Due diligence has always been essential to any hotel purchase, but the process is (or should be) far more intensive today. With tighter lending requirements and increased awareness about environmental issues, buyers need to arm themselves with more and more information before they sign on the dotted line. Four experts from different sides of the hotel sector weigh in on what investors need to know.
The financial Commitment
Times have changed, and lenders are requiring more information than they ever did before, an outcome of the economic downtown of 2007/2008.
“There’s more detail required and a lot of that is driven by compliance requirements across the board,” says Ian Ricci, a senior account manager at GE Capital who specializes in hotel finance. “You have to be more sure now. You have to be absolute and ironclad in terms of having all the right information.”
Being organized and prepared is key. For example, buyers should have monthly financial statements organized and available in advance. “[Lenders] want to see trailing 12-month periods, whereas before it might have been OK to just use an annual statement,” says Ricci. “There’s more granular analysis.”
It’s also important that internal statements and account-prepared statements match up. “Sometimes they don’t,” says Ricci. “And, if they don’t, you have to understand why, because that question will come up.”
Ricci’s checklist for potential buyers looking to appease lenders also includes: understanding the financial performance of the hotel; understanding the competitive landscape in which the hotel operates; and, if there’s an existing franchise, understanding the situation of the franchise and the requirements for the next 12 to 18 months.
All this information is needed quickly. “Time can kill things, so speed and access to information is really important,” says Ricci. “The faster you can respond to certain questions, whether it’s about ownership structure or a period in the financial statements where things look different, [the better].”
The Carbon Footprint
Environmental issues are now front and centre in the due-diligence process, as investors want to know exactly what they’re buying and what they need to fix. They want to know whether the hotel has mould and if there is waste storage that could cause a damaging spill. “They know [these issues] can cost a lot, and they know the health implications to their guests and employees are significant,” says Rob Watters, president and CEO at Toronto-based Watters International, which conducts environmental assessments for companies, including hotels.
Many operators are now spending up to tens of thousands of dollars on an environmental assessment to minimize potential costs. For example, older hotels sometimes require substantial repair to meet the current regulations for asbestos. “If you’re buying a hotel and you have to fix asbestos, you need to know that before you buy it,” says Watters.
Another reason for increased due diligence is growing consumer awareness about other similar environmental issues that affect air quality. “The public is demanding higher standards than in the past,” says Watters. In addition, employees are demanding a safer working environment. “It’s all positive, because we don’t want people staying or working in a building that’s compromising their health.”
And, while it’s important to understand the environmental condition of a site, due diligence doesn’t end when the assessment is done and the deal is closed. Issues such as dealing with mould or making sure swimming pools meet health and safety standards at all times become ongoing operational issues.
“There is a lot of responsibility for due diligence on behalf of the hotel owners and operators to not just say they’re doing something but prove it,” says Watters. “And we’re starting to see hotels being visited by regulators more frequently.” That means it’s important to have systems and processes in place and keep meticulous records. “If you do that, you’re gold,” adds Watters.
The Personnel Element
Traditional due diligence is centered on financial, building and environmental conditions, but lately investors have been increasingly focused on employee liabilities due to the significant costs that can result from terminating employees, for example.
“Understanding things like vacation, pension and retirement are [also] critical these days when you’re doing due diligence,” says Jeff Hyslop, director, Asset Management, Westmont Hospitality Group, a hotel owner and operator in Mississauga, Ont.
On the brand side, finding out if there are encumbrances on the property, the capital costs of maintaining the brand and the cost of terminating the brand are issues buyers should consider. “But conversely, as a seller, you need to strategize on how you’re going to deal with these issues,” says Hyslop. For example, if a seller decides to market the asset as unencumbered, they’ll have to cover the cost of getting rid of the brand and any encumbrances.
Brand liabilities have always been taken into account, but as more investors look at alternative uses for buildings, such as student residences or condos, brand liability becomes a bigger issue. Employee issues tie into this as well, so if a building is converted, the owner will have to terminate the hotel employees’ jobs at a huge cost.
While there are many opportunities for hotel acquisitions, the perfect deal or property is hard to find. “You can always find reasons to kill a deal,” says Hyslop. “The important thing as a buyer is to understand your risks and liabilities. Know what you’re getting into and what the worst possible outcome could be, and have a measured understanding of the liabilities going into a deal.”
The Design Question
For Gordon Stratford, director of Design at HOK’s Toronto office, due diligence is about being proactive, so buyers can avoid being surprised by potential design and structure problems. “It’s the ability to get more upstream in understanding the condition of the building and being able to more proactively plan and anticipate costs,” he says.
Buyers preparing to take over a building, re-flag a property or refresh it should request the ‘as-built’ drawings — existing drawings that reflect the current condition of the building.
With these drawings, owners will have a better understanding of issues such as the hotel’s mechanical, heating and cooling as well as plumbing systems. “Ideally, [you should] find out the age of equipment and what changes have been made so you can identify parts that are going to need to be replaced,” says Stratford.
Getting the as-built drawings are especially relevant now, as the sustainability trend means more investors are using existing buildings rather than building new ones. “People are increasingly aware that it takes a lot of effort, energy and cost to create new buildings,” says Stratford. “It depends on the location and the condition, but it may make more sense to retain existing buildings than it would to create new ones.”
It’s also essential for potential buyers to create a master plan, which gives stakeholders a big-picture view of the hotel, says Stratford. For example, the as-built drawings (or even a building assessment) might reveal that the cooling system is 10 years into its 20-year lifespan. So, the master plan should include a plan to replace the system in year 10.
“Due diligence is such an important part of the process,” says Stratford. “[It] will help all parties concerned have a healthier investment, a healthier return and perhaps fewer sleepless nights.”