KEY ASPECTS of HOTEL
REAL ESTATE DUE DILIGENCE
by Christopher Barker and Benjamin Tschann
nvestors know the importance of conducting thorough due diligence in the
acquisition of real estate assets. Generally speaking, the due diligence tasks
for completed and stabilized projects
are the same regardless of the type of
assets to be acquired. For those evaluating hotel assets, however, the due diligence tasks are greater, and these expanded investigations are crucial to understanding not only the real estate being
acquired, but the business that comes
with it. For hotel assets, apart from the
due diligence associated with tax structuring issues that arise if tax-exempt entities
or REITs are involved, there are four main
categories of additional due diligence
required to evaluate both the real estate
and the business: (i) branding; (ii) hotel
management; (iii) employment matters;
and (iv) operating licenses and permits.
Each area must be evaluated for financial
as well as legal consequences.
What’s Your Brand?
While many consumers may be under
the impression that every Hilton, Marriott,
and Hyatt is owned by the chains bearing the same name, in reality most
hotels are not owned by the “flag”
associated with the hotels. Rather, institutional investors, REITs, and other third parties usually own the hotels and enter into
licenses to associate the hotels with a
particular hotel brand or chain. Like any
brand driven business, the brand associated with a hotel can enhance the value
of the real estate asset. Brands known for
luxury accommodations or a hip lifestyle
can command higher room rates, but such
luxury and lifestyle bring higher operating
expenses and more frequent capital improvement projects to remain associated
with the brand.
In addition to brand value, real estate
investors should evaluate the following:
• Brand reputation and consumer demand
• Licensing, marketing, reservations system,
technical services, and other fees due to
the licensor
• Assignment rights
• Required periodic property improvement
plans (so-called “PIPs”), costs associated
with PIPs, and the frequency with which
the licensor may “re-PIP” the hotel and
require the owner to make capital
improvements to rooms, furnishings, and
common areas
• Termination rights and associated fees
(characterized as liquidated damages)
•The right of the licensor to grant
additional licenses to other hotel owners
and the right of the owners to own
other hotels in geographic proximity to
the hotel
• The services that the licensor will provide (e.g., national advertising, centralized
reservation systems, award programs)
• If the brand will change in connection
with the sale (in some cases, a hotel
guest will go to sleep in a Hyatt and
wake up in a Hilton), who is responsible
for removing signage, branded inventory,
etc., and what is the time period for
doing so?
Can I See the Manager?
Sometimes the management company
affiliated with the brand will manage
the hotel, but often the manager will be
an affiliate of the owner or a third-party
management company. Changes in management of a hotel in connection with an
acquisition can present unique challenges.
The transition is not always seamless and
can be quite rocky if the existing manager
