News for the Hospitality Executive
Workouts and Special Servicing for Hotel Mortgage Loans:
What Is So Different About Troubled Hotel Loans
|By Jim Butler, Hotel Lawyer | Author of www.HotelLawBlog.com
- November 4, 2008 -
In September, the hospitality
industry fell off a cliff . . .
For most of 2008, the torrid performance the hotel industry has displayed for the past several years slowed significantly, but the industry was still doing quite well as it came off historic highs. Of course, since August 2007, those with larger hotel loans coming due worried about being unable to refinance them, and new financings grew increasingly more difficult. But in September 2008, the events surrounding the "Global Financial Crisis" have apparently broken the dam that was holding back a flood of loan defaults where the underlying assets are hotels or other special purpose real estate closely intertwined with an operating business.
For almost a year, lenders have talked about a "flood" or "tidal wave" of troubled loans that were "coming." But until now, few loans defaulted and few bankruptcies were filed. It appears that all of a sudden, that has now changed. As lenders and investors deploy their special servicers, workout teams, and turnaround specialists to deal with the defaults on these assets, it is wise to remember that these loans are different. What is so different about TROUBLED HOTEL LOANS? Let's take a quick review.
Like falling off a cliff . . .
We all read the headlines and we know the reasons the hospitality industry had to take a hit -- the economic crisis, cost of oil, cut back in airline seat capacity, collapsing of consumer confidence, job layoffs, and corporate cut backs. But the magnitude of the sudden downturn for the hotel industry was summed up well by Steve Van, President and CEO of REMIC Hotels, when he said, "Year to date performance in the hospitality industry for 2008 is irrelevant. In September, the hospitality industry fell off a cliff . . . and is still in free fall, with business dropping as much as 30% in some markets and market segments."
With the CMBS markets and traditional lenders still frozen up , maturity defaults, and even payment defaults now loom on many hotel loans. And with cap rates increasing, LOI falling, few hotel loans are refinanceable today even before you take into account lower loan to value ratios and higher debt service coverage requirements.
In fact, the hotel lawyers at JMBM's Global Hospitality Group® have already seen a sudden change as our experts on workouts, receiverships, and bankruptcies have been called to action with hotel loans going into default and owners filing bankruptcies. So it seems timely to discuss some of the unique issues and problems lenders and owners encounter in dealing with troubled loans on special purpose real estate assets with operating businesses such as hotels. By the way, many of these same issues apply to franchised gasoline stations, convenience stores and restaurants.
What is so different about Troubled Hotel Loans?
Special purpose real estate assets associated with operating businesses present unique problems. Examples include loans secured by hotels, casinos, franchised gasoline stations, convenience stores, restaurants, and the like. These assets involve an operating business that is integrally intertwined with special purpose real estate, and that operating business comprises a large component of the asset's value.
It is the operating business that raises some thorny problems. The operating business often needs management and franchise affiliations, licenses and permits, extensive vendor relationships, marketing efforts and a significant work force. Many of these aspects of the operating business are critical to the value and success of the asset and the recovery to be realized. They can evaporate very quickly during the handling of the troubled loan.
For example, what is the value of the underlying real property of a Marriott, Holiday Inn, Hilton, Hyatt or Four Seasons if it loses the brand and professional management? It becomes just a big box hotel with no name, no reservation system and no professionally run staff. What impact does it have on the lender's collateral if a breach of a management or franchise agreement exposes the owner to the expected profit of the brand or operator for a remaining 20 or 30 year term, or more? What damage is done to the public image of the asset if quality is not maintained, rumors of bankruptcy taint expectations of service, inventories fall below acceptable levels, and relations with critical vendors are damaged?
Or, to use another common example of loans secured by a gasoline station with franchised restaurants and convenience stores, it may be easy enough to renegotiate gasoline supply agreements, but what is the value of the underlying real property of a Burger King or Del Taco restaurant that loses its franchise, jeopardizes its ground lease, and faces defaults under its franchise agreement and other contracts?.
Understanding the "structure" of hotel ownership and operation
Many lenders and servicers are unfamiliar with the business and legal "structure" of these special assets, so we will first use a hotel example to illustrate the franchise and management overlay that complicates working with many of these assets. The typical hotel is owned by an individual, institutional investor or investor group, and this owner is usually the borrower on the hotel loans. Complications grow geometrically when the operator also has a joint venture or other investment interest in the ownership, and such arrangements are common with many hotels. The hotel company -- Marriott, Starwood, Hilton, Hyatt, or whatever -- is a separate entity that will manage or franchise the owner's hotel.
Hotel franchise or management agreement. When you drive by a hotel and see a big red Marriott sign on top, the chances are great that an owner has entered into a franchise or management agreement with Marriott to brand the hotel and plug into Marriott's reservation system and expertise. But it is fairly unlikely that Marriott owns the property or has a significant interest in it. In many instances, the hotel is managed by the branded hotel company, but often the hotel will have a franchise from Marriott or one of the other branded hotel companies, and an independent management company -- unaffiliated with the brand -- will manage the hotel under a separate arrangement.Four "special issues" for Lenders with troubled hotel loans and other special assets with operating businesses.
Hotel loans present at least four categories of issues that lenders don't usually encounter with traditional real estate loans such as their loans on office buildings or apartment houses. These special issues should all have been addressed in initial loan underwriting, but need to be reconsidered as a loan gets into trouble. They include:
1. Subordination and SNDA. Subordination agreements and SNDAs are frequently encountered with branded hotel management agreements. The lender's rights are often vitally affected by the terms of a subordination agreement or a common variation called the SNDA which the owner, lender and operator may have executed. Such agreements typically provide comfort to lenders that upon a foreclosure, deed-in-lieu or sale in bankruptcy, the lender or its successor in interest will continue to enjoy the benefits of the management agreement. (See "Hotel Management Agreements: SNDAs or Subordination Agreements" on www.HotelLawBlog.com.)
About the Author:
Jim Butler is one of the top hotel lawyers in the world. GOOGLE “hotel lawyer” or “hotel mixed-use” or “condo hotel lawyer” and you will see why. He devotes 100% of his practice to hospitality, representing hotel owners, developers and lenders. Jim leads JMBM’s Global Hospitality Group®—a team of 50 seasoned professionals with more than $40 billion of hotel transactional experience, involving more than 1,000 properties located around the globe. In the last 5 years alone, they have brought their practical advice to more than 80 “hotel-enhanced mixed-use” projects, a term Jim coined to fill a void in industry lexicon. This term describes one of the hottest developments in real estate-where hotels work together with shopping center, residential, office, retail, spa and sports facility components to mutually enhance the entire project’s excitement and success. Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them. They are a major gateway of hotel finance, facilitating the flow of capital with their legal skill, hospitality industry knowledge and ability to find the right “fit” for all parts of the capital stack. Because they are part of the very fabric of the hotel industry, they are able to help clients identify key business goals, assemble the right team, strategize the approach to optimize value and then get the deal done. Jim is the author of the Hotel Law Blog, www.HotelLawBlog.com. He can be reached at +1 310.201.3526 or email@example.com.
|Also See:||Tough Sledding Ahead for Hotel Industry / Karen Johnson / September 2008|
|Agreement on Bailout Bill? The ''Emergency Economic Stabilization Act of 2008" / Jim Butler / September 2008|