Hotel Workouts Today
By Nelson Migdal Shareholder & Co-Chair Hospitality Practice, Greenberg Traurig LLP | April 02, 2010
The news seems to be going from bad to worse. The economic indicators that track occupancy, room revenue and average daily rates appear to be going from worse to still worse. The dollar value of commercial mortgage-backed securities issued in connection with hotels during the past few years is reportedly a very intimidating $30 billion (in round numbers). One of the key concerns on everyone's mind is what happens next?
There are numerous possibilities, but many of them will eventually bring to the table a hotel owner, hotel operator or franchisor, lender (and others such as the loan servicer or REMIC Trustee) and perhaps the labor unions at the hotel.
The underlying mechanism may begin with a deed in lieu of foreclosure, or the court appointment of a receiver to assert dominion and control over the hotel. Some of these matters will go right to litigation with no intervening process to attempt to negotiate a resolution. Some of these matters, and perhaps it will be a majority of these matters, will be resolved through negotiation to try to achieve a workable result and preserve any capital that might remain for the preservation of the asset rather than the payment of professional fees.
The underlying loan documents and hotel operating documents, including things such as the Franchisor's "Comfort Letter" in the franchise context, and the Subordination, Nondisturbance and Attornment Agreement in the hotel management context, were probably well designed and well drafted when the loan was made. That is not the challenge. The challenge is that the context in which the documents are being interpreted and applied is unlike anything that has come before. The challenges of today may require more creative solutions than in years past.
Creative solutions to difficult questions will be a challenge for all the players in this unique and complex market. For example, how will we address the operating hotel that is not generating sufficient gross revenue to cover operating expenses? This is likely to be a recurring theme, so it deserves consideration. If the hotel is "upside down", which is one of the many phrases out there today intended to mean that the hotel is loosing money every day, then some resolution has to be found to address the problem - i.e., stop the bleeding. Replacing the hotel owner with the hotel lender may not be the answer and may be unappealing to the lender. The hotel owner has no cash, which is why the lender is looking at the deed in lieu of foreclosure or a receivership in the first place, and the hotel operator is not obligated to fund the owner's short-fall. In the marketplace today, the hotel operator is itself lean on cash, which makes it less likely that the operator can rescue the owner even if it had the desire. Then there is the lender, that can and may make protective advances under the loan documents to protect the value of its security, but how many checks can the lender write these days? Not many - so it seems.
So, what breaks the free-fall other than the cold hard ground? How about an early negotiation prior to the deed in lieu of foreclosure or the receivership and foreclosure to see if all parties in interest can bring something of value to the table to try to preserve the asset? The initial meeting is based upon just one goal, that of keeping the hotel open and operating as nearly as possible to how it should be operating but for the current economic turmoil. This means that all parties in interest start with the goal of keeping everyone in the game. The owner should be prepared to offer something, which is why engaging in this process early is better than starting when it is already too late and panic has set in. The operator and lender likewise should be prepared to discuss all viable solutions, even solutions that call for a compromise of the "brand standard" or that delay completion of a capital expenditure or property improvement plan. Based upon the sheer magnitude of the CMBS debt and the lack of liquidity in the debt markets, the most likely new lender for the hotel owner will be the current lender through the modification and extension of the current debt. This will not be a "one size fits all" solution, and there will be instances when the hotel owner will not be the best party or the party most deserving to own the hotel going forward. On the other hand, many lenders are unwilling and unprepared to become a hotel owner, and may be far better off restructuring the loan and making a deal with the hotel owner and the operator to devise temporary solutions that will maintain guest satisfaction but still reduce staff, limit some amenities, and generally do more with less. No aspect of hotel operations can be immune from examination. Perhaps a check-in kiosk with fewer desk clerks, limited in-room dining, even at the luxury level, and the temporary elimination of guest rooms or floors will all require implementation over time. Remember that in the coming months the goal will not be brand maintenance or maintaining net operating income as much as it will be to cover operating expenses, maybe have some net operating income and stay open. If we believe, as many do, that there will be terrific opportunities in the months to come, and brighter days will return, those opportunities will be there tomorrow only for those who can first survive today. Working together to come up with creative solutions is a key component to survival.