Considerations for Distressed Hotel Acquisitions Resulting from COVID-19
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Considerations for Distressed Hotel Acquisitions Resulting from COVID-19

Brownstein Client Alert, April 29, 2020

Seemingly in an instant, the response to the COVID-19 pandemic brought the hospitality industry to a standstill, with hotel occupancies plummeting to unprecedented, unimaginable lows and owners and managers facing the unenviable choice between closing properties or sustaining operation at a minimum level. In this environment, it is virtually impossible for a hotel to generate meaningful gross operating profit (let alone cover debt service) or to refinance a high-leverage loan. Governmental support and loan modifications are providing interim relief from this crushing financial burden, but those measures will eventually burn off or be fully expended, leaving hotel owners facing a long, uphill climb back to the days of covering debt service and distributing a return on investment.

This “distress” will ultimately be too much for many hotel owners to overcome, and private equity and other industry players are gearing up for a resurgence of distressed hotel acquisitions similar to those that resulted from the 2008 financial crisis. This client alert highlights certain considerations for buyers looking to acquire distressed hotels in the near future.

  1. Cash Is King. Buyers will have a significant advantage in securing the earliest acquisitions if they can move quickly (for example, an all equity closing with any financing pushed post-closing) and decisively (for example, minimal or no due diligence, aggressive timing and early hard deposits). Similar to the wave of acquisitions that resulted from the 2008 financial crisis, private equity players will be first to the table and aggressive on pricing and terms, requiring institutional buyers to adjust from a conventional hotel acquisition approach and mindset to be competitive. Additionally, buyers should be aggressive but commercially reasonable (under the circumstances, of course) on pricing—many deals were lost in the last downturn by buyers seeking to extract the greatest possible pricing concessions rather than cutting a favorable deal and moving quickly to closing.
  1. Know Your SellerBuyers should ascertain who is or may become the controlling decision maker for the distressed hotel. If ownership remains in control, a buyer should evaluate whether there is a consensus in the ownership group for a sale or if any entrenched owners exist and remain adverse to or capable of blocking a sale. If the hotel’s indebtedness is in default, it may be that the lender, a receiver or a special servicer (heaven forbid) is in control. Control by a lender (or lenders with a mezzanine and mortgage piece) will complicate a transaction with the hotel owner but can open the door to additional acquisition approaches such as buying the debt on the hotel (loan to own) or waiting for a REO disposition following foreclosure or after an owner “throws back the keys” to the lender.
  1. Know the Hotel’s Debt. Buyers should understand the status and terms of the hotel’s indebtedness, including whether a payment or other default exists, whether the lender is enforcing any remedies, whether the debt may be prepaid (and any prepayment penalty/make whole amount) and whether, and on what terms, the debt could be assumed by the buyer in connection with an acquisition.
  1. Management Implications. Many of the early buyers of distressed assets will be affiliated with or have pre-existing and negotiated arrangements with hotel management companies, and these buyers should evaluate the ability to terminate existing management, either under the terms of the existing management agreement or with the assistance of the lender pursuant to the terms of a subordination agreement. It is worth noting that transitions of management at distressed hotels can be difficult if the exiting manager is owed fees, reimbursements or other expenses in connection with a termination, and buyers should evaluate whether to expect cooperation or obstacles in the transition. If buyers have not predetermined who will manage the property following closing, buyers should evaluate whether there is value in keeping existing management, at least for an interim period, to facilitate a quick and smooth transition of ownership at closing.
  1. Property Condition; Deferred/Required Cap Ex; Accounts PayableBuyers should evaluate the hotel’s physical condition since most distressed hotels will have been capital starved for some time. This evaluation should include obtaining an expedited property condition report and analyzing and pricing any repositioning plans and any outstanding property improvement plans required by a franchisor, manager or lender, which requirements can often be renegotiated or phased over time. Additional complications arise if the hotel is undergoing any significant renovations at the time of closing. Buyers should also evaluate outstanding liens and accounts payable—the liens will need to be satisfied or otherwise released at or prior to closing, and buyers should factor in the need to negotiate with unsecured vendors or find new service providers in order to ensure uninterrupted hotel operations.

If you would like to discuss any matters relating to distressed hotel operations, acquisitions, dispositions or financing matters, please contact Brownstein’s hospitality, resort and recreation attorneys.

Click here to read more Brownstein alerts on the legal issues the coronavirus threat raises for businesses.

This document is intended to provide you with general information regarding considerations for distressed hotels in light of the coronavirus pandemic. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions.

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