Article

Buying Hotel Properties: Unique Issues in Purchase and Sale Transactions

September 10, 2019

In many ways, drafting and negotiating a purchase and sale agreement for a hotel is like any other commercial real estate transaction. The parties will negotiate major business and legal provisions such as purchase price, the scope and timing of diligence investigations, representations and warranties, and closing conditions. Hotels are also operating businesses that need to be considered from multiple viewpoints. Is the hotel affiliated with a franchise or brand? Will the employees stay with the hotel after it is sold, or will a new team take over operations? How will bookings and other items be prorated between the parties?

Generally, buyers and lenders looking to invest in hotel properties should negotiate for, among other things, representations and warranties that address operational concerns. When purchasing a hotel, buyers and lenders must also consider the timing and calculation of prorations for many different categories, including accounts receivable, advanced bookings, gift certificates, and petty cash, to name a few. There will also be negotiations with respect to the inventory, such as in-room bed linens and toiletries and food and beverages offered at the hotel. It should be kept in mind that furniture, equipment, and inventory make up a significant portion of the value of any hotel property. Acquirers and their lenders will have to address employment considerations, as well as the transfer of major licenses, contracts, and permits required for the hotel’s operations.

This article serves as an introduction to potential buyers and their lenders looking to invest in hotel properties, and is the first in a two-part series. Here we outline the purchase and sale agreement provisions that will require specialized negotiations for hotel properties. We also explore the importance of a multidisciplinary team working with the acquirer throughout the transaction.

Hotel Purchase and Sale Agreement Provisions

Purchasers should request representations and warranties from the seller that address the operations of the hotel property. Purchasers ought to require that sellers maintain the current operations prior to closing so the hotel inventory, furniture, and equipment are not depleted. In addition, any current marketing and booking efforts should be maintained by the seller prior to closing so the purchaser will take over a hotel that is strongly positioned with future bookings.

Special prorations and adjustments are needed for hotel properties. For example, the parties may negotiate to equally split the hotel room revenues and advanced bookings from checkout time on the calendar day immediately preceding the closing date through and including checkout time on the closing date. In addition, the buyer should expect to pay the seller for any petty cash at the property as of the day of closing. The parties will also have to agree on an adjustment for any gift certificates or discounts provided to customers by the seller prior to the closing date, but which will not be redeemed by customers until after the closing date. Note that many times, proration true-ups will be required post-closing.

If the property has a bar or restaurant, the parties will need to arrange for a transfer of the liquor license to the buyer on the closing date. Because each state and even some cities have different requirements for liquor license transfers, the transition process can be lengthy and may require special counsel. Accordingly, the parties should start the process early in order to plan for situations in the event the transfer is not completed in time for closing, in which case the buyer may need to have an agreement in place allowing the buyer to use the seller’s existing license for a certain period of time post-closing.

Employee considerations may also require the need for special counsel. For instance, if the employees belong to a union, then there may be negotiations with respect to a collective bargaining agreement. If the hotel is a smaller, perhaps an independently operated property, it may be that the purchaser will bring in its own team of employees as of the closing date. In this instance, the existing employees will need to be terminated and the new employees brought in seamlessly so as not to interrupt guest services while complying with applicable notice requirements.

Preview of Third-Party Management Agreements

Another major consideration for purchasers and their lenders is whether there is an existing franchise or brand management agreement in place. These agreements tend to be heavily weighted in favor of a particular franchise or brand and may have restrictive assignment provisions. Because the negotiation of these agreements is in many cases just as complicated and involved as negotiating a purchase and sale agreement, specific considerations will be discussed in more detail in our second article.

Multidisciplinary Practice

Even before negotiating a letter of intent, lenders and borrowers should consider that purchasing a hotel requires a diverse team of experts. Purchasers will want a strong commercial real estate lawyer to lead the acquisition and reach out to specialists. The best commercial real estate lawyers will have good working relationships with specialists who will help to anticipate and underwrite every component of a hotel acquisition.

Your real estate lawyer will focus on the transfer documents and oversee the entire acquisition as well as put the lender and borrower in touch with the best suited experts for the transaction, including, but not limited to:

  1. Employment lawyers, who will help with the transition of current hotel employees, whether they will remain with the hotel or be terminated and another management group take over. They will also navigate complex collective bargaining agreements.
  2. Liquor license lawyers, who will help with the transfer of the liquor license to a buyer and should be engaged early in order to avoid any delays in this process.
  3. Tax lawyers and consultants, who will advise on many issues from 1031 tax-deferred exchanges to helping REIT investors meet requirements when investing in a hotel property.
  4. Risk management experts, who will assist with obtaining the required insurance policies, including, property and general liability insurance, employee insurance, and dram shop/liquor license insurance.
  5. Finance lawyers, who, depending on the nature of the acquisition, should be experienced in foreign investment and security interests in equipment, inventory, accounts, licenses, and other personal property, and may also be required to advise during the acquisition process. 

Conclusion

Before investing in a hotel property, purchasers and their lenders need to make sure they have a dynamic team that will help to guide them through the acquisition process. This team will ensure that the buyer and its lender have accounted for every aspect of the acquisition and are strongly positioned to negotiate the purchase and sale agreement.