Whether you buy a hotel for a long- or short-term investment, your business plan should always include a built-in exit strategy. Here are six questions hoteliers should consider when developing such a strategy to ensure a smooth transition and maximize value.
1. What is the current valuation of my hotel?
The valuation of your asset is a complex process, and different potential buyers will favor different types of assets.
“Besides the most common factors for any real estate product type underwriting such as age, location, cash flow, cap rates, CapEx or deferred maintenance, comp set, and new supply in the pipeline, the element of franchise company and brands within such franchises makes an enormous difference. For example, a very well kept and operated but unbranded hotel on a beachfront may be valued significantly less than luxury branded hotel adjacent to it,” said Chris Gomes, executive managing director, hospitality division, Marcus & Millichap.
To get the most reliable estimation of value, owners should seek a full appraisal or consult with one or more trusted hotel brokerage firms for a ‘broker’s opinion of value (BOV).’ “If an appraisal is ordered, the owner should make sure to choose a firm or appraiser who is a hospitality specialist and likewise if requesting a BOV, the selected broker should be both an expert in the type of hotel being sold and experienced in the hotel’s local market,” said Ed James, managing principal, Mumford Company.
2. What Are Current Market Conditions?
One of the first tasks is to analyze the market conditions for your hospitality asset, as hotel values can change rapidly as a result of both macro and micro economic conditions at the time of sale. External factors like the state of the economy following the election, for example, can influence these conditions. This is why monitoring market conditions over time is imperative.
“Property sales prices are maximized in periods of strong revenue and sub-market growth and conversely, they are lower in times of economic contraction and revenue decreases. The same guidelines apply to the market for hotel acquisition lending. In a low-interest rate environment or in times where profitability is increasing, underwriting guidelines allow for more leverage and lower cost for financing, thus property valuations rise,” said James.
3. What Are My Financial Goals for Selling and the Resulting Tax Implications?
Ask yourself what your financial goals are for selling off an asset, whether that is minimizing tax liabilities or ensuring cash flow for a continued period of time. “There are myriad reasons why investors sell properties, and some of the most common ones for non-merchant developers are age of the asset and resulting CapEx or deferred maintenance, franchise term ending or renewal coming up, brand mandated cyclical renovations, asset or market underperforming, investment timeline approaching, maturing debt and/or asset achieving optimum cash flow and ripe for a transaction,” said Gomes.
The tax implications can be huge and can impact your overall financial objectives, but many hotel owners are not aware of the impact of capital gains taxes on net proceeds after the sale of a hotel property.
There are strategies to mitigate or defer taxes, which is why consulting with a CPA prior to any sale is critical so have transparent information about such consequences. “There are many investors who simply choose to pay their fair share at the end of the day, but there are strategies available out there that not only help defer such taxes but also help create and grow wealth faster,” added Gomes.
In addition to consulting with a CPA, James said that an attorney should review any legal obligations that may come with a sale, including such possible encumbrances like management contracts that would survive a sale, leases on FF&E, signage or other similar obligations.
4. What Is My Best Exit Timeline?
Timing the market can be difficult, so it is important to keep an eye on the market and, as Gomes said, be proactive rather than reactive. “I have witnessed, multiple times, investors who refuse to divest despite offers that would generate the best risk adjusted returns in anticipation of a better tomorrow. There is always a recession, pandemic, high-interest rate environment, global unrest, etc. lurking around the corner,” said Gomes.
James said that both seasonal and locational factors can affect decisions regarding when the time is ripe for selling a hotel property. There are slow times of year, such as the period between Thanksgiving and Easter, and he said that a sale in late fall can often yield more than one in early spring based on cashflow alone. “In college towns, larger cities, and destination markets, owners should consider planning a sale around special events, sporting events, or seasonal beach traffic, to maximize yield in a sale,” added James.
“The best advice is to sell the hotel while sales are up, to maximize the sale price. Do not do it on a downward trajectory, because buyers will take advantage of it,” said Dinesh “Dan” Rama from NewGen Advisory.
5. In What Condition Is the Property?
The condition of the property affects the actual and perceived value of the asset, so it is imperative to conduct a thorough assessment of the property’s conditions to identify if repairs or renovations may be necessary.
If the property is not in the best condition, the question then becomes whether to invest in upgrading or repairs prior to the sale, or let the buyer take care of any necessary renovations, as it can be a huge undertaking. For example, if you renovate and sell, you need both manpower and capital to make improvements. “Capital improvements take time; you may or may not get the benefit of that improvement,” said Rama.
James advised that it many cases, it is best to leave optional repairs to the purchaser, especially in light of specific requirements some franchises have that will come into play at change of ownership. “Often, buyers prefer to handle those requirements post-closing after negotiation with the franchisor over scope and timelines of work,” he said, adding, “For hotels that have been completely renovated already, obviously higher sale prices can be achieved as little expense will be required after the sale. Many professional renovation service providers are available to assist hotel owners in determining cost and timeline of any needed renovations for buyer or seller.”
6. What Role Will Professional Advisors Play?
Having expert advice when creating a complex exit strategy is critical, starting with a CPA and an attorney, who can help guide the process. Importantly, your team of experts should be engaged well in advance.
“At the end of the day, you have to hire a good broker who understands the market and has a proven track record. He or she will be the person that will give you the maximum price for the exit,” said Rama, noting that everyone involved has to be in sync and on the same page.
“Involving a hotel-specific real estate broker with expertise in the needed property type and location along with an appraisal firm that specialize in hotel valuations will yield the best analysis of property value and the expected process of a sale,” said James.
This article was originally published in the November/December edition of Hotel Management magazine. Subscribe here.