Nov 18, 2013

With transaction volumes in early 2013 50 percent ahead of the level in early 2012, many owners today are asking themselves if this is the right time to sell.

Previously published in www.LodgingMagazine.com 11/12/2013

With transaction volumes in early 2013 50 percent ahead of the level in early 2012, many owners today are asking themselves if this is the right time to sell. They see very low cost capital that is abundantly available, contributing to higher values. Yes, interest rates have ticked up from their recent lows, but long term, fixed rate debt is still priced in the low five percent range on a 25 year amortization schedule to 70 percent of value/cost. For buyers, this translates into cash on cash returns in the low to mid teens on almost any deal.

After a number of years of living with their properties underwater, sale prices have now increased to the point where owners might not just clear their debt, but may actually see a profit. Imagine moving from loan modification discussions with your lender, to tax planning discussions with your accountant.

Improving operating metrics support the sell scenario and are driven by relatively low supply growth numbers. While RevPar growth has been moderating in many markets of late, RevPar's are hitting historical highs across the country, unadjusted for inflation. That said, early-stage new supply continues to see additions and owners understand that it may become more difficult for older properties to maintain their competitive positioning.

There is a real danger that NOI growth will moderate, or that NOI's may even erode in the coming years. Consider the risks associated with increased labor costs (some states like NJ are increasing minimum wages), higher health care costs, more government regulation, ADA compliance and taxes. Savvy owners know they should leave some upside on the table for buyers, so for many, these conditions represent an ideal time to monetize their assets.

Once you've made the decision to sell, the next question is how to maximize value on a sale. There are a number of steps that should be taken in readying a property for the marketing process.

Physical Asset

There are certain property-level items to consider before putting a hotel on the market. The hotel should be critically examined for any areas ripe for creating value increases. Look at all aspects of the property with an eye toward additional revenue potential or cost savings. Even if this may require some capital expenditures, you will want to either complete the work or be able to articulate the costs/benefits of the opportunity for buyers. Another often overlooked angle is the potential for expansion or redevelopment of the asset. Sellers should be able to explain the potential upside and risks associated with any opportunity for expansion/redevelopment. The best thing to do is to try to view your hotel as if you were buying it today. Would you keep the F&B the same? Are there neglected CAPEX items that should be addressed? Is the brand appropriate for the facility? Are other, more desirable brands available and at what cost?

Operations

Hotels are operating businesses with a significant real estate component. They are valued off their income streams and so maximizing NOI is the most critical step a seller can take in preparing for a sale. This includes both a revenue and an expense audit to identify and implement strategies for improvement. Since a property's trailing 12 NOI is heavily weighted in any buyer's pricing model, the sooner an owner gets started in this area, the better. Any good broker will assist in crafting a story to "sell the dream," but reality is always the easier case to make. On the revenue side, examine your sources of revenue and market mix. What is the "income efficiency" of each of your customer segments? Are you or your manager actually pursuing the "highest income guests?" Some property managers have fallen into the habit of going after only the low hanging fruit and don't want to put forth the effort to capture the higher-rated business.

After revenues, expenses should be examined for possible reductions. Owners need to be careful not to put their property's market positioning at risk by cutting essential expenses, particularly in the area of marketing. A personnel review is critical in reducing costs. Look for efficiencies and potential for combining of roles. We were recently marketing a property where a reduction of over $300,000 in payroll and benefits was able to be realized. This goes straight to the bottom line, increasing value significantly. You should also critically examine all contracts and leases for the property. There are usually some older agreements that can be renegotiated or bid out to achieve sometimes material cost savings.

Lastly, a critical factor in any transaction is transparency in reporting. A competent broker will review your financials and look to eliminate any non-recurring items to get to a "normalized" NOI. This is impossible without detailed, well-documented financial reporting. Sellers should help the buyer get to the highest possible underwritable NOI.

Market/Competition

The market in which the hotel operates needs to be understood and monitored. Are there other properties on the market or being considered for sale? How does your hotel fit into the market in terms of its competitiveness. If you're not already doing this, Trip Advisor and other similar services should be reviewed to gain an external view of your asset. Every buyer we survey uses these tools in evaluating a purchase. Are there hotels in your market with attractive brands that may be leaving that brand? Is there a potential rebranding opportunity for your property that would add to its value to a buyer? Is the market improving, stable or declining? These factors will have a major impact on a buyer's and lender's view on valuation and collateral security.

Capital Stack

Sellers should be familiar with the current capital stack for the property. Factors like debt prepayment, assumability, terms and leverage levels are all important to completing an effective sale. If your property is saddled with high-cost, non-prepayable debt, this will be reflected in any buyer's view on valuation. The reverse is also true, so Sellers should investigate the existing debt as well as the potential market for new debt. This will allow the seller to be realistic in terms of pricing and terms for their sale.

These are just a few of the factors sellers should consider in the decision to enter the market and how to effect the best transaction. As always, a good advisor can be instrumental in achieving the most beneficial execution. Hotel asset sales are complex and require knowledge of both hotel operations, and hotel capital formation as well. Without the former, the best case for value cannot be made. Without the latter, the seller has a very hard time evaluating the various offers for their veracity.