Hotel Owners - Weathering Difficult Times

02/06/2002

According to the fourth quarter 2001 report of Lodging Econometrics, the accelerated decline in the operating performance of the lodging industry will continue until the middle of the first quarter of 2002 due to the events of September 11, 2001, and the recession.  Further, while the operating performance of the lodging industry may show signs of improvement by September of 2002, the effects of that improvement may not be felt until the first quarter of 2003.  Many hotels will continue to undergo hardship and may consider filing for bankruptcy to get some relief from their creditors.  If a hotel files for bankruptcy, decisions relating to the hotel may be subject to scrutiny and approval of the bankruptcy court.  Further, an owner will need to enter into protracted discussions with creditors to formulate an acceptable reorganization plan.  As an owner, you may be able to avoid such a predicament by taking proactive steps.  To do so, an owner must be realistic about the likelihood of a hotel’s success.  Set forth below are some of the steps an owner can take to make an assessment of such likelihood and to formulate a realistic approach.

Operational Issues.

  • Don’t Stand on the Sideline.  Most hotels are managed by professional hotel operators or managers.  Don’t be content with getting the operating results at the end of each month.  As an owner, you should make sure that you know how your resources are being utilized to maximize profits, or in the alternative, to minimize losses.  Ask the manager or operator for back-up information on expenses.  This is particularly important for chain services that you are obligated to pay under the terms of the management agreement.  These payments should be directly attributable to your hotel, and the operator should be able to show that the allocation is correct through its back up documentation.  Also, make sure that you attend operational review meetings.  If the operator does not schedule the meetings, insist that they occur.
     
  • Take Time to Understand Hotel Operation and Business Trends.  The numbers won’t make sense unless you understand the nature of hotel operations.  For example, the room rate might be high, but the occupancy rate low, ultimately resulting in a low revenue per room.  Does that mean that the rate is not competitive or does it mean that the market is in a down cycle?  This will be hard to evaluate unless you have information about market segments and the share of the market the hotel is successfully capturing.  Understanding the hotel operations and business trends will help you better evaluate whether the operator/manager is operating the hotel effectively in the current market and whether it is pursuing all possible business sources to increase its revenue.  Understanding business trends will give you a realistic picture of the hotel’s ability to compete in the long term.
     
  • Take a Tour of the Property Regularly.  Does the hotel appear to be well maintained?  Has the operator been spending the funds allocated toward maintenance in the annual budget that you approved?  Is an adequate level of money being put aside for long term capital items?  (Note:  This may cut into an operator’s incentive fees).  This determination is hard to make unless you are familiar with the physical condition of the hotel.  Tours of the hotel also will help you evaluate whether it is being operated well to survive the economic downturn.  Such evaluation is critical in determining whether remedial steps should be taken immediately and in assessing the long term prospects for the hotel.
     
  • Check to See if Operator is in Default of its Obligations under Management Agreement and Other Contracts.  Make sure that the operator is meeting all of its obligations under the management agreement.  Are you getting the operational reports on a timely basis?  Are you getting disclosure on affiliate transactions?  Are you getting your share of the rebates?  Are the corporate marketing funds being expended properly to adequately advertise the hotel?  Is the operator meeting the budget goals that you approved?  If not, do the deviations and explanations look probable?  Most importantly, is the operator responsive to your requests for information?  All of these issues will impact the bottom line.  Remember, given recent court decisions, an operator is a fiduciary and has the obligation to act in the best interest of the hotel and to disclose when it is not doing so.
     
  • Make Sure You Have the Right Personnel.  For most hotels, payroll is the biggest expense item.  You need to determine whether the employees are right for the hotel.  Are they doing what they are supposed to be doing?  Is their time being spent on management company issues rather than issues dealing with the hotel?  Management companies want to retain control of the employees and the exclusive ability to supervise them.  While it would not be appropriate for an owner to supervise employees directly, it is appropriate to request from the operator immediate clarification on the role played by each employee and his or her expertise.  Remember, owners can do this as part of the budget process and operational review.

    Steps to Take.

  • Get an Operational Assessment.  If you are fortunate enough to work with an operator who conducts operational analyses regularly, you may be able to work with the operator to agree on areas of improvement. If your operator does not conduct such analyses, you may want to request them so that the operator can identify potential areas of improvement (operationally, top line and bottom line).  This serves two purposes:  (a) it will get the operator to focus on how it can improve its performance and (b) you will be able to see if the operator has what it takes to weather the downturn.  However, if the operator is not cooperative or doesn’t produce an analysis that you find helpful, you can hire an independent outside consultant to give you an assessment.  This will give you the basis for determining whether the hotel is encountering temporary difficulties due to the economy or whether it is a project with long term issues.  This assessment should provide you with a set of remedial suggestions which can be implemented operationally.  If the operator is not cooperative in its implementation, you will need to think about an alternative strategy in dealing with the operator.
     
  • Negotiate with Lender.  An operational assessment should give you a realistic view on both the current hotel operations and its future prospects.  It may show, for example, that given the operational needs of the hotel, the revenues will not be able to withstand the current debt payment.  Before you are forced into the situation of having to choose between operating the hotel or making the debt payment, approach the lender with a possible debt restructure.  This may give you the relief you need to weather temporary market conditions so that the operations remain competitive and may prevent you from defaulting on other trade creditors and the operator.  No lender wants to stand in line with other creditors by forcing a borrower into bankruptcy.
     
  • Negotiate with Operator.  During these economic times, operators are also concerned about the ramification of a hotel owner filing for bankruptcy.  Once that happens, the owner can “accept or reject” the management contract and by rejecting the contract opt for another operator to come into play.  If it will prevent an owner bankruptcy, the operator may agree to defer its fees until such time as the economic conditions improve.  Management companies tend to refrain from reduction of cost of chain items, but may be willing to consider deferring fees or making a loan for capital improvements. 

    For additional information, please contact one of the authors listed at the top of the page.
     
    © 2002 Haynes and Boone, LLP

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