News for the Hospitality Executive
Opportunities and Pitfalls in Buying Debt on Timeshare,
Fractional or other Vacation Ownership Projects
By Jim Butler, April 26, 2010
One of the most profitable endeavors for savvy lenders has been acquisition and development loans and consumer receivable financing for vacation ownership projects -- timeshare, fractional and vacation club projects. For various reasons that have little to do with the continuing sound fundamentals and continuing consumer demand for such project, the biggest lenders in this area have essentially stopped lending to deal with their other problems. And recently, some opportunistic investors have sought our advice on some potentially exciting loans being sold at a fair discount.
Due diligence is the caveat. (See What have we learned from "The Crash of 2008"?) There are no shortcuts for due diligence! There is great opportunity here, but also significant risk that can be ferreted out and analyzed to provide great confidence about the investment. In this article, my colleague and timeshare lawyer David Sudeck, a senior member of JMBM's Global Hospitality Group®, shares some of his insights on this subject.
In many ways, the issues are similar to those involving condo hotels in that both vacation ownership and condo hotels involve not only an operating business but also third party stakeholders and their expectations (and their attorneys). Click here for 100 Questions you should ask when looking for distressed condo hotel opportunities.
How to buy distressed notes secured
Opportunities and pitfalls in buying debt on timeshare, fractional or other vacation ownership
A Good Time to Buy, But Proceed with Caution!
By David Sudeck, Hotel & Timeshare Lawyer | JMBM Global Hospitality Group®
A wide variety of loans secured by vacation ownership real estate are in distress as receivables financing lenders have pretty much cutoff most time-share, fractional and private residence club developers, leaving limited carry-back financing options to offer to consumers. At the same time, consumer confidence has been beaten down by the prolonged economic downturn and unemployment.
We are Seeing Timeshare and Fractional Loans Trade!
While there may be signs of recovery (see, for example, "Increase in Asset-Backed Securities Signifies Robust Recovery for Timeshare Market" ), we are seeing more timeshare developer construction loan defaults. In this distressed economic environment, a lender with a non-performing mortgage loan is faced with difficult choices. It may elect to pursue foreclosure, but this process can be long and expensive (especially if the borrower files bankruptcy). Furthermore, most lenders lack the desire or the expertise to own and manage a timeshare or fractional project or the related interval sales. In addition, many do not want to assume the liabilities and obligations of ownership, including real property taxes, environmental liability, and obligations to existing owners. Furthermore, if the lender has written-off some or all of the loan, then selling the loan may reflect favorably on the lender's books. As a result of all of the foregoing factors, some lenders are selling off loans secured by timeshare, fractional and other vacation ownership developments at meaningful discounts. Other lenders are selling portfolios of loans that are performing because the lender has decided to exit the business or the market segment. In many cases, the decision to sell performing debt has nothing to do with the debt itself - the lenders may be focused on other problems that they or their affiliates have. For our clients with liquidity and patience, this means opportunity!
Due Diligence Is Critical When Purchasing a Loan Secured by a Vacation Ownership Property
The purchaser of a loan secured by any commercial real estate should conduct due diligence in connection with the loan (including the borrower under the loan) and the property that secures it. Conducting loan purchase due diligence is usually difficult because (1) the lender has often kept poor files, (2) the lender is hesitant to provide full access to its files to avoid claims of misrepresentation and in support of the "as-is, where-is" nature of the sale, (3) the borrower is uncooperative, and/or (4) the third party management company or broker responsible for handling project management and sales is, for one or more reasons, uncooperative. When you include all of the issues that are specific to a vacation ownership property, completing due diligence becomes a major undertaking.
Ask the right questions!!!
It is critical that a loan purchaser asks the questions below and understands the answers or that the purchase price of the loan has been risk-adjusted if these questions have not been answered:
1. Are the loan documents enforceable? How much is owed?Negotiating the Loan Purchase Agreement
We intend to cover the key terms of a Mortgage Loan Purchase Agreement or its equivalent in a separate article. We have significant experience from this downturn and previous downturns negotiating loan purchase agreements. Needless to say, because most lenders did not intend to be in the business of selling loans and because the sellers perceive these sales to be at highly discounted prices, the loan purchase agreement tends to be seller-oriented (as-is, where-is, etc.). Nonetheless, to the extent possible, we try to mitigate, through the provisions in the agreement, certain of the risks associated with purchasing a loan secured by a complex and regulated collateral like a vacation ownership property with intervals for sale.
Challenges Associated with a Bankrupt Borrower Involving a Vacation Ownership Project.
Another wildcard that a loan purchaser may need to deal with is a borrower bankruptcy before foreclosure is complete. Unfortunately, bankruptcies involving timeshare or vacation ownership properties are particularly challenging. They have a lot of stakeholders (e.g., receivables and other lenders, individual timeshare interval owners, management companies, brokers, and vendors), and the property, with its wide variety of components, may be very difficult to classify as a "Single Asset Real Estate" proceeding for purposes of securing an expedited relief from stay (to allow the lender to proceed with its pending foreclosure) pursuant to Section 362(d)(3) of the Bankruptcy Code. For a detailed analysis of this issue, read "Hospitality Lawyer - 'Speed bumps' in the road to bankruptcy for hotels and resorts. - Can a hotel ever be a "single asset" for bankruptcy purposes?" (from that article "The classic cases for single asset real estate involve a single office building or apartment house passively held for income. Properties involving an operating business, like hotels, are more problematic"). When there are many creditors, a borrower may be able to not only significantly delay the relief from stay, but it may be able to successfully secure bankruptcy court approval of a "cram down" pursuant to which the loan terms can be modified in a way that is unfavorable to the loan buyer as the new lender.
Understanding Obligations to Third Party Management Companies
Whether or not a timeshare or other vacation ownership property is operated sold using a branded affiliation, most such properties are managed by a management company. If a loan purchaser intends to foreclose on the property after buying the loan, that purchaser must be certain that the original lender/seller has not signed a non-disturbance agreement. If so, then it may not be possible to terminate the services of the management company except pursuant to the terms of the management agreement itself. For a detailed analysis of this issue, read our blog article on the topic "Hospitality Lawyer: Hotel Management Agreements: SNDAs or Subordination Agreements."
What does it all mean?
Through careful due diligence and drafting, much of the above risk can be eliminated. However, in order to truly understand the nuances of a property and avoid the delays and costs associated with a borrower bankruptcy, it is best to have the full cooperation of the borrower. How can that be achieved? Sometimes an offer of guaranty relief or walking away money can result in a "friendly" transaction. If the borrower is cooperating, then a concurrent transfer of the property to an affiliate of the loan purchaser will also eliminate much of the risk of borrower bankruptcy during a foreclosure. For a detailed analysis of this issue, read "Hotel bankruptcy? Distressed hotel loan mortgage? Restructuring hotel debt? Troubled hotel asset? How about an Enhanced Note Sale™?".
The hotel lawyers at JMBM's Global Hospitality Group® have a rich library of free information on dealing with distressed hotels, vacation ownership and condo hotels correctly (visit www.HotelLawBlog.com and see "Timeshares" or "Workouts, Bankruptcies & Receiverships").
Jim Butler is a founding partner of JMBM and Chairman of its Global Hospitality Group®. Jim is one of the top hospitality attorneys in the world. GOOGLE "hotel lawyer" and you will see why. JMBM's troubled asset team has handled more than 1,000 receiverships and many complex insolvency issues. But Jim and his team are more than "just" great hotel lawyers. They are also hospitality consultants and business advisors. For example, they have developed some unique proprietary approaches to unlock value in underwater hotels that can benefit lenders, borrowers and investors. (GOOGLE "JMBM SAVE program".) Whether it is a troubled investment or new transaction, JMBM's Global Hospitality Group® creates legal and business solutions for hotel owners and lenders. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them. For more information, please contact Jim Butler at firstname.lastname@example.org. or 310.201.3526.
|Also See:||Special Implications of the Downturn for Vacation Ownership: Strengths and Vulnerabilities You Should Consider For Your Project / David Sudeck / November 2008|