The best time to talk about how to handle the inevitable downturn is when times are good. Even better, hoteliers should really be planning for the next market downturn before they even purchase or build a hotel.
“Planning for a market downturn is one of the most important critical steps, and hotel owners don’t spend enough time on it or plan for it at the onset,” said Rahul Patel, managing partner of law firm Patel Gaines.
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He said the core starts with having all the correct structures in place with a solid, well-thought-out business plan that will ensure everyone is informed and understands their roles during down times.
Drew A. Senulis, associate attorney at Patel Gaines, said the pre-planning phase before a downturn is a great opportunity to talk to stakeholders about the plan while there are no hard times and nothing is causing pressure.
“Keeping stakeholders informed and aware of both their rights and obligations during the good times, such as making required capital contributions when necessary, can help smooth things out during any downturn,” he said.
That said, entity documents—operating or company agreements—should directly address funding matters.
“Do a good job during the strong time to make sure the hotel has enough cash flow or reserves to get through it,” Senulis said. For example, if during the good times a hotel has high occupancy, that will translate to more wear and tear on furniture, fixtures and equipment, so hotels need to have enough reserves for continued success.
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When it comes to financing versus funding, Patel said hoteliers can’t have a 20-year plan with only a five-year loan. They need to know the pros and cons of the different loan structures they face. For example:
- Small Business Administration loans have good rates and terms, but the personal guarantee for larger investors in the entity might affect the ability to secure other loans.
- Conventional loans are all about the details because these can vary widely, but here hoteliers are usually dealing with local bankers.
- Commercial mortgage-backed securities offer low rates, can be nonrecourse or full amortizations, but hoteliers might not be able to refinance or pay them off early without a penalty.
Patel advised hoteliers to consider putting more cash in up front for a 75 percent loan-to-value or less versus an 80 percent LTV.
“Give yourself a buffer and cushion with the lender,” he said. “It’s really about using that positioning to leverage yourself to get what you need.”
During a Downturn
Patel said that hoteliers need to remember that cash is king, both in making and keeping it. He advised hoteliers to do the following to keep that cash:
- review existing financing arrangements, including banking;
- communicate regularly with stakeholders and key employees to increase transparency;
- manage cash more aggressively and investigate discrepancies immediately; and
- track performance against financial and nonfinancial parameters to ensure all of the information and documents are in one place.
Patel said that communication with lenders can be OK during rough times, but hoteliers need to be cautious. He said that hoteliers will often reach out to their lenders during a downturn to work out solutions, but they could be doing themselves a disservice.
“This is where you create a bevy of legal problems by giving information away in hopes of getting a work-out [solution]. You are giving them legal ammunition,” Patel said.
One of the biggest pitfalls is entering forbearance agreements, the attorneys said.
“Let’s say you get a six-month forbearance. The lender is not doing you a favor; think about what they are getting out of it,” Senulis said. “It always entails a lot of documentation. We see lenders asking for more documents than [when] you originally signed up for the loan. What they are doing is they are going into defensive mode.”
He said forbearance can just be a Band-Aid, and if hoteliers get their six months yet have zero plan, then they will be worse for it.
“You’ll still have interest and it doesn’t solve the problem,” he said. “Although, it can be good if you have an exit strategy.”
Related Story: Planning a hotel’s exit strategy begins before the purchase
Finally, if hoteliers wish to sell their properties during a downturn, Patel said it is critical to disclose everything to avoid being sued.
Senulis said hoteliers need keep all documentation with them when selling during a downturn.
“Those are your records, and the problem is if you get into a dispute you are giving the purchaser all your documents that you don’t have copies of,” he said. “You will need those documents, and it’s difficult to get them after the fact. It’s a point of weakness when you have to ask for them.”