Every transaction is different, but every offer must cover a consistent set of deal points. Hotel offers contain many of the same important deal points as Big Four CRE offers even though they are different on many levels. The essential hotel deal points deviate in their treatment of operational transition.
Note: All information presented here is for discussion purposes only. Nothing in this article should be construed as legal or accounting advice. Please seek guidance from a professional qualified to guide you in making the most appropriate offer for your situation.
1. Purchase Price
Sale price is the headline public deal point for every transaction. It offers the market a benchmark for property values and indicates the skill of all parties involved. The purchase price is also the first thing most buyers and sellers consider when, respectively, preparing or reviewing an offer.
Each investor arrives at their purchase price in different ways. The analysis is comprised of a combination of popular valuation methods, including:
- Discounted Cash Flows – solve for purchase price with projected cash flows
- Direct Cap. Rate – apply market capitalization rate to historical net operating income
- Room Revenue Multiplier – apply market multiplier to historical room revenues
- Comparable Sales – survey market for sales of similar properties
- Replacement Cost – survey market for cost to build a similar property
The depth and breadth of this analysis is valuable in coming up with arguments in support of your offer when the seller raises questions. That said, purchase price is only the beginning when it comes to essential hotel deal points that strengthen or weaken your offer. Additional terms and your reputation often have an outsized impact on whether your offer wins.
2. Closing Timeline
An offer is commonly described by its “price and terms”. Terms are important for two reasons – speed and probability of closing. The closing timeline addresses both concerns.
The timeline is an essential hotel deal point because there are so many areas with long lead times. Hotels have operational systems, multiple service and revenue contracts, and human capital to consider in the transition in addition to the standard CRE requirements. This necessitates that the closing window account for enough time to prepare for and execute on an effective closing once the seller accepts your offer.
An inspection period allows the buyer to extend her underwriting and due diligence by digging deeper into the seller’s operation and property condition. Many investors hire qualified third parties during this time to align the conceptual plan developed in the initial underwriting with the realities on the ground.
You’ll likely put up an earnest money deposit to show your commitment to the deal, which is refundable in most cases. The objective is to further probe your assumptions and refine the business plan. After the expiration of the inspection period, you’re committed to closing the deal or risk losing your deposits.
Deal sponsors also use this time to piece together the capital stack. The preparation of a financing package could take a week or more, but the most critical piece to this task is having clarity of purpose. Your business plan can be rough in the early stages. However, be prepared to present a polished package when it comes time to close the deal.
Thirty days is a competitive inspection period with more strength given to realistic shorter durations.
Closing and Transition Period
The time following the inspection period is for transitioning the operations and tying up loose ends on financing, brand, and management agreements.
A smooth closing builds on a strategy that incorporates effective communication, tracking, and transparency. Work backwards from the closing date to determine the critical path items to complete each week from executing the purchase and sale agreement (PSA) to the closing date.
Franchise and PIP negotiation along with lender inspection requirements have the most complexities and longest lead times. These include third-party inspections that take time to schedule and return a report. Further, you must account for a question and answer period after receiving reports to ensure they address all your concerns.
Forty-five days is a competitive inspection period with more strength given to realistic shorter durations. Plan to front-load as much as you can into the inspection period to gain valuable days in the closing and transition period.
3. Extraordinary Contingencies
Nobody likes when a deal slows or freezes for issues outside their control. Therefore, the seller will look down on provisions that may prevent the buyer from closing on the prescribed date. That said, transparency in these essential hotel deal points will win favor with the seller and intermediary and could push the deal your way.
Survey and Title
Your effective ownership and beneficial use of a property is contingent on a variety of physical and legal impediments that accumulate over time.
Surprises kill deals, and title surprises tend to be the worst kind.
It’s easy to put title on the backburner when pursuing a sale or acquisition. The financial pro forma and capital stack are much more exciting aspects of the deal. However, title clouds that build up with utilities providers, adjoining properties, or governmental entities can throw a wrench in your plans to close on time and at the prescribed price.
Ask for a survey and potential title issues prior to preparing your offer. Then, incorporate how you plan to handle any title clouds in your offer. Once in contract, order an ALTA survey and a zoning opinion early in the inspection period to surface any issues before they become a problem.
“All-cash, non-refundable deposit day one, and 10 day close” may be one of the sexiest things you can say to a seller. It’s even sweeter for the intermediary that stands to benefit from a quick sale commission.
Unicorns like this don’t come around that often, though.
The reality is that most deals require a comprehensive financial package that includes debt and multiple equity partners. How you treat this in your offer defines its strength against non-contingent competitors.
A financing contingency is an essential hotel deal point because it allows the buyer to abandon or delay the deal after the inspection period. It introduces uncertainty and risk for the seller because financing is completely out of her control.
Competitive offers for simple deals rarely have a financing contingency. A plain vanilla transaction at a market price shouldn’t have any problems getting financed. However, larger, complex deals are more open to this option.
Hotels operate with dozens of service and revenue agreements. In-place financing, management, and brand agreements are the largest and most focal. Still, you ignore the smaller agreements that materially impact operations at your peril.
Every offer should be clear about retaining or transferring major agreements. Further, your offer should include a mechanism for terminating or renegotiating material agreements prior to closing.
4. Each Party’s Financial Responsibilities
Purchase price is the headline financial number. However, everything else on the periphery are also essential hotel deal points.
Financial responsibilities of each party come with two components – timing and value.
As discussed previously, most offers come with an earnest money deposit (AKA “initial deposit”) at the start of the inspection period. This shows the seller that you have a firm commitment to spend time and money on the project even though the initial deposit is typically refundable prior to expiration of the inspection period.
The initial deposit becomes non-refundable (“goes hard”) at the end of the inspection period. An additional non-refundable deposit usually accompanies the initial deposit at this point to make up a considerable share (5%+) of the purchase price.
The buyer places all deposits in an interest-bearing account, and all proceeds are a credit to the buyer at closing.
Your offer may include additional non-refundable deposits along the way to provide for extensions in the closing timeline. This distributes risk between parties in deals with financing or development planning contingencies. These additional deposits act as options for the buyer to maintain exclusive control over the property through an extended closing timeline.
Closing Costs and Prorations
The purchase price is never the only cost of acquisition.
Third-party inspections, financing origination fees, title insurance, legal costs, government fees, and many more additional costs can balloon to a substantial share of the total cost of acquisition. Some of these costs, like pre-paid taxes and insurance, fall on the balance sheet and amortize, while others, like those mentioned above, remit to service providers on a cash basis.
Regional and industry standards dictate which closing costs are attributable to each party. However, it doesn’t hurt to clearly state who is responsible for these essential hotel deal points.
Prorations are another area where hotels are slightly different than other CRE. Due to the nature of nightly leases, it is important to clearly state which party is the beneficiary of net revenue from those guests on the night before closing. This can vary between deals, but it’s worthwhile to test the temperature in an initial offer to give you a sense of where the pain points are for the opposing side when it comes to PSA negotiation.
5. Exclusivity and Access Agreement
Once the seller accepts your offer, it takes time to draft, distribute, review, and negotiate a purchase and sale agreement. Unfortunately, you’re dependent on so many people and their competing priorities through this process. This is valuable time that can materially affect the closing timeline.
Legal costs associated with negotiating the PSA can accumulate, and you’ll likely start ramping up your team for due diligence inspections. You need comfort that the seller will not continue shopping the deal through this period.
An exclusivity period following acceptance of the offer gives you the comfort that the deal is yours, so long you can work out all legal and business points in the given period. While 15 days is standard, your objective should always be to complete this sooner than later.
Access and Due Diligence
Your team’s excitement surrounding the deal is your greatest asset in moving toward a smooth closing and transition. That excitement fades with time so it’s best to capitalize on the energy as soon as you get a signed letter of intent. Therefore, it’s helpful to include language that allows you to begin due diligence simultaneous to the PSA negotiation.
This initial inspection is usually a simple desktop review of service agreements, revenue leases, title documents, and so forth. However, the extra few days are beneficial, particularly in deals with tight closing timeframes.
Most of the essential hotel deal points in your offer are non-binding and open to negotiation in the PSA. However, both parties should be bound to the exclusivity and access agreement. There are too many risks to outside interference at the stage between offer acceptance and PSA execution to leave this to chance.