Ten Survival Strategies for Distressed Hotel Owners
October 13, 2020
By Deborah Friedland and Joe Rubin
The pandemic has hit hospitality harder than any other real estate sector. Lockdowns, lack of tourism, and prohibitions on business travel have swept away all of the critical demand drivers of the industry. While occupancy has begun to improve, it is far from pre-COVID-19 levels. Recovery will vary greatly by the type of hotel and its location. Business and group business is on life support; and the staycation has replaced exotic vacations for most leisure travelers. As a result, urban and destination resort hotels that are dependent on international tourists, corporate, and group demand are under extreme financial distress. Hotels and vacation rentals located in suburban and rural markets have outperformed; especially those properties located proximate to national parks and beaches.
The recent margin and liquidity squeeze has been more immediate and severe than that of the Great Recession, with little relief expected in the near term. What we know today, that we didn’t know in March, is that the recovery of the sector will be a long-term process. Most owners have been in emergency response mode, doing what they can to attract demand, cut costs, and seek forbearance on loans. As we enter the fourth quarter of a very unpredictable year, longer-term strategies must be implemented.
Here are ten strategies for hotel owners. Some owners may have already taken short-term action in some of these areas; however, it is now time to create a multi-year plan.
- Understand Your Obligations. Take the time to reread all agreements including management, franchise, loan, partnership, leases, and insurance policies. Know your rights and your obligations, notification and reporting requirements, definitions of default and remedies, performance thresholds, and business interruption coverage. An incomplete understanding of your legal situation may mitigate your ability to develop and implement successful business strategies.
- Monitor Your Cash. In any distressed situation, cash is king. While projecting revenue in this very unpredictable environment is difficult, owners should create a cash flow model with alternative scenarios of revenue and expense on at least a monthly basis for three years. If possible, the first ten to twenty weeks of the cash flow should be modeled on a weekly basis. The cash flow estimates should be based on best efforts assumptions of occupancy, room rates, food and beverage, and direct and indirect operating costs. Assumptions should be thoroughly documented. This model will not only allow investors and management to monitor the business, but be available for discussions with debt and equity capital providers. The model should be refreshed real time as market information is received and hotel performance changes.
- Refine Cost Cutting. Most owners have already raced to reduce operating expenses at their hotels. It is now time to step back and determine whether the reductions were optimally allocated. The key is not to cut back at the expense of potential revenue as demand improves. Identify those expense items that are behind the scenes and will not impact the guest experience. Beyond typical operating costs, look into longer-term savings such as property tax appeals and cost segregation studies, if appropriate. While there is insufficient price discovery today to determine value, there is little doubt that, for now, most hotel values have declined. Consult with an advisor to determine if you are taking advantage of all relief programs offered by the federal government including PPP loans, employee tax credits, and changes to the tax laws which are designed to provide financial relief.
- Don’t Slash Marketing Costs. While cutting operating costs is imperative to surviving the downturn, be selective when evaluating your marketing budget for cost savings opportunities. Carefully evaluate specific costs with an eye toward return on investment. Look at professional memberships, subscriptions, and event spending before cutting your sales team, especially if the team members are productive. This is your chance to maintain and even gain market share by actively soliciting corporate and group accounts while your competitors are distracted. Encourage your sales team to be creative, while keeping costs low.
- Promote Proactive COVID-19 Practices. The most important thing hotel owners can do to attract guests is ensure guest safety. Post your COVID-19 practices on your website and communicate the specific steps taken to provide a warm but contactless approach to hospitality. Refine your policies and procedures continually to comply with latest information on preventing the spread of the virus and maintain compliance with CDC, state, and local civil orders. Use technology to your advantage to keep your guests engaged.
- Restructure Debt. To get through the liquidity crunch, many owners have already requested loan forbearance from their lenders. That temporary exemption may soon be expiring. Given the distressed state of the hospitality sector, it is extremely difficult to refinance with a new lender, even for hotels with positive cash flow. Modifying current debt is more likely to be successful. Start planning now for discussions with your current lender on a more permanent restructuring of the hotel’s financings. Have a well-thought out proposal in hand that includes a three-year cash flow model with concrete profit optimization ideas. Be prepared to contribute additional equity to demonstrate your commitment. Most loans already have low interest rates so there may not be much room to negotiate. Depending on the circumstances, focus instead on extending maturity with a lower overall payment, and be mindful of the covenants in the original agreement that might be tripped even with new loan terms. Never forget to consider the accounting and tax consequences of any modification.
- File Business Interruption Claims. The courts are filling up with litigation over whether all risk business interruption insurance policies cover the negative economic consequences of the pandemic. While the judicial process is churning, understand the terms of your policies and file for business interruption. If you do not file, you definitely won’t collect. Consider raising your liability coverage unless Congress passes liability limitations when employees and guests spread the virus at your property.
- Find New Capital. A prolonged lack of liquidity pending the restoration of demand will force many hotel owners to seek additional capital. The good news is there is abundant capital among real estate investors for the right deal. The not-as-good news is that such capital is expensive and negotiating the property’s value will be difficult without comparable sales in the market. Sources of capital will vary greatly depending on circumstances including market, chain scale, and the current and anticipated level of distress. As such, investors will range from asset managers to more liquid hotel owners to private equity. While the process may be painful, it will allow an owner to survive the crisis and emerge with the financial strength to compete in a new market reality.
- Rethink the Property Improvement Plan (PIP). Conserve your cash and consider only those projects that are mandatory to maintain good standing for licenses and agreements. Negotiate with the brand on the timing and scope of brand-mandated projects. Solicit revised bids from your providers. With the decline of new hotel development projects and capital improvement projects being delayed, contractors and vendors might be more inclined to reduce their costs.
- Explore Repurposing the Real Estate. For a variety of reasons, including market over-supply prior to COVID, some hotels will not recover and alternative strategies must be considered. Hotels are most easily converted to multifamily, senior housing, and student housing, although the pandemic is also having a deleterious impact on the latter. Consider conducting a highest and best use study that evaluates the location and physical attributes of the existing structure, supply of and demand for the prospective alternative property types in the local market, and the return on cost associated with a significant renovation and repositioning of the property. Converting a high cap rate, difficult to finance property into a low cap rate, easy to finance property may prove a good arbitrage for owners with the know-how, flexibility and capital to implement this strategy.
Given that consensus estimates that the industry will not return to 2019 levels for another three years, owners, both independent and branded, must begin to seek longer-term solutions to maintain a viable business model through what may become a prolonged down cycle. As events unfold, new patterns of business and leisure travel will evolve and the hospitality market must be nimble and creative to capture demand. Analyzing the specific circumstances of each property is essential to developing a customized and workable survival strategy.