What every hotel lender needs to know about hotel due diligence

What every hotel lender needs to know about hotel due diligence

The due diligence required in hotel lending is far more intensive than for any other kind of real estate lending and requires far more expertise. The article below by my partner Guy Maisnik gives a few examples.

Why hotel loans are different than other real estate loans: A quick review

Underwriting a hotel loan is different than underwriting a real estate loan. Hotel lending is far more involved. In addition to the due diligence a lender would do for a real estate loan, an experienced hotel lender will want to ensure it understands everything about the hotel, its operations, occupancy, rate history, market penetration, finances, employment conditions, management, compliance with applicable laws and brand requirements. The lender has to dig and investigate issues.

Standard reports

  • Are the reports provided comprehensive and detailed? 
  • How frequently are reports provided? (More than the typical real estate loan, updates should be provided regularly.) 
  • Are the reports consistent with the hotel operator’s reporting requirements under its management agreement? 
  • Do the reports satisfy specific accounting, recordkeeping and computerization requirements? 
  • In the case of a franchise, are copies of the franchisor’s own inspection reports available for review?
Operating statements

Are the income and loss statements reflecting the real costs of running the hotel? Is the hotel lender looking beyond the reports? Here are some sample questions the hotel lender ought to be asking: 
  • Has the hotel owner deferred payments to vendors? 
  • Have the hotel sponsors received loans from the hotel operator, vendors or third parties — or taken other actions — to make hotel operating costs appear less than they actually are? 
  • Does the hotel owner own other hotels, bars or restaurants? If so, are OS&E, food and beverage and other purchases being purchased with this hotel’s revenues or revenues from other hotels or sources? Or, are OS&E, food and beverage and other purchases for this hotel being made through its other hotels? 
The hotel lender needs to look beyond the reports it is receiving and review the facts and circumstances carefully — then require that the reports be tailored accordingly.
Appraisal analysis
  • Did the appraiser take into account forecasts, market volatility, and occupancy demand for this hotel’s market segment? 
  • What is the competition in this market segment?
  • What is the likelihood of rate compression from higher-end hotels that could steal this hotel’s business or new hotels coming into the market area? 
Market and brand compatibility

The hotel lender must be confident that the hotel owner is selecting the right hotel brand and operator. Experienced hotel lenders and advisors will have a good idea, after the analysis is complete, if the operator, the market, the owner and the property are compatible. The wrong decision means the hotel may have to rebranded, which is exceptionally costly, particularly if the hotel owner signs a long-term, no-cut contract that the lender is required to honor through an SNDA.

Additional areas for review
  • What major repairs or upgrades are needed, if any? Will the lender have sufficient reserves as part of its collateral? 
  • Are the hotel’s workers unionized? If so, are there considerations that affect the value of the hotel or the obligations of the lender? 
  • If the hotel workers are not unionized, has the hotel implemented the right planning and training to ensure that unionization does not become an unnecessary reality? 
  • Is the hotel ADA-compliant? Is the hotel subject or vulnerable to an ADA investigation or lawsuit? 
No shortcuts to due diligence, and no replacement for hotel expertise

There are hundreds of questions a hotel lender, its consultants and lawyers will ask when analyzing a prospective hotel loan. One thread is pulled to find it is securely knotted. Another is pulled and the fabric begins to unravel, revealing weaknesses that lead to further questions.

Knowing what questions to ask at each juncture comes from specific hotel lending experience. A thorough analysis will let a lender know what potential weaknesses exist and provide assurances that the lender has adequate protections and solutions in the event of default. The analysis can also reveal serious discrepancies or festering problems that will cause a lender to reject the loan. In both cases, it is time and money well spent. 

Due diligence for hotel lending requires expertise, time and resources. While there is a cost associated with doing things right up front, the costs of a bad decision can exceed millions of dollars, especially after loan default, when remedies need to be exercised and solutions to problem areas are most needed.