Real estate has always been a traditional part of UHNW and HNW families’ assets and investments. Increasingly we see those investments widen into broader “passion assets” (so yachts, art, classic cars to name a few of the more conventional).But there’s a space where traditional real estate investment and passion assets combine, and that’s around luxury hotels, aparthotels, serviced apartments and private members clubs. The unique and luxury status of iconic hotels and private members clubs can have equivalent appeal to many families as the “trophy” asset status of a famous office tower or football club. It can also be an opportunity for families to combine their investments and personal requirements (e.g. a base for family and employees when in London, a project for a specific family member, a private members club that suits specific personal requirements etc.).So when adapting core real estate financing offerings to cater for clients “hospitality” passions what are the key things to be aware of? We’ve put together the three “B”s to help you on your way…
Breathing
A hotel is a living breathing business (not just an inert real estate investment) so to value a hotel consideration needs to be given to the wider assets and liabilities. With traditional real estate (eg an office) income stream is evidenced by the rent payable under occupational lease/s backed by assessment of tenant covenant strength. All hotel investments will have their unique structure but there are often opco or third party leases. Where these specify a particular rental level they indicate income levels in a similar way to an office investment financing. However, frequently rent will be a turnover percentage rather than a specified rent. Here more detailed assessment is needed by the valuer to assess covenant strength. Commercial assets such as brand agreements and franchise agreements have value and the entity within the group that operates the business will be subject to usual business liabilities (employment, tax, disputes, licensing etc.) The trading assets will also be “in flux” as part of hotel operations eg stock, furniture, cutlery, service contracts etc.
Business
There are a variety of different structures used in hotel ownership and investment and a diagram of the structure in hand is a must to assess where security is required in terms of capital value and income and business control. Typical structures include:
With an opco/propco structure capital sits in the propco but security needs to be taken over opco to place controls over ancillary assets and ensure controls over cashflows (income accounts will sit with opco). Where a hotel is let to a third party tenant operator there is very little difference in terms of security to any other real estate financing transaction (security is taken over propco’s real estate interest and an assignment of the rents and a charge over the rental bank accounts in the usual way. Where there are franchise agreements and hotel management agreements these need to be reviewed as they may be terminable on borrower insolvency or have change of control provisions both of which are relevant on enforcement. Non disturbance agreements would usually be used to give a funder comfort around these issues by providing equivalent to step in rights for lenders. A tripartite agreement can be used to join a lender into a franchise agreement to provide the comfort of control here.
Additional loan covenants you may see in the facility agreement include:
- wider information covenants to include business information (not standard asset management information)
- financial covenants - may be linked to specified profit levels if rental incomes are profit related
- Class of hotel - maintaining 5 star status maybe applicable for a luxury hotel financing
- Lettings - usual controls over lettings may prompt a borrower to negotiate carve outs for restaurant, gym and other leases required to maintain brand standards and run their business. Lenders usually want control here as tenant covenants are linked to the brand and therefore value. Borrowers will want flexibility to get on and run their business and the level agreed is likely to reflect the size of the transaction and the covenant strength and sophistication of the borrower.
Brand
Brand is relevant to many luxury assets, whether the brand of an iconic hotel itself or the brand under a franchise agreement or the brand of the hotel manager. Commercial agreements relating to the various brands involved are important as the brand is likely to hold value. Hotels need to be regularly updated to maintain their brand positioning and regular capital expenditure (“capex”) is routine to ensure appropriate updating. A lender is likely to agree carve outs from works covenants to facilitate this and may have covenants requiring agreed Capex to be carried out throughout the loan as part of maintaining asset value.
Are hotels transactions complicated?
There are complexities to hotel financings. However there is a significant difference incomplexity between hotel trading facilities and investment facilities. Where a borrower’s ownership sits at propco level only (so akin to any other real estate investment financing with a third party tenant) whilst the dynamics of “the three Bs” are going on at trading level the borrower is not operating the hotel and engaging with these. Understanding of these dynamics is helpful context but does not add a great deal of complexity to the transaction. These transactions are primarily commercial real estate financings with a hotels dynamic. You might call these transactions hotel investment facilities. Conversely hotel trading facilities have greater similarities toother business trading facilities and both diligence requirements (from a valuation and legal perspective) and loan covenants will be more in depth and bespoke.
Hotel investment facilities align for many private banks with assisting their HNW and UHNW clients with their portfolio investments. They have similarities to commercial real estate financings and with specialist legal and valuation support can be progressed in a similar manner.
