How to properly negotiate replacement reserve clauses

It is natural for borrowers to focus their mortgage negotiation attention on the interest rate being charged for borrowed funds, the amortization schedule being used and the length of the loan; after all, each is an important factor defining debt cost and, as a result, impacting the hotel’s ongoing cash flow. The purpose of this column is to point out ways for you to significantly reduce your exposure to reduced cash flow by reason of the mortgagee’s replacement reserve clause requirements. 

In almost all hotel loans, the lender requires that the borrower set aside sums to be subsequently used for a variety of ongoing property up-keep related CapEx purposes. Usually the borrower is provided with a lender’s standard clause form, it’s accepted (or modestly altered), then incorporated into the final loan documents. More often than not, that’s a mistake, since large sums of money are involved—sums that can climb to levels approaching a quarter to half of the monthly mortgage payment. 

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Here are some thoughts for inclusion in your lender discussions regarding this mortgage loan clause.

1. Maximize the definition of what is included for payment from the replacement reserve account by providing a list to the lender of what you think it should encompass. In addition to payment for the goods itself, include all hard and soft costs associated with the item’s installation. 

2. Permit payment from the account to be made from the vendor’s invoice rather than for reimbursement of previously purchased goods. Often, lenders will allow replacement reserve funds to be accessed once delivery of goods is made to the property. This forces the borrower to pay up front, then be reimbursed once the goods are delivered, creating an obvious and needless adverse impact on the borrower’s cash flow. 

3. Minimize the amount required to be paid into the replacement reserve account by negotiating: (a) the percentage of sales to be set aside…e.g. 3 percent, or a descending percentage of agreed upon sales volumes; (b) a fixed-dollar amount set aside, rather than a percentage of sales; and (c) the total amount of capital to be kept in the account.

4. Eliminate the replacement reserve clause altogether. Propose to the lender that it consider permanently, or temporarily, waiving inclusion of the clause by offering to complete any work required by the hotel franchisor within the time frame required by them.

5. Include a “hard” time frame for bank payment or reimbursement of funds from the replacement reserve account. 
Hopefully, this column has highlighted to hotel loan borrowers the importance of paying serious attention to the negotiation of this clause.

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