Selling your hotel investment
Owning a hotel may or may not be a passion, but it is always a business venture. Your hotel investment has a lifecycle. A hotel investment starts with the acquisition or development of the property, moves through opening, ramp up, operations, renovations, other capital investments, and ultimately, it is time to sell the hotel.
When you plan the hotel investment, its sale is anticipated in the appraisal or valuation. It should also be something you plan at with your initial investment. How long do you want to own the hotel? What age do you want to be when you sell the business? How does the sale tie into strategies for your other investments? Will the sale be timed to coincide with other life events like retirement or children graduating? Will the sale be opportunistic – simply a response when you get an offer – or will it be planned to optimize your return?
Lifecycle and Exit Strategies
One of the reasons hotels can be desirable investments is that the combination of operating profits and appreciation can mean strong short and long-term returns. However, timing is an important part of realizing those returns. Here are some of the considerations:
- Sell in a strong real estate market. The hotel industry, and real estate in general, has market cycles. Your exit strategy has to be flexible enough to let you adjust sale timing to meet the market. You might plan to exit the hotel in year 7, but if that year coincides with low hotel values, you might wait a few years until the market is strong. Or if the market is very strong, you might sell early. Market timing can mean the difference between losing money, breaking even, or making a very strong return.
- Optimize operating profits. When you consider selling early, one consideration is whether the extra value you expect to get from selling months or years early more than offsets the operating profits you miss during that period.
- Hotels have to be renovated every 7 to 10 years and this often coincides with a franchise renewal. Renovations are major investments so when you plan the sale of the asset, consider whether to invest the time and money in the renovation or to sell before the renovation and let the new owner do the work and realize the upside. Not surprisingly, it should be easier to sell a hotel that has been renovated or has several years until a renovation/franchise renewal will be required. Reasonably, hotels that need renovating may sell at a discount.
- Franchise terms impact hotel value in different ways for different deals. Hotels that are within one to three years of the end of their franchise license may be disadvantaged if the franchise company plans to replace the hotel with a new property in the system. A new owner who wants to continue the franchise is buying the risk that the franchise will not be available. Conversely, a hotel that is being bought to convert to another franchise may find a short remaining term advantageous. This is because terminating a franchise early can carry liquidated damages based on the value of the future revenues the franchise company will lose. In each unique situation, franchises affect value. You and the buyer can work with the franchise company to estimate and potentially control the cost.
- Hotel owners commonly expense a variety of items to manage their tax bills and take income out the business. At sale the highest value is achieved through having the highest income and lowest reasonable expenses, thereby producing the highest Net Operating Income. Buyers look at two years or more years of financial statements. So at least two years in advance of a planned sale, it makes sense to review all expenses and allocations for the hotel. Areas to consider are:
- Items that are depreciated versus those that are expensed.
- Purchases that may not be strictly necessary or may not be needed prior to the sale.
- Allocations of parent company expenses to the hotel.
- Depreciation recapture. When you sell the business, all assets on the books are valued and, if they are worth more than their depreciated value (which may be $0), then you pay income tax on the difference at the ordinary income rate rather than the much lower capital gains rate. This is called depreciation recapture. Minimizing recapture is a process that starts well before the sale. You should have a detailed list of depreciating assets in your tax return – down to headboards and carpet. Review the schedule of assets and depreciation every year and retire assets that are not in use.
There are tax implications for you and your investors when you sell and this may affect the timing of your exit. Getting ready to sell the hotel is a planning process best started in the years leading up to the sale. Owners and their accountants plan ahead to:
- Minimize depreciation recapture.
- Plan capital investments.
- Organize the books to present the hotel favorably.
- Plan reporting of ordinary income and capital gains and set aside sufficient funds to pay taxes.
- Plan for the reinvesting of sale proceeds.
Then, as part of the preparation for the actual closing of the sale, you will review all the relevant information with your tax accountant or financial planner and bookkeeper. In the process, they will work with you to:
- Pay off all trade accounts, mortgages and other debts as of closing.
- Collect receivables or value them to include in the sale.
- Pro rate items like property tax that will be split between you and the buyer.
- Calculate distributions of operating profits (after all expenses and receivables are cleared) and sale proceeds to investors.
Exposing the asset to the market
The only way to really know what a hotel is worth is to put it on the market to present to willing and knowledgeable prospective buyers. Ideally, you get more than one interested buyer and there is pricing pressure to get the best value. Conversely, if interest is minimal and you receive low-ball offers it is not the time to sell – if maximum value is your sales goal.
Hotel assets are exposed to the market in three ways. They are presented by the owner, through an auction or they are brought to market by a broker.
- Individual owners bring their own hotels to market or sell them privately themselves for a variety of reasons. They want to save the fees charged by a broker. They don’t want the emotional drain of dealing with employees, family and the local community during a public sale. They are made a private offer that appeals to them. They are well-connected with prospective buyers themselves and can create a competitive market for the hotel privately.
- Auctions are a relatively small share of sales and tend to be for smaller assets. However, there are specialists in hotel auctions to carry you through the process. Auctions are transparent – the highest bidder wins. The sales process tends to be comparatively fast. This format tends to appeal to cash buyers, although not exclusively. Sellers can set a minimum price so if the bidding does not yield an acceptable price, the sale does not close.
- Hotel brokers are in a position to expose a hotel to more qualified prospective buyers than most owners. Brokers who specialize in hotels bring expertise to the process as well as a book of prospective hotel-specific buyers. They also help sellers move through an emotional process with clarity of purpose, which can improve the odds of completing the sale.
Hunter Hotel Advisors www.HunterHotels.net
Avison Young https://hospitality.avisonyoung.com
Dowdle Real Estate www.linkedin.com/in/lynn-dowdle-39772012/
Mumford Companies www.MumfordCompany.com
Newmark NGKF www.ngkf.com
Hotel Broker One www.hotelbrokerone.com/
HWE Hodges Ward Elliott https://hodgeswardelliott.com/
Hodges Ward Elliott www.hodgeswardelliott.com
The Plasencia Group https://tpghotels.com/
Broker’s Opinion of Value
As part of the process of being considered as your broker, you can request that the candidates provide a broker’s opinion of value (BOV). The broker will assess the hotel, analyze the financial performance, evaluate the market (through STAR reports and other information from you) and review other factors to estimate what you can get for your hotel. A range of 30 percent in BOV estimates from one broker to another is not uncommon.
While a BOV is certainly not a guarantee, brokers typically expect to be able to sell the hotel for close to the BOV. If they give you an overly optimistic estimate, you are likely to decline reasonable offers they bring you. If they give you an overly low estimate, you are likely to select another broker.
Selecting a Hotel Broker or Auctioneer
Hotel brokers are specialists because hotels are specialized and complex real estate and buyers for hotels are also specialized. It makes sense to work with a hotel broker who has experience with the type of hotel you are selling. Brokers who work on $5 million hotel sales are likely to have a different clientele than brokers who work on $150 million hotels. The right broker is knowledgeable about your specific asset type. You can identify brokers who work on different types of hotels by viewing the hotels listed on their websites. You can also meet brokers at conferences to identify candidates.
It is a good practice to interview brokers with three to five brokerage firms. You can compare them on these attributes, among others:
- How does the firm advertise and market hotels?
- What information does the firm prepare about the hotel; compare the quality and appeal of e-flyers, sales books (a detailed prospectus on each hotel), website listings, ads and other marketing materials?
- How large and how targeted is the firm’s database of qualified buyers and what types of potential buyers will the broker present the hotel to?
- What is the sales process the firm uses?
- What hotels like yours have they sold and how recently? If it’s very recent, they may have solid prospective buyers waiting.
- What is the broker’s opinion of value (BOV)? If you get one value that is significantly higher, you can discuss it with the broker and decide if you think it’s realistic. If you get one value that’s significantly lower, you can also discuss it with the broker, but it may not be the most desirable choice.
- How do you feel about the knowledge, quality, depth of experience, responsiveness, resources and trustworthiness of the team that would be assigned to your sale?
- What are their fees (a range of 2 to 5 percent of the sale is typical)?
Among other considerations, choose a broker that you can ask questions and that you think will represent you well. You will be relying on them for a service that has a significant impact on your financial future.