Mr. Glincher

Hospitality Law

When to Renovate, How Much to Invest, and How to Raise the Money

By Andrew Glincher, Office Managing Partner, Nixon Peabody LLP

Whether in the leisure or business travel market, hotels that haven't already done so need to take this opportunity to evaluate the condition of their facilities and determine whether renovations are possible, necessary, or desirable and whether the economics of these investments make sense.

In some cases, such as most properties with franchise agreements, there are likely continuous requirements for maintenance and renovations during the term of the agreement, with funds set aside in replacement reserves to keep the hotel up to the brand's standards.

For those hotels and others, there are strategic and business decisions to be made. First, market research is necessary. What is your competition doing? What do their properties include? Have they been upgraded recently? If there are several hotels in your area, all of which compete for the same travelers, and all of the others are undergoing significant renovations, you may have no choice. You will have to invest that money and make improvements in order to compete effectively in your market.

Or there may be an opportunity for increasing room rates. Sometimes, for example, a three-star property can upgrade itself sufficiently to earn another star and position itself to attract a new category of traveler. That's where a careful business analysis comes in. Are there other four-star hotels in the area? Is there sufficient demand to allow an additional one to be successful? Under those circumstances, it might be better to invest a smaller amount of money and spend it in different ways - perhaps creating a better experience for your existing, three-star clientele. When committing resources, you must determine where the most opportunity exists for your hotel to best compete and succeed.

Research on your existing clients and those you hope to be your future clients is obviously crucial. Are you losing clients by not having high-speed Internet connections in every room? Do you need to create a state-of-the-art business center? Do other nearby properties have more attractive fitness facilities - and how much business are you losing because of that? These are the kind of ongoing business decisions properties owners make, but during the downturn, with cash flow tight, some actions may have been deferred.

Once the decision is made that renovations are desirable or necessary, the next issue is raising the money to complete them. And the difficulty of that process depends on a variety of factors. In general, though, lenders will be most interested when it is clear that the property generates sufficient cash flow to support the additional debt burden. When that is not clearly the case, renovations may still be possible if:

• The lender already has a significant amount invested in the property and is concerned that its collateral position may deteriorate or a default may occur, without an additional infusion of capital to make improvements.

• The loan covers a portfolio of properties and the blended cash flow and debt service covenant of all the properties combined is sufficient.

• The future success of the property is uncertain, but the lender believes that whether the current owner is able to make a go of it, or defaults and gives the property back to the lender, the improvements under consideration are necessary and will be beneficial - regardless of who owns the property.

• There is a significant upside, often in the form of interest on the debt as well as equity component or shared appreciation, for the lender.

Independent properties may be in the position of trying to raise money speculatively - believing that they can compete more effectively, raise their room rates and improve revenues if they can raise the money to upgrade their properties. That is a difficult case to make to banks, being asked to make non-recourse loans, and fearful of taking an entrepreneur's leap of faith based on speculative projections. Lenders will want to see current cash flow and a pro forma, along with assumptions on which future cash flows are based.

In some cases owners may consider using their own funds to finance improvements or bringing in partners who have the resources to give the property an infusion of capital.

In any of these scenarios, a step-by-step financial analysis, combined with careful research and an understanding of the marketplace, will provide a roadmap toward the type of renovations to be done and the scope of the investment necessary.

Andrew Glincher specializes in the negotiation and resolution of business and real estate disputes. Mr. Glincher has represented developers and owners of retail centers, hotels, movie theatres, office and industrial buildings and parks, utilities, restaurants, subdivisions, apartment complexes, assisted living housing complexes, long-term care facilities and condominium projects. Mr. Glincher is admitted to practice in Massachusetts, the U.S. Court of Appeals, Third Circuit, the U.S. District Court, District of Massachusetts and the U.S. Tax Court. Mr. Glincher can be contacted at 617-345-1222 or aglincher@nixonpeabody.com Extended Bio...

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