As the physicist Nils Bohr said, “Prediction is very difficult, especially if it’s about the future.” After the industry’s strong performance over the most recent few years, the forecasts made by hotel buyers, lenders and operators were for continued strong performance. None could have imagined an April year-over-year revenue per available room decline of 95 percent. There are many projections of when business will return and to what level. Although all experts expect business to substantially improve from the present level, when and how much is the subject of many conflicting opinions. Most believe that there are likely permanent or at least long-lasting changes in travel involving hotel stays, and the changes are not positive for the hotel industry and its ability to service present debt levels.
Hotel owners often will contact us after taking every possible action to cut costs and after exhausting all available cash. They have eliminated as much payroll as possible by enacting a combination of layoffs and pay cuts. They have delayed purchases of important inventory items such as linens and equipment, and they have reduced the quality of the consumable items. Their marketing spend is often at near zero levels, and funding of a capital budget is not even on the radar. Often, by the time they contact us, they are several months behind on their debt service payments and their product and service quality has diminished below acceptable levels.
A realistic assessment of many, perhaps a majority, of U.S. hotels will result in a finding that many hotels will be unable to service their debt for many years. Pro forma economic models upon which hotel owners relied when purchasing their hotels and incurring their debt grossly overstate most hotels’ ability to service debt. The reality for many hotels in the U.S. is:
- Hotel revenues will not be sufficient to service present debt for many years.
- Expense cuts will be insufficient to solve the debt problem, and certain cuts will be counterproductive, ultimately diminishing the quality of the guest experience and the resultant guest return intent and review scores. And marketing fund cuts will diminish future revenues.
- If the hotel is to survive and function properly, the amount of debt will need to be reduced.
Debt restructures happen in various ways, including lender-forced pay downs, foreclosures, short sales and negotiated note restructures. When your competitors’ debt gets reduced (even if the reduction is by foreclosure and ownership change), those hotels can return to profitability, allowing them to make required capital improvements, fund pay increases, invest in marketing and advertising and provide a superior guest experience. Those hotels who do not restructure cannot compete with those who do, and revenues ultimately lag the comp set.
In order to keep your hotel competitive:
Restructure early. Owners must make a realistic assessment of the hotel’s future and unless there is evidence of a return to sufficient revenues to service the debt, fund capital improvements and make a profit, the debt level must be addressed.
Create a plan to reduce debt and meet with your lender. Banks will offer temporary forbearance agreements—which seldom solve your problem, but solve the bank’s problem—at least temporarily. Beware of these agreements, which often require more collateral or pledges, increasing the borrower’s risk and failing to provide a permanent solution. Be sure that your plan solves the debt problem permanently.
If you are current, decide whether to keep the note current. Most hotels that are current today are staying current by using cash from other sources. If there is no realistic path for the hotel to fund its own debt service payments in the near future, staying current may be counterproductive. It uses up precious cash and may keep the loan out of the work-out department, which makes restructuring much more difficult.
Consider whether advisors are needed. If you have a solid understanding of the banking industry and ample time to work on your debt problem, you may be successful on your own. However, if you have not been through a restructure and if your time is required to run your business, knowledgeable advisors can pay for themselves many times over.
Mark Bouzianis is managing director of Delta Capital Group.