10 Key Steps to Successfully Purchasing a Hotel Property

Anish Parikh and Sonia Mann, Parikh Law Group

Thinking about buying a hotel? Whether it’s your first or fifth, here’s some of the basic information you should know before buying to help make the process easier.

1. Determine your acquisition criteria

First, decide why you want to buy a hotel. Are you looking to make a quick profit by selling it later? Or do you want steady income over many years? Here are some key things to think about:

a. Purchase price and commitments for capital expenditure and working capital immediately and in the medium and long term

b. will owner operate the hotel, enter into a franchise agreement, or have the brand manage the hotel

c. potential appreciation in asset value

d. upside potential from re-branding taking into consideration the cost of any associated property improvement plan (PIP) required by the incoming operator etc.

e. financial performance, including current and potential cash flow yield, revenue per available room (RevPAR), occupancy rates etc.

f. a hotel as a “trophy asset”

g. whether the hotel is Sharia compliant, which includes not only that it is alcohol free but includes other considerations

h. location – strategically, a buyer may want an asset in a certain city or part of a city and assessing the competitive set of the hotel and there is no right or wrong answer but ultimately a buyer needs to be clear on what its reasons are for wishing to purchase a hotel before entering the acquisition process.

2. Identify the right target

Next, reach out to hotel brokers, consultants, or hotel brands to find available properties. Visit the ones you like, study their business potential, and work out how much you’re willing to pay.

3. Manage the bid process

Hotels are often sold through auctions. You’ll need to make an initial offer, and if shortlisted, submit a final bid with legal paperwork. Remember – having the highest bid doesn’t always win! Sellers also care about whether you can pay quickly and agree to their terms.

4. Determine the right price

As with any acquisition, one of the most important factors when buying a hotel is the price you pay. There are various different hotel valuation methodologies – for example, discounted cash flow analysis, EBITDA multiples, comparable hotel sales, surveyor valuations etc. and you should discuss which one is appropriate with your financial adviser. Bear in mind that in an auction process, where you may be one of many bidders, price will be a key factor.

5. Determine the right structure

As a buyer you will have two main options. One is to buy the shares of the company that owns the hotel property and other assets which make up the business; the other is to buy from the company the hotel property and other assets. If shares in a company are purchased, all its assets, liabilities and obligations are acquired (even those a buyer may not know about). On an asset deal, only the assets and liabilities which the buyer agrees to acquire and assume, which will be identified in the sale agreement, are transferred. Generally, asset purchases tend to be logistically more complex than share purchases due to the need to transfer each of the separate assets which form the business and to obtain approvals of third parties (counterparties to contracts, licencing authorities etc.), although change in control issues also arise in share purchases. In Dubai, there are other structural issues which arise as a result of foreign ownership restrictions and local authorities’ requirements in terms of which types of entities can own property and hold a hotel license. Offshore entities will also need to consider potential tax implications based on their specific circumstances.  Your lawyers will be able to advise you on all structuring matters.

6. Ensure that your financing is in place

You will need to consider at the outset of the transaction how you are going to fund the purchase and, potentially, an initial capital expenditure program.  Will this be from existing cash resources, other investors or bank debt? If bank debt is going to be required, you should speak to potential lenders at an early stage to find out how much they are willing to lend and what specific requirements they may have in terms of security over the hotel and/or the bank accounts. This will enable you to determine whether the deal is feasible and, if it is not, you can stop work and avoid incurring unnecessary costs. If there is an existing hotel management agreement in place, the operator may have already imposed certain loan to value criteria which would need to be complied with as well as the requirement to obtain a non-disturbance agreement. 

7. Carry out proper due diligence

On any hotel deal, due diligence is of critical importance. You will need to appoint a good, experienced team of advisers which will typically include lawyers, financial advisers and property surveyors. Each adviser should conduct a thorough investigation of the part of the business that corresponds to its area of expertise. High quality due diligence should uncover material issues which can then be dealt with up front – for example, by way of contractual protections or deductions to the price (or, in extreme cases, by pulling out of the deal altogether).  Bear in mind that you are acquiring more than a real estate asset.  A hotel is an operating business so the due diligence process needs to be conducted accordingly.

8. Assess your management options

In most cases it is likely that a third-party management company is managing the hotel already. If so, their consent will be required for completion of the deal (which includes approval of the buyer by the management company). Therefore, it is important that you discuss this with the seller with a view to agreeing how best to approach the management company and at what stage in the process to do this. Although you will not want to contact the management company at the outset, you will not want to wait until just before completion either.  Most hotel management agreements are for a long duration (often up to 20+ years for luxury brands) and you will need to check if there is any ability to terminate the agreement. If there is a provision for termination upon sale it normally comes with a high termination payment. If there is no incumbent management company or it is run by the current owner, you will need to consider your management options. You should engage with a third-party management company at an early stage as they will need to assess the hotel for compliance with their brand standards and assess if a PIP is required. You should appoint a hotel specialist lawyer to assist you negotiate the terms of the hotel management agreement.  Franchising is another option pursuant to which the owner obtains the right to use the brand and operate within the brand system (i.e. reservations systems, loyalty programs, etc.), but operates the hotel itself or with an unbranded operator.

9. Negotiate the right price adjustment mechanism in the SPA

One of the key negotiation points in the SPA will be the pricing mechanism. The two most common structures are: (1) a valuation based on the target company’s accounts at completion and adjusted through a completion accounts process (Completion Accounts); and (2) a target valuation based on historic reference accounts, which is fixed as at a historic reference date and where all subsequent economic upside (and downside) in the business since that date is for the account of the buyer (Locked Box). In broad terms, a Completion Accounts mechanism is typically the preferred choice for buyers as it means they only pay for the balance sheet that they actually acquire, and they are able to check and verify the financial position when they are in full control of the business. On the other hand, Locked Boxes have traditionally been the mechanism of choice for sellers as they result in certainty of proceeds and no post-completion adjustments nor any of the associated costs. In an auction process it is common for sellers to insist on a Locked Box mechanism and there is unlikely to be any scope to negotiate on this – in such a case you will need to make sure that you carry out sufficient due diligence on the historic reference accounts.

10. Negotiate a robust set of warranties and indemnities in the SPA

Warranties serve two purposes. Firstly, they complement the due diligence exercise by confirming that the information that has been given to the buyer is accurate and by ensuring that the seller discloses any known issues to the buyer prior to signing the SPA. Secondly, warranties apportion risk; in essence, the buyer can sue the sellers for damages for breach of contract if the warranties prove to be untrue or inaccurate and, as a result, the value of the acquired business is reduced. As a buyer you will want warranties on all of the key aspects of the target business – good title to the hotel land, accuracy of accounts, absence of litigation etc. Any known material risks – for example, a court case which is likely to result in the target company having to pay damages after completion – should be dealt with by way of indemnities (which provide dollar for dollar compensation in respect of the specific losses suffered).

Contact Parikh Law Group for expert guidance on your hotel acquisition. Whether you are new to the hotel arena or a seasoned investor, our team of legal experts can guide you in the achievement of your hotel investment goals. 

Call (312)725-3476 or visit www.plgfirm.com. We appreciate your trust in our legal team for over a decade and are happy to assist you.