Buying or selling real estate tends to follow a certain predictable pattern. But when a franchised property is involved, a whole different set of rules can come into play, making the process increasingly complicated. For anyone considering a transaction of a franchised property, here are 10 rules to remember, as suggested by some industry experts.
1. Know what you are buying.
“Make a distinction between stepping into the shoes of an owner and operating a leased property or acquiring ownership of a bricks-and-mortar building,” said Scott Augustine, a shareholder with law firm Chamberlain Hrdlicka. The two acquisition methods involve different dynamics and have different rewards, he added. His fellow Chamberlain Hrdlicka shareholder, Scott Ratchick, agreed. “If you own the bricks and mortar, you have more flexibility,” he said. “You own the land and the property rather than a shorter-term lease. If you, as a landowner, want to terminate your relationship with your franchised brand, you have the facilities, and are in a better position, to find another brand that you want, and you’re more attractive to that new brand because you have stability at your location.”
2. Have all financial papers in order.
“The owner has to scrub his own financial statements and make sure adjustments are made where appropriate to drive up the sale price,” Augustine said. “The last thing a buyer wants to see, especially if it’s a multiasset deal, is anything not in order.” Formally audited financial statements may not be necessary, he said, but an accountant should at least review all papers. Keith Thompson, a principal with Hotel Assets Group, listed the most important documents an owner should have ready to present to the buyer: “Three years of detailed financial statement along with the current YTD statements, three years of STR reports that are free to all franchised hotels, all service contracts, a copy of any environmental studies, conditions reports etc., the last three quality service reports from the franchisor, tax bills, warranty data like roof replacements, etc., and lastly any professional photography performed on the property.” In some cases, Steve Kirby, a principal with Mumford Company, noted, an attorney’s services may be necessary to get everything ready.
3. Order the change-of-ownership property improvement plan from the franchisor.
“This is usually a $5,000 to $7,000 expense,” Thompson said. “To properly value and market a franchised hotel, they must first know the cost of the PIP improvements the buyer will factor into his investment strategy.”
4. Understand the current financial conditions of property.
This, according to Ratchick, can include what the hotel needs, what its occupancy rates are and what its expense ratios are. “A lot depends on the location,” he said. For example, if the hotel is close to an airport, a buyer should look at the terms of any agreements the hotel has with the airlines for employees, or other relationship agreements. “See what the terms of the agreements are and when they expire or come up for renewal," Ratchick said. "That can drastically change the economics of the deal and whether the hotel will keep its occupancies where they are.”
5. Know the terms of the franchise agreement.
“Many franchisors require notification at the time that the property is offered for sale, others have a right of first refusal on the asset. Liquidated damages may be involved if the purchaser does not wish to retain the existing franchise—the list is lengthy,” Kirby said. Vendors and potential buyers alike should know if the franchisor has the right to repurchase the franchised business. As Augustine and Ratchick noted, many franchise agreements allow the franchisor a unilateral right to purchase a franchise at a time in the future for some stated price, which may leave a franchisor obligated to sell the franchise to the franchisor for less than it is worth. If the franchisor does allow the sale, Augustine said, the company usually will want to know and vet the potential buyer to make sure that he or she will represent the brand correctly.
6. Know the terms of the management agreement.
These are usually set for a specific term—five to 10 years is not unusual—but as Augustine said, the agreements can vary and are not standard. Any kind of early termination may include a penalty, and the management company may have the right to terminate the agreement early if the brand changes.
7. Know what third-party consents are required.
For transactions, including licensing issues—especially liquor licenses. (All of this presale due diligence can take months of research, Augustine said.)
8. Read the fine print of any agreements and be prepared for unusual charges.
For example, the seller may be required to pay for the buyer’s training, or any outstanding accounts and fees to the franchisor. “Training costs, if any, are spelled out in the license agreement and the franchise disclosure documents,” Kirby said.
9. Don’t expect a fast turnaround
Especially when many consents and approvals have to be signed. “Build in some lag time to get it all done,” Ratchick advised. “This varies with each franchisor, but a general rule is that it takes a month from full application to have an approved franchise,” Thompson said. “This month-long process needs to start very quickly after contract execution.”
10. Have a good business plan in place from the beginning.
“Business owners choose to franchise for numerous reasons, but the local business plan should maximize the franchisor services: training, local marketing assistance, participation in promotions, following the provided operations guides to maximize profitability,” Kirby said.