Approaches to developing and implementing a survival strategy for hotel owners facing COVID-19
The coronavirus disease 2019 (COVID-19) pandemic has decimated the hospitality and leisure industry. The World Travel & Tourism Council's (WTTC) latest research indicates that, with this year's COVID-induced collapse of international tourism, the US economy will lose $155 billion in 2020. This is tantamount to a shortfall of $425 million a day, or almost $3 billion per week. HVS, a leading hotel consulting and valuation firm, describes this economic situation in its August 2020 Outlook for the Hotel Industry as an unprecedented downturn. HVS is one of many predicting that the industry will not return to 2019 performance levels until 2024.
The urgent problem for hotel owners is whether to try to survive until then and how to do so. The benefits of the CARES Act are expiring, and the American Hotel & Lodging Association and other industry advocates are petitioning for federal relief to help hotel owners. Perhaps the government will provide some relief by the time you read this article. However, most owners are not counting on federal relief to survive and instead are working on developing and implementing their own strategies to combat the economic hardships caused by COVID-19.
However, discussing "hotels" generally is misleading because every hotel needs its own risk/reward analysis. Perhaps more than other commercial real estate assets, hotels are not fungible. The impact of the COVID-19 downturn has varied depending on each hotel's class and location. A given hotel's timeline to recovery will differ depending on factors such as location (with drive-to leisure properties probably recovering first) and by property type, with limited service properties probably recovering before full-service business-type properties.
An assessment of the likely timeline to recovery is a critical starting place for strategy. Whether an owner should support a hotel until return to profitability, whether it should be closed temporarily or permanently, whether the owner should give the hotel back to a lender or whether it should be re-branded or repurposed are all potential options. This process is more complicated than for other commercial real estate assets due to the number of stakeholders typically involved in hotel ownership and operation.
Developing and implementing a strategy will require all those stakeholders' input and cooperation, whose interests may not be entirely aligned. Owners, investors, lenders, loan servicers, brands, managers, unions and municipalities may all have seats at the table in determining future success. Coordinating among them to devise a game plan takes time and skill. Market consultants, tax and accounting advisors and, of course, experienced lawyers can help determine and execute the appropriate strategy. Communication, transparency and cooperation are key.
Some high-level topics for consideration, each of which poses its own complications and challenges, include:
- Is bankruptcy a viable option to give the owner some breathing space? Would this trigger full recourse under the loan documents? Might it allow reflagging, which could change market positioning and improve profitability?
- Will the lender cooperate in a loan restructuring? Is there additional collateral, in the form of guarantees or otherwise, to give the lender further assurance?
- Based on an owner's financial situation, it may be most prudent to negotiate a deed in lieu of foreclosure with the lender. As has been widely reported, the CMBS market is overwhelmed with the onslaught of defaulted loans, and it is difficult to get attention from special servicers, but other lenders might be more approachable. Before embarking on this path, a careful review of loan documents and tax implications is necessary. The potential for liability under other guaranties, such as a franchise agreement guaranty, should also be carefully considered.
- If the hotel is strategic to a franchisor, might the franchisor provide financial support or waive certain financial requirements, such as accruing fees, waiving reserves or delaying PIP requirements? An extension of the agreement term might be enticing to the brand. Would re-branding the hotel improve performance?
- After review of the hotel management agreement, if there are opportunities to terminate the agreement, a manager may be willing to provide "key money" (where the manager contributes cash to the owner in exchange for a long-term management agreement) or "sliver equity" (where the manager purchases a small interest of equity in the owner) to keep the agreement, especially if the hotel is a strategic asset. As with the franchisor, there may be other concessions a manager is willing to make in exchange for concessions when performance improves.
- It might be worth discussing assistance with local governmental entities. Federal programs such as PPP and the CARES Act have received much publicity, but state and local governments may have other programs that can provide relief. Tourism, including hotel/motel taxes, provides substantial revenue to city governments, incentivizing them to promote a healthy hotel base.
- Recapitalizing a hotel owner or selling the asset is another possibility. While the traditional mortgage loan market has not yet jumped back into the market, there may be other sources of capital available under more or less expensive terms. Insurance companies, family offices, and sovereign wealth funds may all be options. Buyers are in the market to repurpose hotels into multifamily or student or senior housing facilities and have raised funds for this purpose.
- If the hotel has union labor, a review of the collective bargaining agreement and conversations with union officials will be necessary before implementing any cost-saving changes to employment terms and conditions.
- Many hotel owners have become creative in generating additional sources of income. Some are making hotel rooms available for student housing, or on a daily basis for temporary office use, or are advertising special rates for staycations. To maximize such flexibility, greater use of technology and robotics may help drive down costs. These developments are no longer just a gimmick, and owners should seriously consider them.
- If investors have approval rights, getting them on board with the plan is crucial to avoid challenges down the road. Investors should approve the extent of future financial support required to achieve the goals in advance as well.
In sum, developing and implementing a successful strategy to combat the impacts of the COVID-19 downturn requires significant up-front analysis, communication and cooperation among key stakeholders. Even in the face of the unknowable, there should be significant benefits to owners who are proactive with their planning efforts.