Once you identify an opportunity that meets your investment parameters, winning the deal requires acting quickly. In a standard hotel sale, the process from contract to close is expected to take less than 90 days, although sometimes the process gets extended as it goes along. Your role is to manage the specialists engaged in each step, make the decisions as they come up, and importantly – you keep the process moving.
Sequence of buying a hotel
This is the general sequence that takes you from finding the deal to closing.
- Package and NDA: You find a hotel that interests you, perhaps on a broker’s website. You register on the broker’s website and ask for the package. The broker sends you a confidentiality agreement or non-disclosure agreement (CA or NDA); once you’ve signed and returned the agreement, you get a link to the package (or offering memorandum or other investment summary).
- Market assessment: Assuming the package supports your interest, you and the broker connect to discuss the opportunity. You will get additional information, such as property description, encumbrances (management contracts, unions, brands, leases that would continue after the purchase), summary of historic operating performance, capital expenditures, and pricing expectations. Brokers commonly provide detailed information through an on-line data room. You do your own preliminary market assessment (there is a template on Fortuna’s Table).
- Tour: You tour the hotel with the broker (front of the house and back of the house). You should also tour the competitive hotels to understand this property’s relative pricing power (based on location, physical product, brand and other positioning aspects) and opportunities to improve the hotel’s performance relative to the competitors.
- Offer: You discuss the acquisition with your team, attorney and the broker and make an offer. Your offer is based on your investment parameters and your assessment of the opportunity. You develop the offer based on discussions with the broker and your own market research. Remember the broker represents the seller. So, you also work through the offer with your attorney. You involve your partners if they are active in the deal. It is common for the broker to present the seller with several offers, then the broker and the seller decide which offers are their first, second and third choice. You may compete during successive offering rounds, or you may negotiate the terms of the purchase without competition. In either case, you negotiate based on a clear understanding of your own pricing and investment parameters.
- Franchise: If you want to change the existing franchise to your name, you need to apply to the franchise company and make sure that the transfer can go forward in time for closing. If you want to change brands, you need to apply for the new brand and plan for the time required to make the brand change (signage, Product Improvement Plans or PIPs, and other requirements). If you are changing brand, you also need to ascertain the costs that you will incur from dropping the old franchise, these can be significant. Whether a new brand or a change of ownership with the existing brand, the franchise company will require a PIP, which carries a cost, and you will negotiate timing to implement the PIP so it works with your closing schedule.
- LOI: If your offer is selected, you write an LOI (Letter of Intent) presenting the terms of your offer, review it with your attorney, and submit it to the broker. The seller may negotiate changes (these are usually modest because the broker and seller have already negotiated the terms with you) then the seller accepts (countersigns) the LOI (more on LOIs below).
- PSA: You (with your attorney) have a specific amount of time, defined in the LOI, to negotiate and complete the PSA (Purchase and Sale Agreement), usually a week or two, and execute it.
- Earnest money: You write a check for the earnest money deposit, which is deposited with the broker. Earnest money reflects your commitment to complete the purchase and the value of the seller taking the property off the market for you. Earnest money is deposited with the caveat that contingencies are in place. If those contingencies are not satisfied, the earnest money is refundable. Earnest money deposits and contingencies may be in stages such as a first stage including clear title, physical inspections, financial review, etc. A common second stage is securing financing (financing contingency). As contingencies are resolved, at the time specified in the PSA, the deal goes “hard” and your earnest money is at risk. There may be one earnest money deposit, or earnest money may be deposited in two steps. There may be one time at which all the earnest money goes hard, or contingencies may be removed in steps. (more below)
- Title search and insurance: Your attorney will arrange a title search, survey review and the purchase of title insurance. This gives you assurance that the title is clean and unencumbered by liens, debts or other (potentially expensive or deal killing) impediments to your ownership. It is not uncommon for the title search to uncover issues. These may or may not be a surprise to the seller. When a title search uncovers an issue, you and your attorney negotiate its resolution as part of the purchase and closing process. It may be a bureaucratic error that the seller clears through the local government. It may be an expense that the seller clears with a vendor or contractor. It may be something that is worked out in a negotiation of contract terms. Occasionally there is a cloud on the title that kills the deal, but most often the buyer, seller and their attorneys resolve these issues – with a little patience and work.
- Due diligence: You do your due diligence, usually in about 30 days; there is time pressure. This is a busy time while you work through due diligence and deal preparation with your franchise operator, attorney, accountant, contractor, architect, partners, lenders, investors and everyone else involved.
- Financing contingency: There is a second deposit of earnest money, defined in the PSA, which leaves only a financing contingency. Your lender will complete an appraisal to support the loan amount as part of this financing contingency process. This contingency period is also about 30 days so financing should already be well underway when the first earnest money goes hard. At the end of the financing contingency, all contingencies are removed and the full earnest money goes hard.
- Close: You go to the attorney’s office, review and sign a stack of purchase and loan documents, close and become the owner.
- Take possession: You implement your plan to take over the asset.
While your attorney, lender and various experts are doing their work in preparation to close, you and your team will also be getting ready to take over the operation, including:
- Plan hand-over and integration of the operation into your management
- Change over service and supplier contracts
- Change over of employment contracts – terminate & rehire, assumption of accrued benefits
- Replace and/or get approvals as required with hotel management and branding agreements
- Set up vendor and service provider agreements – you don’t want service gaps, and you don’t want to be stuck with payables that should belong to the seller, so you verify payables to close out all accounts for the seller as of closing, meanwhile, you set up accounts so service is seamless at the property. The seller will provide lists of vendors and service providers, if they aren’t in the on-line data room or if they are out of date, ask for these lists.
- Define closing adjustments – at closing, you and the seller cash each other out for transactions at the hotel that are in process. You put a value on inventory you will be buying (take inventory the day before closing), account for the cash in the clerk’s banks and the safe (counting cash), verifying deposits/advanced bookings because you cash the seller out for anything pre-paid, assessing receivables (under the PSA, the seller may keep and collect their receivables or you can take them over but you don’t want to buy uncollectible receivables), verifying payables so you only agree to pay vendors for payables that have value after the closing date (you don’t want to pay for goods that were used up before you took over)
- Plan for staff celebration and communication with customers and suppliers
Hotel Acquisition Checklist from JMBM (detailed) https://www.hotellawyer.com/files/books/pdf/hotel-acquisition-checklist.pdf
Handbook on hotel acquisitions from JMBM https://www.hotellawyer.com/files/books/pdf/how-to-buy-a-hotel-handbook.pdf
Your development and other key players are a critical part of completing your hotel deal. There is a separate post about building your team and identifying key people who support closing the deal in addition to the buyer (you) and the seller.
There is a saying that “time kills all deals”. Given too much time, the buyer or seller will decide to find other opportunities, the seller may take the hotel off the market, the Purchase and Sale Agreement is voided by missed deadlines, costs go up affecting deal feasibility, and so on.
You, supported by your broker and your legal counsel, coordinate all these players and keep them moving. Any one of them can kill the deal. The appraiser can come up with a value so low that the buyer must raise additional equity. The environmental consultant may identify something potentially problematic (which may be a serious issue or something the consultant is unnecessarily worried about). There may be something on the title which confuses the surveyor or title representative and slows down their process. One of your roles is to stay in close touch with all the participants so you know as early as possible what questions and concerns are bubbling up. Then you can help identify the proper information, so the process keeps moving on schedule (or is cancelled on scheduled).
While most generally want to facilitate the closing, it is not uncommon for one or a few to require very careful management to keep them moving forward on time, and all will require attention.
The good news is that key players will be working with you. Your attorney will coordinate with the seller’s attorney and the lender’s attorney about scheduling, contracts, and specifics like title search and title insurance. The broker will manage the relationship with the seller. The lender contracts with the appraiser – your role is to make sure the appraiser has the right information and understands the opportunity and your plans as early as possible. Your bookkeeper/accountant does the work for the business transfer and take-over; your role is to make sure they have the information and can keep their work on schedule. The franchise company specifies the property and liability insurance you need; your role is to select a provider and buy the insurance. While the process is not simple, you are managing the process through experienced and knowledgeable people.
Contracts and legal due diligence
You will establish a relationship with a lawyer around the time you prepare a Letter of Intent if you haven’t already. The attorney will then work with you on a Purchase and Sale Agreement. It is generally most cost effective and valuable to your success if you work with an attorney who has a specialty in hotels. There are many and you should take the opportunity to interview two to three. Pricing, knowledge and responsiveness can vary widely. Legal fees can escalate quickly so it is important to understand the attorney’s fee structure. Some work on only on an hourly basis. Some will have package pricing for hotel acquisitions.
Recognize that you will be dealing with this attorney through significant learning curves and periods that may be emotional or stressful. So, find someone who you are comfortable asking questions, feel is trustworthy, and like.
Your attorney will guide you through the legal due diligence, tell you what you need and advise you about optional services.
The attorneys for you, the seller and the lender assemble the closing documents including loan documents. The is the package you review and sign at closing. Depending on your contract with the seller and the nature of your financing, loan documents vary. Your attorney will explain them (or ask to have your attorney explain them) as you go through the process. After closing you will get a copy of all the closing documents, including the loan documents. This usually comes in electronic form.
LOI (Letter of Intent)
The LOI is the preliminary commitment between you and the seller that you will make the purchase and they will sell you the asset for a given price. This preliminary agreement outlining the basic terms of the deal gives buyer and seller the confidence to invest the time, effort and money to negotiate the final contract. LOIs usually have short expiration dates – either the deal moves forward, or the seller is free to find another buyer. MOU’s (Memorandum of Understanding) are similar to LOI’s and function in much the same way with regard to hotel transactions.
LOI’s are often non-binding – you and the seller can change your minds. If there is a broker involved in the transaction, they may draft the LOI. Unless you are very clear that the LOI is non-binding, you should have your attorney review it.
LOIs are important because they trigger the iterative work between the buyer and seller to reach agreement on the details of the sale. Your attorney, their attorney and the broker are all involved in that process. LOIs are short while PSAs (Purchase and Sale Agreements) are long and detailed. Many LOIs include non-disclosure agreements which stipulate what aspects of the negotiation must be kept confidential. An LOI includes:
- Identification of parties
- Identification of property
- Transaction terms
- Due diligence
- Binding or non-binding
When you have an LOI, congratulate yourself. It means that you’ve been selected as the buyer in a process that is often competitive. It’s a major step in becoming an owner.
Video explanation of LOIs: https://www.youtube.com/watch?v=dgPmUSXr-iw
PSA (Purchase and Sale Agreement)
The PSA is a binding legal contract with the details of the transaction between buyer and seller. It includes the negotiated details of the transaction and dictates the terms of the sale including:
- Parties to the agreement
- Agreement to sell and purchase
- Purchase price, type of payment and terms of payment
- Consideration (payment for the property)
- Restrictive covenants
- Warranties and indemnities
- Conditions precedent
- Earnest money
- Timeline/closing date
- Title insurance
- Title condition
- Arbitration protocol/dispute resolution
Examples of PSAs:
Contingencies and earnest money
Writing a check for earnest money can feel like a big commitment. It is a bigger check than most of us usually write. In reality, it is a fairly low risk part of the process. The idea of earnest money is that the seller gets to keep the earnest money if you back out of deal, because you have tied up the asset for some time. To be fair, the PSA recognizes contingencies under which you get your earnest money back if the deal falls apart. Contingencies are commonly in two stages. After the first contingencies are satisfied, a portion of the earnest money goes hard. Since completing due diligence for financing can take longer, this may be set up as a second contingency with a later “go-hard date”. In the meantime, the earnest money is held by the broker or title company.
- Satisfactory title: if the seller can’t deliver a satisfactory title, you should not be obligated to close on an asset they cannot deliver.
- Property survey: You should verify that the land has the dimensions you expect, doesn’t have any easements or other encumbrances you don’t know about, has legal curb cuts and can physically be used for a hotel.
- Inspection: You need to inspect everything about the hotel – sometimes whole sections haven’t been renovated, furniture is missing, equipment is missing, electrical or plumbing or roofing systems have failed, etc.
- Other due diligence: The PSA gives you the opportunity and legal right to review income including financial statements and records that support the statements, leases and other agreements that extend beyond the sale, land use approval, environmental conditions, etc.
- Financing (the second stage contingency): the seller will want reasonable assurance that you will be able to get financing, but if you can’t, you get out of the contract with your earnest money back.
If you find something in the due diligence process that requires adjustment, you discuss it with the broker. If it is significant, you may negotiate a price concession. Or it could be as simple as a vendor obligation that the seller must satisfy or it can be paid out of the proceeds at closing. After satisfying any concerns, you waive the conditions in the PSA at which point the earnest money goes hard and the sale can move forward.
An option is a contract provision that grants you the exclusive right to purchase a hotel or land (site) for a certain price within a given time period, called the “holding period”. In return, you pay a fee called an “option consideration”. Options are generally for a few weeks or months. They are not long term. Options are typically used to tie up a property while the buyer looks for capital. In a market with few potential buyers, a seller might consider an option. However, in a market with a choice of buyers, a seller is more likely to choose a buyer who already has capital lined up or who puts a better offer on the table. The holder of an option can force a sale if the terms of the option are met, so a seller can’t take a better offer during the option period. This is a strong disincentive to options. They are commonly used for the purchase of hotel sites (land) than for hotels themselves.