Maybe you’ve been working in the hotel industry for five to fifteen years for either a small group of investors or a major hotel company. At some point you may have thought to yourself, “If I only had my own place.” Well, it may be about time but where do you start and how do you go about it? In the following paragraphs, I’ll give you a simple and short course on how to go about it.
An important step is finding something to buy. Clearly you want to buy something that you are capable of putting the money together to purchase, fix up and carry until it is profitable. It may not take as much as you might think. For the purpose of this article lets assume you can scrape together at least $100,000 cash. This might include savings, IRA (yes, there are penalties), family, a couple of close friends, home equity loan and a personal line of credit for $5,000 to $25,000. This money will be used for the down payment/equity portion of your purchase, closing costs, legal advice and working capital. Once you believe you have your equity pulled together you can start establishing purchasing parameters.
These parameters are driven by your equity resources, hotel experience, geographic and personal preferences and the mortgage loans you might get. Clearly your equity resources in this example preclude you from buying the Minneapolis Marriott City Center! In fact, if you figure that you’ll have to pay 10% to 20% down on a purchase using 75% of your $100,000 you’ll only be able to afford a hotel costing between $375,000 and $750,000. That is quite a range and it assumes it doesn’t need any fixing up and will immediately carry the mortgage payments. More importantly, it assumes you’ll be considered a qualified buyer by brokers, sellers and lenders. However, you can see, minimizing the down payment will significantly assist in leveraging the purchase of a larger hotel. In fact, many sellers today are taking a little as 5% cash with seller financing. With $100,000 equity, the purchase price potential is now $1.5 million.
Before you start telling everyone you want to buy a hotel, set some criteria for yourself. A good one might be that you will only consider a hotel which is immediately self-sufficient and has seller or assumable financing. This can be accomplished in two ways: don’t even look at hotels that will not be able to carry the proposed mortgage or negotiate a mortgage with lower payments during an initial period of six months or a year.
Another criterion might be geographic in that you can get to it easily or that you may have to live there! Limit your search to markets you really know the dynamics of as it relates to supply and demand. Swear to yourself that you will not consider hotels just because they are esthetically appealing. Remember this is an investment for a profit!
One way to get on with your goal is to let a number of real estate brokers specializing in hotels know about your interest in a purchase and what your resources are. Focus on brokers dealing in the type of hotel you can afford. Stay tuned to the rumor mill as to what might be for sale in the geographic areas you are interested in by getting to know area hoteliers. There is nothing wrong with driving around and looking for properties that appear to fit your criteria. Are they in bad condition, poorly run, etc.? It might be just right for you! Note the address, go to the county seat and find the office with the real estate records. With a little digging around you can find out who the real owner is, the lender, some of the terms of the original purchase and related loans and whether the owner is current on the loan, bills and real estate taxes. This is all useful information on a prospective purchase when you are bottom fishing.
After all, that is what your doing at this price range! Now it may start occurring to you that if you did start putting a deal together the hotel might need some remodeling. Simply tell yourself up front that the cost of that is either going to have to be a deduction from the purchase price in order to free up some of your equity or that you will have to finance the remodeling. You could get the seller to help you finance it, get some secondary financing, talk to the community’s development agency and examine if the cash flow of the hotel might help pay for it.
When you start getting offers to sell (referred to as packages) take a quick look at the location, description and asking price to see if the hotel appears to meet your basic criteria. If it does, go through the package to see if it has sufficient detailed information. This would include financial statements for the most recent two or three years, information about the hotel’s physical facilities, market demand, surrounding area, competition and seller financing. If these things aren’t there or if the hotel doesn’t fit your criteria call the person who sent you the package. Ask for the items you need without letting them draw you into your likes and dislikes about the hotel. If the hotel didn’t meet your criteria tell them why.
Once you have the necessary information, do your own estimate as to what the hotel’s operating results will be for the next three to five years. Use the seller’s insurance and real estate taxes for your estimates for the time being. Watch for expenses that are unusually low or high and find out what is impacting them. Do your own staffing schedule based on your operating style, the hotel’s level of service and local wage rates plus whatever premium you might pay to have better employees. Take great care with maintenance and energy expenses. Your estimate should go all the way to the cash available for debt service.
Now take the asking price and subtract what you will pay in the equity down payment. Consider if your offer will include a request that the seller finance some improvements. You might be able to negotiate this up to an amount equal to your down payment as the money will be going directly back into the hotel. The net result is the value of the asset is enhanced for the seller and they have your attention because you have at least $75,000 invested in the hotel. You are both happy, as long as the seller didn’t need the cash to pay previous obligations like real estate taxes and past due mortgage payments.
Once you have established what the approximate amount of your mortgage will be, you must examine various amortization scenarios. You might start with 20 years at 8.5% and then examine the effect on the payments if you lower the interest rate a few tenths of a point or increase the amortization period to 25 years. The resulting calculation will need to come out to an amount equal to about 80% of your cash available for debt service. This is the point where you can really tell if you can afford this purchase at an offering price somewhat below the asking price.
One concept to be aware of is the “call” or “bullet”. This is when you have a long amortization period for the purpose of calculating the payments but that rather than amortizing (paying off) the loan over the full period you must pay the balance at the end of a shorter period such as five years.
If you are having difficulty making the numbers work for you, look at alternative ways to structure the acquisition. Do not revise your operating estimates without good foundation. Doing that is like trying to print counterfeit money! You might examine Small Business Administration (SBA) loans. A key concept in these is that a subordinated second mortgage from the seller or another source can be considered equity in addition to your cash. While this increases your leverage, it will call for higher debt service as second mortgage loans which are riskier than firsts typically have higher interest rates and shorter amortization periods. This alternative should really only be used if you are short of cash for both the down payment and necessary remodeling and the cash available for debt service is more than adequate.
Once you understand the various scenarios that work for you, make an offer that is most advantageous to you. Don’t worry, while it is a big step, you won’t have to live with it if you are wrong in some of your estimates. Your offer should be just a short letter and should mention some contingencies. These must include a reasonable time to inspect the property and get detailed estimates for repairs and remodeling, the right to examine the records (revenues and their supporting documents, utility bills and tax records) and subject to a mutually agreeable purchase agreement. The seller will probably counter with a higher price or changes in the terms of financing. Compare them to your previously worked out scenarios to see if they work for you.
When the seller and you have a tentative agreement, have the seller start writing a purchase agreement while you find a good real estate lawyer, preferably one with experience with hotels. Remember it is more expensive to write the contract than it is to review it although the seller will have greater control because it is harder to remove or change wording already in the documents. But an experienced lawyer will help insure that the purchase agreement works to your advantage while you reexamine the investment in great detail from every perspective. Your lawyer can also draw the process out while you raise a little more money or look at another package that may have come to you recently. A properly phrased purchase agreement will still be something you can get out of up until closing with little expense other than legal fees.
Once you decide to finalize the purchase use the period before closing to get all of the things in your business plan in place so that little or no time is lost getting things done to maximize your revenues and minimize your expenses.
(By Kirby D. Payne, CHA)