Hotel Acquisition Landmines

By Nelson Migdal Shareholder & Co-Chair Hospitality Practice, Greenberg Traurig LLP | May 11, 2010

A sophisticated real estate investor may know all the ins and outs of purchasing office buildings, retail venues, residential complexes, and mixed-use properties, but may fall short when it comes to identifying and avoiding potential landmines in hotel acquisitions. While purchase agreements used in hotel acquisitions may appear familiar at first glance, there are several key differences purchasers and sellers should be aware of before jumping into a hotel acquisition. Since every acquisition by a purchaser requires a sale by a seller, this article will provide some insight about things to look for during the entire hotel sale and acquisition process.

Flag or No Flag

There are many very familiar "brand" names of hotels and national hotel operating companies. The name carries value that investors and underwriters recognize in hotel valuation. Whether or not a hotel carries a "flag" "franchise" or "brand" is an important factor for prospective sellers and purchasers to consider in the universe of transactions representing components of what we consider the hotel sale and purchase. The flag impacts everything. The financial health of the hotel today and in the future as a result of the management of day-to-day operations of the hotel, the inventory of personal property that is sold along with the physical structure of hotel, collective bargaining agreements with unions, such as UNITE-HERE, unfunded pension liability, and intellectual property rights are all relevant.

The flag of the hotel is critical to the revenue generated and the value of the hotel. For example, if a hotel changes its franchise affiliation and goes from a strong franchise to no franchise or to a weak franchise, the hotel may lose a portion of the revenue stream that might have come through a strong central reservation system and an array of amenities provided by the brand through what is commonly referred to as "centralized services". A hotel that is sold "encumbered" (in the language of hotel owners) or "enhanced" (in the language of hotel operators) by a strong flag may be valued much higher than an independent hotel or a hotel that is sold with a weak flag. Purchasers must consider that along with the physical structure of the hotel, comprised of the land and the building, they may also be purchasing the right to use the name of the hotel, and all the benefits and obligations that entails. Sellers must ponder the same consideration, along with one other. The potential that the hotel management agreement includes a right of first offer, right of first refusal or some other purchase right or option for the benefit of the hotel manager. Hotel seller's should not assume that the sale of the hotel can occur without the involvement of the hotel manager as a matter of right. If the seller does not have an asset manager that may be intimately familiar with the management agreement, the seller needs to check for purchase options as part of the initial selling strategy.

This will play out in the negotiation of a purchase and sale agreement ("Agreement") through a clear understanding of the terms and conditions of the franchise agreement or management agreement, the ability to terminate that agreement, and the elements of the asset and the operations that are encompassed within such an agreement. Specifically, it is a common oversight to see an Agreement that defines the "Property" being sold and conveyed by the seller to include rights and duties relating to employees, permits and licenses, and marks and brands used in commerce to identify the hotel. With a "flag" in place, all of those rights are generally owned and controlled by the hotel operator and cannot be sold or conveyed by the seller. The hotel employees are often employed by the manager. The operating permits, particularly the liquor license, are often in the name of the manager. The proprietary marks are almost always the sole and exclusive property of the manager or its parent company. The lesson to be learned is assume nothing. The initial due diligence for both seller and purchaser should involve an assessment of who owns what and if and how it can be conveyed. This should come before the development team and the legal team spends too much time developing the checklist of what the seller is expected to sell under the Agreement. The seller may not actually own everything.

Franchise Agreements vs. License Agreements

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