By Liza Stone, Esq., JMBM, (310) 785-5367
August, 1997 - The hospitality industry recovery is finally gracing Hawaii. For the first time in many years, investors are taking advantage of the tremendous opportunities that abound on the Hawaiian Islands.
But hotel deals in Hawaii are unlike anywhere else in the United States. Hawaii has its own unique customs and norms which must be taken into account in underwriting a potential acquisition and conducting a due diligence review. You and your counsel must know the critical pitfalls and issues that may arise in connection with your acquisition.
Assemble the Right Team
As with any hotel deal, the key to success is to have experienced, knowledgeable players on your team. Retaining sophisticated hotel counsel is critical. That hotel counsel will coordinate with local Hawaii counsel to address various local law matters. Although the property may be in Hawaii, the players (buyers, sellers, managers and lenders) are often large, institutional parties from the mainland who are represented by sophisticated legal counsel. It is important that an investor considering a deal in Hawaii retain hotel counsel who can interface effectively with each of those players, and efficiently manage the multitude of legal issues which arise.
Foreclosure
Hawaii is a judicial foreclosure state. If your acquisition is structured in the form of a note purchase, you need to be aware that this process can involve a significant expenditure of time and money to complete.
Entitlements
Your entitlements review should include a "County Confirmation of Zoning" letter, which can typically be obtained on an expedited basis. If you are considering remodeling or renovation work following the acquisition of a hotel, you may be required to obtain a Shoreline Management Area Permit.
Ground Leases
Hawaii properties are often subject to ground leases, many of which are over 20 years old and provide for rent adjustments to fair market value which are due to kick in within the next few years. Due to the tremendous appreciation in land value in Hawaii since the Ground Leases were originally entered into, investors can be assured that there will be significant rent increases under those older leases which can have a devastating impact on the investment analysis, and must be taken into consideration. Further, many ground leases provide for the rental to be calculated as a rate of return on the "fair market value" of the property. Be especially wary of language which defines the fair market value as the "highest and best use" of the property. Recent arbitrators' decisions as to the highest and best use for a particular property have been worlds apart from the actual use being made of the property under the ground lease.
Labor
The State of Hawaii has its own plant closing laws, which may, in some respects, impose even greater restrictions than the federal WARN Act For example, even if all of the existing employees at a hotel are rehired by the purchaser, failure to strictly comply with the Hawaii notice provisions can result in significant penalties.
Taxes
Hawaii's successor liability laws make it critical to obtain a tax clearance certificate from the Hawaii Department of Taxation certifying that all taxes due to the State have been paid. Note that Hawaii imposes a general excise tax equal to 4% on all "gross receipts" (including rental income). In hotels with a retail component, a well-drafted lease will pass through this tax obligation to the tenant. Be aware, however, that this same tax is usually passed through to the lessee under a ground lease, thus increasing the actual rent paid by the lessee.
Liquor Licenses
In Hawaii, liquor licenses are typically held by the hotel operator. Make sure your management agreement provides for the smooth transition of liquor operations in the event of a termination of the management agreement in order to avoid "going dark" for any period of time.
Utilities
Many hotels are not serviced by public sewage systems, but instead are part of a private sewage system. Confirm the source of your sewage service and carefully review any agreements affecting your rights to such ser-vice, which may include ownership of stock in the sewage corporation. If that is the case, your acquisition of the hotel should also include acquisition of the stock in such corporation.