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News for the Hospitality Executive |
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Buying a Hotel? Financing a Hotel? 10 Things Every Borrower Should Know. (Part 1) |
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recent update on this topic, click here By Jim Butler and the Global Hospitality Group® Hotel Lawyers | Authors of www.HotelLawBlog.com December 11, 2012 Buying hotels is in vogue right now. But financing hotel purchases has some twists every borrower should understand. The industry fundamentals continue to go from good to better, and values are increasingly favorable compared to alternative investments. Many think that this is the time to jump in, before it is too late. Most hotel buyers will want financing. Some of the big REITs or other cash rich players will buy for all cash and then find financing at their leisure. That gives them an advantage in bidding on hot properties. But most buyers will want financing to pay for their acquisition. Either way, there are some things your mother may not have told you, but as a buyer (and a borrower) in a hotel purchase, you really should know these 10 things that my partner, hotel lawyer Jeffrey Steiner, lays out for us in his article. Because of the length of this article, it is presented in 2 parts. Here is part 1. Buying a hotel and financing a hotel purchase The following are some special aspects of hotel lending for borrowers to be aware in negotiating hotel loans. Many of these matter are appropriately addressed at the term sheet or commitment stage, rather than leaving them to be negotiated in the loan documents. 1. Franchise
Agreements; Comfort Letters. Comfort Letters. To improve the lender's position, typically it will require the franchisor to enter into a separate agreement addressing lender cure and franchisor termination rights upon a borrower franchise agreement default and lender rights to continue the franchise after a foreclosure. This agreement is known as a "comfort letter." Typical terms of a comfort letter. The following are some typical terms of a comfort letter:
2. Hotel
Management Agreement; SNDAs. The hotel lender may require the borrower to replace the hotel manager if there is a failure of financial covenants in the loan documents. The borrower should determine at the loan commitment stage what rights the lender will require to force the hotel manager termination. That way the borrower can evaluate whether it has those rights under the hotel management agreement or if the manager will modify the borrower rights to terminate to conform to the loan documents. Even if the borrower can terminate the hotel manager, the logistics of doing so while remaining in compliance with the loan document covenants may be difficult, unless the covenant terms are carefully negotiated in the loan documents. The loan documents will generally require that the hotel continuously be managed by a qualified hotel manager, while any new hotel manager and new hotel management agreement must be approved by the lender, which can take time. The borrower may be able to negotiate in the loan document a standard for new hotel manager qualification and permitted new hotel management agreement terms, so that the selecting an replacement manager selection process can be streamlined. For instance, if the hotel is branded, the franchisor may maintain a pre-approved management company list, and the lender may allow any franchisor-approved management company to be the manager. Subordination, Nondisturbance and Attornment Agreements (SNDA). A hotel management agreement is a contract for services that binds the hotel owner, but not the hotel real property, as distinguished from a lease of hotel space, for instance, that creates a real property interest to which a future hotel owner's rights will ordinarily be subject. A successor hotel owner, including a lender acquiring by foreclosure, is not typically bound by the hotel management agreement and may terminate the existing hotel manager without liability to it. Major hotel management companies entering into long term hotel management agreements may require that as a condition of the hotel owner obtaining a hotel loan, the general legal principles regarding hotel management agreement survival be reversed. This change is accomplished through a separate agreement of the lender to be bound by the hotel management agreement following a foreclosure, which is commonly known as a Subordination, Nondisturbance and Attornment Agreement (SNDA), a name taken from the real estate leasing world. Lenders also may have want an SNDA with the hotel manager confirming the subordination principle, providing for the lender to receive notices of default and cure rights before the hotel management agreement can be terminated, and imposing restrictions on amendments and terminations without lender consent. 3. Cash
Management. The next stage of the cash management system is more critical to the borrower in terms of its practical effects on day to day hotel operations. In the more restrictive version (sometimes known as a hard lock box or cash management arrangement), the clearing account receipts are swept periodically into a lender-controlled account for distribution to subaccounts, such as for debt service, property taxes, insurance premiums, capital reserves, and operating expenses or excess cash flow subaccount. The subaccounts are filled from the available cash in the clearing account in the priority set forth in the loan documents known as a "cash flow water fall." In this arrangement, the amount payable for operating expenses may be based upon a lender approved annual operating budget, or the amount in the excess cash flow subaccount will be distributed to the borrower's operating account for use to pay operating expenses instead of there being a specific allocation to an operating expense subaccount. The borrower's right to the excess cash flow or operating expense payments may be suspended in the case of loan default. In the less restrictive system more favorable to the borrower (sometimes known as a soft lock box or cash management arrangement), the funds in the clearing account will automatically be distributed or swept to a borrower operating account for use by the borrower in its discretion, until the lender notifies the clearing account bank to cease the sweeps to the borrower operating account. The lender may terminate the sweeps to the borrowing operating account upon a loan default or other triggering events identified in the loan documents, such as a debt yield or debt service ratio test failure. When those sweeps terminate, the funds will be redirected to the cash collateral account and handled in a similar fashion as in the hard cash management system. In negotiating the cash management system details, the hotel owner should take into account the requirements of its hotel manager, which may want hotel revenues to flow through its cash management system, so it has control over the funds to pay hotel operating expenses for which the manager may have personal liability, such as employee wages and benefits. It is advisable for the hotel owner to build in flexibility to meet lender cash management requirements when it negotiates its hotel management agreement. 4. PIP Reserve;
Capital Reserves. Capital Reserve. The hotel lender will typically require that a capital reserve be funded periodically from hotel gross revenues, usually 4% of gross revenues, and deposited in a lender controlled account. The loan documents will address the permitted capital reserve uses, and the conditions upon reserve disbursements. If lender budget approval is required, the capital reserve use may be limited to projects identified in the budget, or else, the capital reserve funds may be available for any projects necessary to keep the hotel in the condition required by the loan agreement, franchise agreement, and hotel management agreement. The conditions upon disbursement may include lender approval of the contractors, plans for major projects, bonding requirements, invoices and lien releases in applications for payment, and title insurance endorsements. Borrower compliance with these requirements may be burdensome and expensive. Through negotiation, certain requirements may be eliminated or restricted only to projects costing above a minimum threshold. Exceptions to the requirement that capital expenses be on the approved budget may also be qualified for improvements to meet brand standards, improvements costing less than an agreed upon maximum, code-required improvements, and tenant improvements. The Approval Mechanism should also be applicable to lender decisions concerning capital reserve use. 5. Annual
Operating Budgets. HOW TO BUY A HOTEL --
Free handbook Here are a few of the articles on the subject under this topic: This is Jim Butler,
author of www.HotelLawBlog.com
and hotel lawyer,
signing off. We've done more than $60 billion of hotel transactions and
have
developed innovative solutions to unlock value from hotels. Who's your
hotel
lawyer?
__________________________ Our Perspective. We represent hotel lenders, owners and investors. We have helped our clients find business and legal solutions for more than $60 billion of hotel transactions, involving more than 1,300 properties all over the world. For more information, please contact Jim Butler at [email protected] or +1 (310) 201-3526. Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group™. Jim is one of the top hospitality attorneys in the world. GOOGLE "hotel lawyer" and you will see why. 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. |
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Contact: [email protected] 310.201.3526 |
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