It takes a lot of time and effort to get control of a deal. Financial modeling, market research, property tours, and other initial due diligence help you form a good offer. Still, the really hard work only starts when you win the deal. It all becomes real at this point, and it doesn’t pay off until you close and execute on the business plan.
You need to be laser focused on optimizing your position. Fight for every advantage when you win the deal. This will give you room to breath when things get difficult – because they always do.
Negotiate a Favorable PSA
A good letter of intent (LOI) defines the high-level business terms and spirit of the deal. The purchase and sale agreement (PSA) codifies those business terms along with various legal stipulations to strengthen either parties’ contractual position.
Hotels transfer more than just the real estate, so these PSAs have more considerations than a standard Big Four CRE contract. Hire an attorney with ample experience in hotel contracts to be sure you get the most from your PSA.
Most of the PSA is standard legal language that explains the requirement of each party in the sale and transition. However, there are some areas where you can squeeze a little bit more value or flexibility.
The Conditions Precedent to Closing section contains the requirements for each party to satisfy before the deal can close. This usually focuses on the seller’s responsibility to deliver a property with clean title and other stipulations, but it could contain a financing contingency for the buyer.
A buyer must be sure to include provisions that clearly defines what you want from the seller. You may include franchise or management agreement termination provisions here. Other conditions could be title-related, like clearing an easement or a replatting.
Scrutinize this section carefully. Consider factors that could enhance your operations or closing conditions that your capital sources would expect. Lenders and investors will usually accept the industry and market standard contingencies. Still, it’s always helpful to give yourself ample room in a contract.
Advanced Business Transition
Closing is never guaranteed, even when you win the deal.
Most sellers will continue to operate their business as-is until they are supremely confident that the buyer will close. This could pose a challenge in the transition, as buyers need time to interview existing staff, book new business, and set up or transition service contracts. These are costly activities that are critical to a new owner’s operation.
Your ideal position would be to begin the transition as soon as deposits become non-refundable. Don’t back down from this.
Financing should be secure at this point, and it’s just a matter of putting the final touches on the deal. You probably have a lot of money and time invested in the deal at this point. It’s time to start treating the deal like your property.
Contract and Lease Termination
Contractual positioning is a key area of value addition in a hotel investment. There are so many third parties that are involved with the operation of a hotel – from elevator maintenance to chemical delivery. Your due diligence period should bubble up all the contracts that are open for renegotiation or termination.
The best operators use their own form whenever possible in contracting with a vendor. Less sophisticated operators accept the vendors contract or mark it up with slight changes. Look for termination and liquidated damages provisions that will allow you to renegotiate.
You probably won’t have this information when negotiating your PSA. Therefore, assume there is no termination provision or the timing is 90 days out.
Based on your experience in the market, it may be beneficial to keep existing contracts in place for at least the first six months of operation. Beyond that, you will have a good idea about the quality of your deal with the vendors. Still, it’s good to have an option to terminate any contract at the seller’s expense after you post a non-refundable deposit. This gives you enough time to on-board a new vendor or negotiate a better deal with the existing vendor.
Note: This is not legal advice. Consult a qualified legal professional when negotiating your purchase and sale agreement.
Kick Off an Efficient Closing and Transition Process
The typical hotel closing takes about three months in two stages – due diligence and transition. A smooth closing clearly lays out the needs in each stage and explicitly defines the owners of every critical item.
There are so many people that contribute to a successful closing and transition process. These include your internal deal team and all the third parties that come in for specific work along the way. It’s helpful to organize and engage these working parties while you’re working on the PSA.
The most important part of managing your working parties is to be clear about each person’s role and responsibilities. Get everyone on the same page by publishing a contact list that aligns the person to their obligations.
People are doing the work, not companies. Therefore, it’s important to have a warm body accountable to each critical item in your closing process.
Very few items on your path to closing must happen by a specific date. Obviously, the closing and non-refundable deposit dates are fixed, but everything in between is more flexible. Arbitrary completion dates only add stress to an already stressful process. Therefore, it’s usually more effective to layout your closing roadmap based on weekly requirements.
A typical closing and transition process may take 11 to 13 weeks. First, identify the actions and artifacts required to have a successful closing. Thereafter, you can work backwards to plug those items into each week along the way. Spread them evenly and consider the various demands on working parties to ensure enough bandwidth to get the job done well.
Regardless of your approach, always allow for a time and cost contingency. No two closings are the same. What works in one case may be the completely wrong approach in another. There will be mistakes and missed deadlines. A fair buffer that keeps this in perspective will ensure that you meet the ultimate deadline with less stress.
Report and Reposition
Communication and transparency are the foundational values of every great modern team. More tools exist today to keep your team connected than ever before. Choose a medium to keep everyone engaged in the process and set up a reliable reporting cadence.
Don’t rely too heavily on meetings. Many organizations falsely believe that a status update meeting is the most effective way to keep everyone moving in the same direction. However, the best team captains are aware of each contributor’s needs and limitations and adjusts accordingly. One person may be most effective in submitting a weekly memo or email while another would be better with a one-on-one discussion.
The team leader should coordinate the entire closing and transition process. Just like no two closings are the same, no two teams are the same. Leverage the team you have to get the results you want. Reflect on weekly progress and reposition the process to reach the most optimal result.
Capitalize the Deal
Very few real estate investors come to the table with all their own cash. In fact, the greatest benefit of real estate investing is that you have the security of a real asset, which allows for the use of affordable leverage.
You are in the riskiest position of the capital stack as the deal sponsor. However, you also have the greatest ability to influence change and add value to the deal.
Capitalizing a deal is difficult even when you have a war chest. You win the deal based on assumptions from your incomplete knowledge of the capital markets. Investors and lenders don’t take you seriously until you get control of the deal even if you floated the idea by them.
Now that you have the deal, it’s all-hands-on-deck to get the thing funded.
Start with an Offer
Your financial model offers a base for capitalizing your deal. It defines the loan terms and equity returns that make your deal interesting. You shouldn’t see too much resistance on your pro forma so long as it’s within a reasonable range of sound fundamentals. Still, be prepared to defend your proposal.
The key to any good negotiation is to set up an aggressive but reasonable ask. You need to be just inside reality to get your prospect’s attention and just outside reality to leave room for negotiation.
An ask for lenders takes the form of loan proceeds. Interest rates are largely set by the market, and you will uncover the best interest rate and terms by running a good process. However, the loan amount is the foundation for any discussion.
Investors are a bit different. You built a relationship based on trust and an understanding of their return needs. Prepare an offer that meets those needs and aligns with your expectations from the deal. A clear proposal is the only thing standing in the way so long as they like the deal.
The “market” hates a blank canvas.
Investors and lenders look at too many deals to get creative on yours. Be clear about what you want and go out to a wide enough audience to form a market. Be prepared for plenty of rejection, but don’t waste time with a “no” from someone who can’t give you a “yes.”
Run a Process
Financing is a critical piece of the many things you must do to get to the closing table. In many cases, it is the most important part. You can’t leave it to chance by haphazardly approaching your handful of likely investors and lenders.
Intermediaries do a great job of getting the best deal terms because they run a process based on broad distribution and competition. They are always in the market with something, so they’ve built relationships based on trust and mutual engagement expectations.
You need to spend the time building any equity relationships, but you should outsource the debt. Investment bankers get the best cost of capital at a relatively low cost for your closing statement because of their process.
If you do plan to go it alone, take a page from the investment banker’s playbook.
Start your process with good marketing materials that are attractive and provide just enough information to elicit a phone call. Broadcast to a wide audience of people that you’ve been building relationships with. Finally, get the prospect’s undivided attention in a meeting to discuss finer details.
The key to any marketing campaign is to have a process with a defined beginning, middle, and end. Seek incremental buy in from each stage in the marketing process.
Expect this to take a few weeks and allow some time to collect and negotiate term sheets.
The best way to get the deal you want is to have multiple offers.
Multiple offers also give you security in the event the lender or investors you choose drop out before closing. There are so many reasons to lose a great deal, but money should never be one of them.
A truly great deal will attract all the money it needs. Therefore, the only reasons for failure are that it’s not a good deal or you didn’t run a good process.
Always collect more offers than you need. If you have three term sheets, get a fourth. There are obvious negotiating benefits to having multiple offers, but the security they provide is sometimes more satisfying than squeezing your relationships for a better deal.