Distressed Hotels: A Good Deal?

investment

Savvy investors constantly search for that really “good deal.” For the right purchaser, a distressed hotel may present this opportunity. Properties are distressed for many reasons, lack of revenue being the number one but also overleveraged debt structure, poor operational control, technical loan defaults, and a host of other causes. When the existing ownership gives up—willingly or otherwise—that may be when an opportunity arises.

The acquisition of a distressed property presents special challenges. Frequently, financial records are limited or incomplete. If the owner is not the seller, some of the typical avenues of double-checking reported financials, such as business tax returns or franchise revenue reports, are probably not available. Financials from distressed properties should be approached with a certain amount of skepticism as to their veracity as operational costs may be under-reported in order to attempt to pay debt service or to divert money to the owner. If financials are available, they should be thoroughly reviewed, not only for above-average expenditures but also for a lack of outlays in areas such as marketing, capital investments, and other areas that would impact the property’s reputation.

A potential purchaser should also consider the property’s current viability in its local marketplace. While hotels are a street corner business, there are many factors that might stress a property’s ability to operate profitably. As the current pandemic or the 2008 financial recession illustrate, the macroeconomic environment can have a major impact on a particular property. Other market stressors may be major road construction obstructing traffic in the vicinity, the closing of one or more major demand generators, or an overall decline in either the neighborhood or the market.

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Branding often plays a major role in a property’s financial success. Frequently, the property reaches the end of its economic viability as a particular franchise and that franchise name is lost through maturation of the license agreement or termination by either party. In some markets, a suitable replacement brand may not be available. If a franchise is available, there may be costs involved in the application, renovation, and repositioning processes.

The condition of the property is another consideration. Smart owners realize that an asset such as a hotel requires regular refurbishment and maintenance. Deferring this business expense in favor of extracting maximum short-term profitability has a long-term cost in reduced occupancies and revenue. Deferring repairs, such as a roof leak, may also multiply the problems, leading to environmental and other damage, and eventually, the inability to rent certain areas of the property. This becomes an acute situation when new competition enters the market. Additionally, consumers now have multiple sites and social media where they can share their displeasure with hotel rooms that are dated, dirty, and in which appliances do not function. As the condition continues to deteriorate, the property’s reputation in its market also declines and further impacts the business it can attract.

A competent and experienced real estate advisor can help owners of distressed hotels in preparing and marketing their properties. A hotel is not just a real estate asset but also a cash flow business. In the earliest stages, the advisor can compare the value of keeping a hotel operational as opposed to allowing it to close and the impact of either decision on the value of the asset. The advisor can also help with decisions in marketing, comparing a more traditional marketing campaign to the immediacy of an auction wherein purchasers may be expecting deeper discounts.

The ultimate success of a hotel asset begins before acquisition. Savvy purchasers evaluate the market’s possibilities and the type of hotel and brand that best meets these needs in the local marketplace, and this is especially true for a distressed asset. The potential purchaser reviews the historical financials, if available, and develops their own budget. After thorough research, they develop a business plan that identifies the improvements that they can make in the property to maximize its profitability. The final decision comes down to if the capital outlay for acquisition and renovation allow a return on investment. A key component to the success of the asset is the debt structure; a trusted advisor can help in this process as well.

For the right purchaser, a distressed hotel can represent a “good deal” wherein they purchase a property at an advantageous price, make the corrections needed to the asset, improve its business, and ultimately reap financial rewards. Real estate advisers experienced in these situations can ease the transition from the seller to the purchaser and help both parties complete a realistic and successful transaction. In these, as in all transactions, prudence should be the operative word.

 


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