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Strategies for Distressed Hotels.
By Pete Dordick
Tuesday, 21st April 2009
 
With many owners unable to refinance and going into default and with lenders looking to dump underperforming assets from their balance sheets, the pressure to sell quickly without a well thought out strategy financially harms all parties.

Getting two parties to agree on the market value of a hospitality asset in today's financial market is nearly impossible. Insurmountable differences between Bid and Ask prices reflect buyers who are looking into the worst economic and travel climate in decades and sellers who cannot get their arms around the fact that their property could be worth half or less of what it was just a year ago when they know it will likely be worth that amount in another three to five years. Who is right?

The answer is that they both are. As downward pressures continuing to mount on sellers, it is becoming increasingly difficult for all parties - lenders, buyers and sellers - to properly value assets for purchase and sale.

Martin Wolf, The Financial Times chief economics commentator in his book Fixing Global Finance, published before the current meltdown said that exotic financial packaging of mortgages has been repackaged so thoroughly and resold so often that it is impossible to clearly connect the thing being traded to its underlying value.

The first $700 billion bailout was designed to remove mortgages and other securities that in some way correspond to real property values from banks' balance sheets. However, that didn't happen, and it is still unclear how these assets are to be valued. All assets today, packaged or not, are being dragged down by the inability of the market to state present and future values with any certainty.

There are many factors at play, all exerting different pressures on the marketplace. With many owners unable to refinance and going into default and with lenders looking to dump underperforming assets from their balance sheets, the pressure to sell quickly without a well thought out strategy financially harms all parties to the transaction - buyers, sellers and lenders.

Lenders may see their options limited to the traditional route of forbearance or foreclosure, taking a deed or deed in lieu followed by the sale of the asset. At the same time lenders want to avoid litigation and its associated costs for lender liability and loan defense claims thereby reducing the bottom line of the sale.

However, a lender taking title to the asset may not be the best route. By vesting title to the property to the lender the borrower may be able to bring a suit for lender liability or he may be pushed into bankruptcy, clouding the ability to quickly and cleanly dispose of the asset.

There are techniques to maximizing asset value while simultaneously eliminating the risk of the borrower raising a defense or claim or filing for bankruptcy. These same techniques benefit the borrower/seller as well as the lender and the potential purchaser.

Buyers want to know that they have as many of the expected protections in place for a transaction as possible. These include warranties and representations concerning the property and environmental indemnities passing through to the buyer. Lenders typically want to avoid making representations of any sort and should take steps to avoid the risks inherent in ownership of a distressed asset.

The standard list of warranties and representations include statements regarding litigation, changes to or violations of laws, threatened or pending actions, liens, parties in possession, condemnation, any action that could result in any material change in the condition or value of the property, environmental defects, soil or sub-surface conditions, insurance issues, uncured notices, demands or deficiencies and entitled rights, and that the representations and warranties will survive the closing.

With proper assurances in place regarding the condition of the property and the sale, the buyer is receiving substantially greater value in the transaction. This may have the effect of raising the sales price, but it certainly stabilizes sale conditions and brings tangible benefits to all of the parties as well as an increase in current and future underlying value of the property.

For troubled asset purchases a buyer wants a strategy that allows him to control to the maximum extent possible junior lien holders and vendor claims. Buyers must be able to stabilize the asset in the shortest possible time and have a cogent framework for future operating efficiencies. Buying a distressed asset from a lender rather than the borrower/seller removes this ability from the buyer and opens him to future claims.

For the borrower approaching a sale with the goal of avoiding foreclosure, litigation with their lender or future bankruptcy should be their strategy. Working with the lender and the future purchaser and making suggestions to close the transaction in the manner that all parties are accustomed to will bring the borrower/seller closer to this goal. If any attempt is to be made to maintain an interest in the asset, either in the form of a position with the buyer's equity group, a hope certificate, or through ongoing management of the asset then a new, solid business plan is a must. The institutional memory of an owner is an important piece of the puzzle and one that lenders can be educated to appreciate as they take asset control.

Another critical step in structuring the disposition and finding the value of the asset is to understand the historical costs of operations under economic conditions as close to those that we are experiencing as possible. The old rule of fixed and variable costs no longer holds. Every item on the operations list must be looked at as a variable and one that needs to be re-structured to fit current conditions. Without an historical analysis you can't be sure where your cost ratios should be targeted. Significant value of the asset may be left off of the sales price and future operational savings for the buyer are lost without a study of operations made against known industry historical operational costs and ratios.

Lenders, borrower/sellers and buyers can structure a win-win disposition, mitigate exposure, limit potential losses, generate cash flow and improve balance sheets with proper planning and utilization of experienced analysis from HVS.

About the author. Pete Dordick, JD is a real estate attorney and hotel consultant. He works with the Boulder, Colorado office of HVS. He can be reached at:

Pete Dordick, JD
2229 Broadway
Boulder, Colorado 80302
303-443-3933
pdordick@hvs.com
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