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Due Diligence Before Purchasing a Hotel Note

Melissa Pitts has 6 years experience as a commercial real estate adviser, note investor, and note portfolio adviser.

Do you invest in hotels?

Do you invest in hotels?

Hotel Note Investing

Are you acquiring or considering investing in a hotel note?

While hotels are commercial properties, investing in hotel notes is different since you are not only purchasing the note but also acquiring the real property. Because of this, you need to do extensive due diligence before purchasing a hotel note. Though this is not an exhaustive due diligence list, this is a good start to the hotel note purchasing process.

1. Perform a physical walk-through of the hotel

When an investor purchases a hotel note, they are acquiring both the note and the real property. Investors should conduct a walk-through with an experienced contractor and engineer. Confirm that all hotel assets comply with environmental laws and any government-issued conditional use permit.

2. Ensure that all loan documents are in place

Before purchasing a hotel loan, confirm how many times the loan has been assigned to a loan buyer. You’d also want to obtain a file of the note seller’s correspondence. Along with this information, look for any hotel management agreements and any comfort or subordination agreements. Work with your attorney to ensure that all the assignment documents are complete and work properly.

3 . Hire a zoning specialist to review the hotel’s compliance

During the due diligence process, it’s appropriate to hire a team of specialists to evaluate the condition and compliance of the property. A zoning specialist, engineer inspector, and environmental inspector should analyze the property and provide a report of their findings. For example, a zoning specialist should review the hotel’s entitlements, such as confirming that the number of parking spaces complies with the zoning requirements. An engineer inspector should provide a report about the physical aspects of the property, including plumbing, electrical, computer, phone, and mechanical systems. The engineer report should also detail the condition of the structural elements.

An environmental inspector should look for any current and potential environmental hazards that may exist on and near the property. The environmental inspector should also verify whether the property and hotel signage is in compliance with all environmental laws and government-issued conditional use permits. The signage should also be verified that it complies with environmental and state laws.

4. Analyze the hotel operations

Analyze the hotel systems. Review the cost of keeping or changing hotel concepts, protocols, and systems. Some hotel note buyers correct or complete the hotel’s financials if the hotel is mismanaged. Keep in mind that some hotel buyers also implement new revenue management systems, reservation systems, and cost containment systems. Take into account these potential costs while analyzing your hotel note purchase.

5. Review all employee files and labor issues

Confirm that all employees (including maids, janitors, and the management team), are legal workers and have the proper documentation on file. If you find there are undocumented workers, it’s a good idea to search for another hotel note to purchase. Ensure that you completely analyze all employee positions, from the janitors to the managers.

In addition, you should look into any union issues. This is definitely necessary if you are purchasing the note of a large hotel brand. For example, if the hotel is the subject of a union campaign, the hotel’s operating costs could increase by as much as 40%. This can lower the value of your hotel note.

6. Review new ownership requirements with the hotel’s franchiser

If you’re considering purchasing a franchised hotel, verify the brand’s conditions and requirements for new ownership. Some franchisers may require that franchisees pay back any unpaid franchise fees as a contingency for using the brand. Some hotel franchisers also require a cancellation fee for new owners that wish to terminate and hire a new operator.

In addition, a franchiser may require a property improvement plan, which may impact the value of the note. A property improvement plan is an upgrade plan for hotels. It is sometimes used for hotels to stay compliant with environmental and government laws. Some franchisers also require it in order for the franchisee to keep up with the hotel brand’s standards. The following are some of the typical improvements:

  • Renovations to exterior facades – including signage, roofing, and colors
  • Room and lobby updates such as lighting and fixtures
  • New amenities such as indoor/outdoor pools and fitness areas
  • Expand or improve parking

7. Search for hidden liens on the property

When you purchase a hotel note, you’re not only buying the loan but you’re also buying the real property. Because of this, it’s important that a lien search be performed on the property. It’s also imperative to run a UCC search for hidden liens. Outstanding liens on a property can lower the value of a hotel note. A knowledgeable attorney should be able to complete the lien search for you.

8. Review the hotel’s financials

Since you will be purchasing the physical property along with your hotel note, you will definitely want to ask for your attorney and/or accountant to perform due diligence on the financials of the hotel. The information that should be reviewed is:

  • Monthly profit and loss statements, with supporting schedules
  • Occupancy and average daily rate (for last 3 years)
  • Current year-to-date profit and loss statement, with comparison to the previous year
  • Audited balance sheet (for last 5 years)
  • Real and personal property tax bills for the last 3 years
  • Annual audited profit and loss statements, with full supporting schedules (for the last 3 years)
  • Inventory of FF&E, supplies, consumables
  • Capital expenditures (for the last 5 years) with current projections for expenditures
  • Copies of all relevant contracts, such as hotel management agreements, service contracts, licenses, permits, leases, collective bargaining agreements, and all documents that detail the obligations that the new hotel owner will assume
  • Insurance coverage documents, including premium costs, language of the policy, and expiration date

Now You Know!

When purchased correctly, hotel notes can be a lucrative investment. As with most investments, it’s important to keep in mind the goals and objectives you’d like to achieve. Purchasing hotel notes are best suited for those with hotel ownership experience and knowledge. If you lack this, it’s recommended to purchase another type of commercial note. If you do have experience in the hotel or hospitality industry and you’re comfortable purchasing hotel notes, be sure to hire an experienced lawyer that can help you through the acquisition process.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2020 Melissa Pitts