms are key to any successful lease arrangement.

Thanks for your attention. I sincerely hope the information is useful. In the next postings we will start to discuss issues related to operation of private country clubs and how these facilities can be more economically self-sufficient, especially in these challenging times of 2009.
See you down the road.
Richard Singer

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In the last posting we discussed an alternative to the big management company, noting that some municipalities are using concession agreements when some form of privatization is imminent for a municipal golf course. In this posting, I will be discussing the most popular form of privatization agreement that is in place at municipal golf courses – the all-encompassing full service management agreement. The primary goal of a management contract or management agreement is to provide a golf facility with experienced, professional managers who are responsible for the daily operations, thus relieving the owner (Municipality) of this task. In a typical management contract, the municipality hires a firm that is charged with all management responsibility. The municipality funds capital improvements, and the management firm hires employees. Because employees work for the management firm and not the municipality, payroll cost may be less; thus, the operating expenses may be reduced.

The management firm collects all revenue and provides accounting reports to the municipality. All revenues belong to the municipality, as well as the responsibility for all expenses. The municipality then reimburses the management firm for all payroll expenses and pays the firm a management fee. The management fee is often a fixed dollar amount, a predetermined percentage of operating revenues, or some combination of both. Sometimes, the management firm is paid an incentive that is predicated on percentages of gross receipts or net income, over and above the established minimum revenues. The operating expense budget must be maintained at the original projection for incentives to be earned. Management fees vary depending on the size of the facility and the level of responsibility of the management firm. The length of the typical agreement is relatively short, two to five years, and may include option periods. Management fees paid as compensation in these agreements typically fall between two and four percent (2% – 4%) of total revenues, or at least $30,000 per facility.

Advantages of Management Contracts

  • Operating costs are likely to be reduced if the management firm hires all employees. There is also procurement and insurance savings through the buying power of a larger company.
  • It is assumed that the company hired has experience and expertise in golf facility operations. Not only can this provide help in operations and maintenance but also in other areas such as marketing and merchandising. Thus the agreement will provide municipalities with “One stop shopping” for golf courses and ready access to a network of professionals in all disciplines of the golf industry.
  • The expertise often provided by experienced management companies will likely include tee time reservation and point of sale systems. There would also likely be cross marketing opportunities with other courses in the firm’s portfolio and operating systems that have been tested and proven successful. The municipality will also gain access to tried and true business plans and marketing programs that have also proven successful in other places.
  • The municipality is removed from day-to-day operation in exchange for a payment of a pre-determined fee plus a percentage of gross revenues or some other formula, which is equitable to both parties. In addition, net revenues (if any) are retained by the municipality.

Disadvantages of Management Contracts

  • Though this option offers the municipality more control than with an operating lease, it offers less control than self-operation.
  • Unlike a lease, management contracts usually do not provide a guaranteed income for the owner (municipality), but rather a guaranteed income for the management entity. The major concern with a management contract is the risk the municipality would be taking relative to shortfalls. The management firm’s fee is guaranteed, as long as the contract provisions have been met (operating risk remains with the municipality).
  • The municipality would still be responsible for capital improvements (which NGF has observed is often a key element in failing golf courses).
  • The municipality would still need some golf staff to oversee the golf operation and maintain contract compliance.
  • Management companies may need to move managers around so as to staff positions that are most appropriate for the management company and its goals. Also, management entities may be tempted to ‘relax’ in the last year of an agreement, unless the entity is strongly motivated to want to renew the contract.

Discussion

This is an option that could produce results, as long as the selected management company is of good quality and is given full responsibility for the operation. Under most true management company scenarios, operating expenses will still flow through to the municipality; however, labor costs are likely to be sharply reduced through the use of efficient effective staffing models and seasonal employees. The overall quality of these types of agreements rests with the municipality’s ability to find a qualified company, negotiate a contract that is “win-win” for both sides, and then provide proper oversight to see to it that the contract is complied with.

In all, the risk would still lie with the municipality, and if the new management company cannot improve revenue performance, the basic fiscal shortfalls that led to this option in the first place would continue with the addition of a new management fee.

Thanks for your attention. I sincerely hope the information is useful. In the next postings we will discuss the operating lease option as a path to improving the fiscal condition of municipal golf courses.

See you down the road.

Richard Singer

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