Franchise Deal, or No Deal?

As those who have closed hotel transaction can attest, purchasing a lodging asset can be a very complicated process. Finding the right hotel to buy, negotiating acceptable terms for purchase, securing attractive financing, and getting over the inevitable franchise hurdles, actually getting to the closing table can be difficult to say the least. In this business, time truly is money and delays can easily cost a purchaser or seller the deal in certain cases.

One of the most common causes of delay in these transactions is the failure of the purchaser to complete the necessary due-diligence functions within the time frames set forth in the contract. The franchise application is delayed until the physical inspection is completed or the appraisal and survey are not authorized until the Phase I environmental is completed, etc. With a little advance planning and understanding of the process many of these “pitfalls” can be avoided.

Let’s make a few assumptions up front. First, the broker has done a good job of gathering the correct information on both the property and the market so that a clear and correct picture of the asset has been presented to the purchaser. Any “big” questions that may later become “big” problems should be disclosed. These issues range from likely franchise future of a property to new additions to market supply and other such important questions.

Second, the purchaser has invested enough genuine study of the information submitted on the property and the market that provided the information “checks out” in due-diligence, he or she is likely to move forward to closing. The object here is to avoid having a purchaser put a property under contract after only a cursory review and terminating once they have studied it in more detail. The purpose of due diligence should be to verify the information already studied and not to present the key elements of the deal for the first time.

In the mid-market and economy sectors, most purchase and sale agreements provide the buyer with a period of between 45-75 days for the completion of all aspects of due diligence including actual inspection, franchise and financing. Delays are often created when buyers do not initiate all aspects of this process simultaneously.

Typically, requirements of the loan and franchise application functions can take longer than the actual inspection of the property, the market, and the books and records. By delaying these steps, the likelihood of the need for extensions of the contractual contingencies and possibly of losing the deal are increased. In short, purchasers are well served by starting all these major tasks–inspection, franchise, and financing, as soon as the ink is dry on the agreement of purchase and sale.

Let’s look at how delays can be avoided in each area:
1) General Inspection: The “inspection period” includes review and approval of all aspects of the transaction (for purposes of this discussion we will exclude franchise and financing issues and handle them as if covered in separate contingencies). Upon execution of the contract, a request should be made of the seller to provide all needed due-diligence documentation including but not limited to detailed financials, tax returns, copies of leases, and contracts, existing survey, title policy, and appraisal (if available) as well as the existing franchise agreement.

This information should already be in the possession of the broker but only in rare cases should it take longer than 10 days to be received by the purchaser. Once received, these documents should be reviewed quickly so any questions or concerns raised can be answered sooner rather than later.

As today’s franchise agreements contain fewer assumption clauses than in previous years, it is likely that the purchaser of most hotels today will be required to apply for and receive a new franchise instead of being able to assume the existing license. Given the required “disclosure periods” for new franchisees, the “punch-list visits” and committee review and approval, this effort can certainly take 45-60 days or more to complete. It is imperative that a buyer start this process early to avoid the need for contingency extensions. Franchise requirements change often as does the franchisers appetite for relicensing certain property types. Thus, even the most experienced franchisees need to tackle this aspect of the purchase early.

This can be the most time consuming part of the hotel purchase effort. In addition to a thorough review and approval of both the purchaser and deal itself, most lenders today require several third party reports to be completed, including a new survey, a phase I environmental report and a new appraisal on the property. Depending on the availability of professionals to complete these reports, it can certainly take 4-6 weeks for delivery. Of the three, the appraisal often takes the longest and given a typical 60-day financing contingency, its authorization should be a high priority for the buyer in order to meet the time frames specified in the contract.

For both the buyer and seller in a hotel real estate transaction, placing a property under contract is a serious commitment. For the seller, taking the property off the market for an extended period of time can result in lost opportunities to find different or perhaps more qualified buyers and can delay the eventual closing if the wrong buyer is selected. In more seasonal markets, the ability to sell a property at the highest price may come in advance of the major earnings season and such a delay can cost the seller real dollars if or when that window to sell is missed.

For purchasers, as we have discussed, starting the due-diligence functions on time can involve considerable expense including travel, franchise related application and inspection fees, and the costs associated with financing including legal expenses and any required third party reports. It is in everyone’s best interest for purchasers to study the deal thoroughly before going to contract, and once under contract to vigorously pursue all aspects of due-diligence as quickly as possible. A qualified an experienced broker can be invaluable to both buyer and seller in this process and should be called upon to assist in keeping both parties on tract to meet these critical deadlines and get to the closing table on time.

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