The hotel acquisition process (Part 1)

As simply as possible, the hotel acquisition process 

The complex relationship between a business and real estate makes the process of buying into a hotel as complicated as one wants to make it, or as simple as a buyer wishes it to be.

Without question it is those buyers who are better informed who get the best deals.

An informed buyer needs to go through a process that will maximize the amount of information and relay the cost/benefit ratio.

As with the procurement of any business there is an acquisition process, a step by step approach.

Namely

  • Ascertaining the acquisition criteria
  • Sourcing the product
  • The initial assessment and the decision to proceed with seriousness
  • Ascertaining the price while compiling a business plan

In part 2 we will cover

  • Negotiation of the deal to a LOI to buy
  • The due diligence process
  • Closing the transaction

First up, ascertaining the acquisition criteria

A prospective owner will look at any purchase in many different ways, be it with an active or non active role, is it a short or long term play, is yield and cash return the key.

What ever the decision-making process is motivated by certain criteria stand out for consideration.

  • The properties type and its location
  • The size and potential cost per room
  • The risks involved with new competition entering the market
  • Is the management structure changeable, is the franchise affiliation changeable, is a management brand or franchise required.
  • The presently achieved cash flow and its potential cash flow and yield
  • The risk analysis to cash flow stability and growth.
  • Where is the upside potential, be it in management related areas, in repositioning through renovation,
  • The potential appreciation or depreciation in asset value

Each buyer will have their own answers to these, in conjunction each buyer needs to have clarity and a strategy within a defined decision-making program as they enter into the hotel buying process.

Sourcing the product

Your acquisition group

A broker

An appraiser who understands your market

An accountant who has hotel clients who can determine the correct net operating profit and if the revenue achieved is all from that business and that costs and controls are adequate, he can also helping the compilation of a business plan.

A market consultant, your asset manager, this is our role, where we help you find out how this property may perform or improve its performance and what strategies could be applied to achieve your financial goals, this is where we can help you put the business plan together.

Your legal adviser, who understands the hotel industry. Critical they do.

Possible an architect and or an Interior designer. If renovations and upgrades are required down the road and with the engineer they can review all the physical components of the building. Electrical, plumbing etc.

The initial assessment and the decision to proceed with seriousness

Obviously many hotels will not pass the initial screening process for numerous reasons.

The most common is an asking price that bears no resemblance what so ever to a sensible yield % based on the net operating profit being achieved.

This is mainly due to realtors accepting to list properties, and in many cases encouraging them to do so, at valuations they somehow dream up all based on what they perceive is a real estate value. Hotels are businesses and their value is mostly reflective in what net income they generate. Obviously some buyers over the years have not caught on to this hence the numerous stream of crazy priced hotels and resorts on the market here in Costa Rica. Same applies to Panama.

Once you find one that may be a possibility a site and property analysis begins and at this stage a possible go or not a go decision needs to be made.

Ascertaining the price while compiling a business plan

Based on an initial property and market analysis the aim is to come to a suitable bid price.

This bid price evolves around ascertaining what potential earnings can be achieved by your management team from the property, obviously an analysis of the present trading results by your experts and an analysis of what future market conditions will be like and the potential properties performance within that market need accessing. A preliminary business plan is then drawn up, key questions are how can we unlock value, by your team and management.

Firstly it is important to understand the market. Simply put this involves ascertaining  the present and the ever-changing dynamics of demand.

An assessment is made on how these market dynamics balance with the hotels concept, its mix of rooms and facilities, the quality of the building of both hard and softs, if applicable franchise or brand affiliation and associated revenues directly generated, the management and options for other organizations suitability to the property, and the capital structure and its future capital investment requirements. The hotels trading history and the projected market performance are complied with assumptions as to future market performance, a base line business plan for the property, with net cash flow projections over 5 to 10 years.

With this information, and your exist strategy with the potential disposition price taking into account your finance costs a professional will work with you to define the discounted value at today’s pricing, giving you the maximum price you are prepared to pay.

Then you have a solid foundation for the next decision as to how to proceed.

Is this an opportunity for a turnaround with good upside potential, or has the property reached its peak in earnings taking into account future capital investment requirements?

Obviously your appraiser will advise on the general market conditions and the weakness or strength of the local market to assist this process of defining the bid price and making that bid offer.

The hotel acquisition process simplified (Part 2)

Negotiation of the deal, BTW please see part one of the hotel acquisition process

So the bid price has been in principle accepted so we need a document outlining the project and the analysis as to what led you to that position.

This guiding paper being the foundation of the operational business plan would include,

A description of the property, the market summary and the projected market opportunities, all the financial information with the cash flow projections, financing aspects, management and brand affiliation opportunities, renovation costs and an engineering plan in general regarding future requirements related to the building .

Now the process of serious negotiations can begin, and the buyer needs to take these next steps forward with due care.

The hotel procurement terms consist of these most important aspects of a deal.

The price, the financing package including seller options, title and property condition, default aspects, an agreement on what is defined as a hotel asset (this list consists of, but is not limited to the land and property, cash, all inventories, prepaid deposits and expenses, all equipment be it fixtures fittings and all equipment, from linen to spoons to security cameras, vehicles, licenses and permits  as well as staff lists, all operational human resource records, all sales and marketing information, clients data lists, suppliers, key accounts, accounting books of record).

Numerous aspects are involved to come to an agreement to the final sales price.  Seller financing will push the price up, long payment terms will push the price up. Can a mortgage be taken over? What is the financial strength of the buyer and how quickly can the property be bought? All will influence the price.

Also a list of contingencies come into play, such as the buyer not being able to secure  financing, get the required licenses and permits to operate, achieve the deal line of due diligence completion.

The contract aspects evolve around agreeing on a non binding letter of intent, or an other option is to go straight into a binding agreement with a list of all the way outs, (for what ever reason during the due diligence process, lack of financing, unable to obtain permits etc.).

It costs more and takes longer to negotiate a binding agreement with outs, and the negative aspect of the LOI initial approach is that you are lengthening the whole process.  You are trading off wasting time with this process compared to  a gamble the due diligence results will be to your satisfaction by going straight into a non binding contract.

Letters of intent can serve good purposes when complicated transactions are being negotiated, for certain legal reasons, if a group of investors are involved.

What goes in and what does not go in these non binding letters of intent or a binding document with outs will be carefully discussed with your lawyers and all advisers. For example does the buyer want the seller to not be able to sell to any one else during and initial period, perhaps the whole due diligence period? Can this be negotiated? Is there a time line for all this process to be completed?

Probably both parties will want to be able to be able to terminate at any time without damages, and as a buyer may be spending a lot of cash during the due diligence period, then they need to have full clarification of their rights to enforce the seller to proceed with the sale.

The due diligence period incorporates the following:

  • A legal description of the property
  • All employees, name, remuneration package details, position, all benefits.
  • All engineering plans and architectural specifications will be provided
  • All insurance aspects with details of all coverage with the costs and details on all limitations
  • All inventories detailed
  • An accountant will audit the profit and loss statements
  • An audited balance sheet for the last five years will be produced
  • Capital and construction expenditure for the last five years detailed and an estimate  of  projections for expenditure required next three years
  • Details of any actual or possibly pending legal threats or litigation against the property.
  • Details of any mortgages on the property.
  • Fire, health and safety reports with an engineers report
  • Land tax and property tax applicable with proof of payment last 5 years
  • List of all supplies of services.
  • List of all tenants, rents, lease details
  • Occupancy and average rate the last three years clarified
  • Recent appraised valuation of the building
  • Reservations and deposits
  • Service contracts with third parties, with details on all issues the buyer will assume like franchises, licenses, permits, management agreements, union agreements.
  • The current operating year profit and loss statement with comparison to previous year will be ascertained to which the management will comment and add certain costs that may be missing so a true reflective NOP can be clearly determined
  • Trade names and copyrights.

Following successful completion the final purchase and sale contract is drawn up.

The content and issues outlined in this document are normally like this.

The property description, the list of assets being purchased, title and survey aspects, all licenses and permits and franchise agreements, the date of transfer,  all the financial terms with the terms of finance and information related to present trading results, the details of the due diligence with the obligations and  rights of both parties, occur and the rights and obligations of each party, closing documentation, closing expense obligations, and legal aspects.

In addition since staff are the most important ingredient of a successful business and one is buying into their expertise their needs should be very much at the forefront of the buyers mind.

The take over of the staff should evolve around the sellers officially terminating all employees on the day the property changes ownership, and then the buyer re hires them (or whoever they wish to hire) on a probationary basis. Management should by this time have a good idea on the benefits of re hiring most staff as the analysis of staff strength should be a critical component of the due diligence process. Aspects covered include staff medical records, pension and benefits, and vacation days owned.

Often a buyer will decide that all staff can bring forward their benefits and an accounting transaction is worked out. Legal advice being taken regarding assuring the buyer avoids taking over any liability issues.

The hotel closing day transactions incorporate calculation of that days property’s revenues and expenses and the physical stock take of all inventories included in the purchase price.

Once the necessary calculations have been worked out and the cash transferred the buyer is the owner!

For advice along the tricky road of hotel acquisition contact mark@turnerlodgingco.com.

Sweet dream or nightmare? Buying a small hotel in Costa Rica

What challenges are involved in buying a small resort lodge in Costs Rica? First off the mark is having to deal with Real Estate agents.

Day after day one comes across realtors in Costa Rica marketing small hotels and resorts for sale, with asking prices that are frankly criminal. I would define criminal as promoting a hotels value at a figure picked out of the air, the bare land price,  the cost to build, add some on for revenue generated, near what he bought it for down the road for last week!! No doubt ask them and they would blame the sellers for asking for such prices.

Is it the same as buying a resort vacation home? No. Is the value of the property calculated as one would a vacation home or residential property, that is on emotion? No.

The price you buy at should be based as far as you are concerned around the forward calculation of what cash flow you as an operator can generate from the business over the coming years at today $. It’s based on cash flow! and only that.

Not what $ a seller has invested in it. If a seller has invested 150K in improvements and the cash flow improvement have netted 10K in cash flow, then that’s 10K towards the valuation, not 150K plus “on potential”.

It’s present valuation based on what actual net cash flow from operations the property is achieving to date. The yield % to calculate this valuation based on the quality standard of the buildings and its location.

Let’s use a most simplistic calculation, ignoring numerous aspects of how a calculation of a commercial hotel business should be done.

Take a 10 bedroom lodge with a average occupancy of 60%, that’s 85% for 7 months and 25% for 5 during the wet and low seasons, way above average for small hotel operators in Costa Rica by the way, at an average rate of $60. That’s generating about 131K in revenue.

Costs of marketing, utilities, your sales efforts and affiliations, transport related,  maintenance, cleaning, laundry, linen, communications, grounds upkeep, insurances, local taxes, taxes, add some salaries to help you clean 6 rooms a day, supplies, you will be very lucky to generate a 65%  operating profit before a management salary.

For 365 days a year of pure graft and effort to manage the business, deduct a modest 40K for your efforts, which leaves about 45K cash flow. 10% yield on the net cash flow generated values this property at 450K, if a buyer is happy with a 40K salary! That’s before a capital plan for replacements of major building items, and achieving a 65% OP is questionable.

At 60% occupancy. Scary. Unless you like working for nothing that is.

Yes, on the market for $1m++ no doubt. !!!! Do the math, 500K down, 500K at 8% with 40K interest only payments, 5K to spare. Or 500K yielding 6% and you sit on the beach with your 30K.

40K to go gradually broke, forced to sell out at a loss, with health issues, or 30K for being a beach bum!

For advice on purchasing your commercial hotel business, do your homework and contact mark@turnerlodgingco.com.