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Why a successful hotel sale depends on preparation

Originally seen HERE.

Even though interest rates have ticked up slightly, now is a good time to be a hotel seller due to the limited number of properties available in the open market. 

 

Most markets have not seen supply significantly outpace demand, but virtually all properties are still waiting for the return of business travelers and group business. Given all the uncertainties already facing buyers in this market, it is imperative that sellers prepare their properties in advance to take many unknowns out of the equation. This will be a key force in yielding the highest selling price possible.

Preparing to Sell

While sellers of hotel assets currently have a pricing advantage over potential buyers, they still need to be cognizant that buyers remain prudent. To capture the maximum price the marketplace will pay for your property, sellers should recognize that a buyer's uncertainty can be mitigated by properly preparing your hotel for sale. A seller’s failure to deliver buyer due diligence material or other deal information in a timely manner can produce “red flags” for buyers, resulting in a discounted offer price or an elongated contracting process.

 
 

When preparing the hotel for sale, start with attaining a complete understanding of the financial encumbrances on your property, starting with your loan documents. A checklist for the loan review includes prepayment penalties, assumption provisions, fees and required escrows for taxes, insurance and any other escrow requirements. A conversation with an accountant or tax advisor is well advised to provide professional experience or guidance on such documents. Calculating capital gain taxes seems easy at first glance, but depreciation recapture may impact ability—or desire—to sell.

Financing

If your existing financing is a securitized loan that cannot be prepaid, you should determine the cost to defease the debt, especially if your existing loan represents a below average loan-to-value ratio or prohibits any additional debt against the hotel. In many cases, it may be challenging to sell your hotel if sufficient financial leverage can’t be obtained by the buyer or if the loan documents prohibit a franchise change. A handy resource for determining an approximation of the loan defeasance is www.defeasewithease.com. If you believe a buyer may wish to assume your loan, you should contact the loan servicing agent and determine the steps and costs required. Be prepared to guide the buyer through any loan assumptions required.

Review any outstanding capital leases and operating agreements you wish the buyer to assume. Most buyers would prefer to purchase the property without capital leases in place, therefore it is best for you to determine the payoff amounts of such leases. Existing operating agreements are usually acceptable to most buyers; however, you should determine if the vendor’s consent is required to assign the agreement to the buyer. If so, obtain any necessary forms. Be prepared to deliver to the buyer, at or before contract execution, a complete listing of all agreements you wish the buyer to assume along with copies of the agreements.

 

Most owners review their title policy and survey at the time they purchase or construct the hotel and then never look at the policy again or check for liens. Obtaining a title policy update or commitment prior to marketing your hotel for sale is an essential step. A policy update should reveal any mechanic's liens, such as the drywall vendor you hired four years ago and paid but failed to obtain or file the lien release. Mechanic's liens and similar encumbrances should be cleared before you commence marketing your hotel. Keep in mind that anyone can record any claim against your property for a relatively small filing fee with the county clerk and sometimes, errors occur. Ensure your title is clear of any nonroutine liens.

On the Same Page

Sellers should attempt to anticipate the buyer’s due diligence needs and collect the relevant data prior to executing a contract. Providing the buyer the basic due diligence material, precontract, may assist in negotiating a shorter inspection period or, perhaps, limit inspection contingencies to latent defects. A checklist of materials most commonly needed are: existing title report and survey, existing environmental inspection report, detailed listing of all personal property included in the sale, the last two quality inspection reports, detailed income statements for past three years, and, depending upon type of financing sought by the buyer, tax returns for the past three years. One of the most time costly mistakes is the seller’s failure to order the franchise product improvement plan in advance. Providing the environmental report in advance of the contract execution can allow this contingency to be limited to material changes since the last report. It can provide the buyer confidence the property will be acceptable to financing sources as well.

To assure that both buyer and seller are in agreement on the personal property to be conveyed, a good practice is to create a detailed inventory. Some sellers attempt to use depreciation schedules to convey this information, although often this will not provide the specific level of detail necessary to avoid confusion. Also, if there are items on site that will not convey, provide a detailed list or, better yet, remove them from the property.

Detailed income statements should display easily understood income and expense categories that have been consistently used across the years. In the event you have elected to expense unusual items, an explanation of the nature of the items should accompany the financials. This will allow the buyer to produce appropriate documentation for his lender that is consistent with the historical statements. All too often financials presented to buyers display inconsistencies in the calculation of occupancy, average rate, application of payroll expenses, and application of expenses to repairs and maintenance. In some of the worst cases, the statements are presented with a blend of accrual and cash accounting. As you can imagine, these inconsistencies create questions and uncertainty, and can hurt the credibility of the seller. Pick a system and consistently apply it. Tax returns likely will be required by a buyer’s lender; if you have reluctance to provide this information, this should be communicated early in the contract process.

In the event the seller is not subject to Sarbanes-Oxley Act regulations, tax returns often are used by lenders and buyers to verify the property’s performance. A common problem with this method is when multiple businesses are rolled up into a single entity tax return and sellers do not wish to provide the breakout information necessary for verification purposes. One way to solve this dilemma is for the seller to obtain a letter from his tax preparation firm that the profit and loss statements provided were the basis for the tax return.

Clear Communication

When the seller presents their property to the marketplace, it is inevitable that their employees will learn the property is for sale. Sellers should consider sharing with employees that the hotel is for sale prior to the hotel sale advertisement going public, and assure them that you intend to conduct business as you have in the past until such time as the hotel is sold. If appropriate, you may wish to create a bonus program for the employees as a retention tool and to provide a level of security to the employee during what can be an uncertain time for the employees. If your organization contains a certain number of employees, the sale of your hotel may trigger the Worker Adjustment and Retraining Notification Act. Before executing a contract, you should consult with appropriate legal counsel regarding the applicability of the WARN Act to your hotel.

The successful sale of your hotel depends upon your preparation. The seller’s objective should be to provide a buyer with the materials and disclosure the buyer needs to gain confidence in the business operation and the future of the investment. Uncertainty creates discounted offers; don’t discount yourself by failing to be prepared.

Steve Kirby is a principal of Mumford Company.