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5 Things to remember when buying hotel notes

13 March 2012

Hotel investment through buying hotel notes As the economy and hotel fundamentals continue to improve, hotel note purchase opportunities will be one of the most attractive hotel investments for savvy investors.

My partner and Vice Chair of our Global Hospitality Group®, Guy Maisnik, has been working a lot on note purchases lately, and I asked him to share some insights with us, which he graciously consented to do with his article today.



Guy Maisnik | Hotel Lawyer and Vice Chair Global Hospitality Group®

The hotel industry experts have published their forecasts for 2012 and they seem to agree on the following two predictions:

(1) The hotel sector will continue to improve in 2012, with RevPar increasing anywhere from 4 to 6 percent, depending on which expert you follow.

(2) It’s going to be a rocky year for hotel loans held by lenders, particularly for those loans made at the peak of the last cycle in 2006 and 2007, and especially for loans that cannot be extended further. Some of these loans are securitized with complicated structures that involve multiple tranches of senior and junior debt sold. Others never got securitized and weigh heavily on lenders’ books.

Our prediction: Capital providers and special servicers will sell more hotel notes and assets in 2012

While the capital markets are warmer, they are still cold and the velocity of debt and equity flows are currently insufficient to preserve many of the hotels in the hands of their current owners. As hotel metrics improve, hotel notes will command a better price, and lenders will sell more of them. We predict that capital providers and special servicers will sell more notes and assets in 2012 than in the past two years.

Out hotel lawyers at Jeffer Mangels Butler & Mitchell LLP (JMBM) have been involved in the purchase of hundreds of notes secured by real property, and experience tells us that most note buyers (other than institutional participants) are looking to obtain the locked up value in the hotel real estate — and not really interested in the fixed income of the note. These note buyers want to get at the hotel asset as quickly as possible, and either operate or sell the underlying hotel. This is the case whether it is a portfolio or an individual note that is being purchased.

What buyers of hotel notes need to know

If you are a buyer of hotel notes, whether it’s a portfolio or single loan, there are some key things to keep in mind, particularly for this coming year. Here are my top 5.

1. Update your checklist and use it

Step one: get your checklist in order. Yes, this is a mundane point. But it will also save your investment. Under FAA rules, not even the most skilled engineer is permitted to check the plane without using a standard checklist before giving approval for take off. Note buying is no different. Without a checklist, it is simply too easy to miss a critical item or issue.

No checklist fits every asset or circumstance, so you must tailor your checklist to your asset. My team starts with a comprehensive checklist that covers virtually every hotel issue we have come up against. Then we brainstorm the particular asset at hand and conform the checklist accordingly.

We almost always find concerns in the hotel loan file that need to be addressed. Do not assume because the loan was prepared by a good law firm that the loan documents work. First, good firms can make mistakes. Second, many hotel loans are done by good law firms that simply do not typically handle hotels, so they miss many hotel related issues. Remember, a hotel is made of anywhere from 15-25 percent personal property. Some of that property could have liens or be leased from third parties. The UCC has an entire body of hidden liens many real estate lawyers simply do not know about. The note buyer must run a proper UCC search. In many states, liquor licenses, which provide value to the hotel, cannot be collateralized. Also, the loan may have been previously modified without guarantor approval; there could be important waivers missing in the note or guaranty. Finally, your checklist needs to take into account any new laws that have come into effect. For example, on March 15, 2012, new ADA Standards become mandatory. The loan could have been assigned multiple times but the assignment documents are incomplete. The note buyer may find that it has to prove up the outstanding amount of loan in front of the bankruptcy judge who requires additional proof. (Good luck getting that done without the assistance of the note seller!) And if you are buying from a note flipper…beware.

Don’t miss this step. Mundane, yes, but well worth the effort.

2. Think like a lender: You are buying a loan not the real estate

Buyers of loans are so eager to get to the property, that when they close on the loan, they often forget that all they have is the loan…not the real estate. Such buyers can often unwittingly trigger liability and claims, causing a devaluation of the loan just acquired. Closing on the loan is different from closing on the hotel. As the new note holder you have to act like a lender, not a hotel owner. You don’t want the value of your note to be eroded by the cost of litigation, so be aware that casebooks are filled with lender liability lawsuits against lenders (even experienced lenders) who overstepped their legal boundaries.

Before buying a loan, know the “dos and don’ts” of lending. If you do not have that expertise, you are strongly advised to engage legal counsel who does. A wrong step can cause you to lose lien priority of all or a part of your loan. Even seemingly innocent acts such as your making decisions on hotel operations or approving or disapproving borrower expenditures can be problematic. In some states, the note buyer can lose its security interest in the hotel altogether.

Hotels are operating businesses, and it is rare that a lender will be comfortable leaving the operations of a distressed hotel in the hands of a hotel owner who has lost its equity. The sophisticated note buyer will understand the applicable rules of receiverships and employ a receiver where permitted. In many states, the receiver has authority to cause a transfer of the liquor license, even if not collateral of the hotel, which can be quite valuable. But again, tread carefully, particularly in single action states.

Remember, think like a lender, not a hotel owner.

3. Due diligence, due diligence, due diligence

Substantially more due diligence needs to be done when buying a hotel loan than most typically real estate secured loans. The hotel note buyer needs to review a) the loan file, b) the operating business of the hotel and c) the real estate. Make certain the loan file is complete with all loan documents in place, and that the documents work properly. If possible, obtain a copy of the note seller’s correspondence file. Pay particular attention to any hotel management agreement in place and any subordination or comfort agreements. Depending on how they are drafted, they will likely affect the value of the note collateral.

Understanding hotel operations is important and is discussed below in more detail (see 4 below). A greater scrutiny of the physical improvements is required for a hotel than for ordinary commercial real estate. For example, if the secured property were a retail supermarket, the supermarket tenant is charged with maintaining and insuring the asset. Thus, if the windows leak or the sprinkler systems do not comply with applicable law, the burden and costs of fixing these items often can be passed through to the supermarket tenant. Not so with a hotel. These issues fall squarely on the shoulders of the hotel buyer. To make matters more challenging, note selling lenders actually often give a shorter period of time to note buyers to review the file and asset when compared with sellers of other real estate.

Use experienced hotel contractors and engineers to walk through the level of physical due diligence needed. Have a zoning specialist ready to review the hotel entitlements. Confirm all signage and parking are on the real property collateral. Confirm the number of parking places complies with zoning requirements. Confirm the asset complies with all environmental laws and any governmentally issued conditional u
se permit. Hotel owners often tweak the physical improvements which can cause the hotel to become non-compliant. The key is to have your due diligence team (hotel consultant, construction/engineer consultant, zoning consultant and legal counsel) ready to move before the note hunting begins, so they can hit the ground running.

Proper due diligence cannot be stressed enough.

4. Understand the hotel business

Secured hotel loans are not like typical real estate secured loans. The value of the hotel, hence the value of the loan, depend highly upon the hotel’s business. Therefore, the analysis and due diligence reviews should focus on hotel elements as well as the real estate. Regardless of intentions, the Noteholder should assume it will own and operate the hotel, and be prepared to do the following:

  • Labor and employment. Replacing hotel employees is costly, at any level. Review employees records to determine if they are legal workers. We have been involved in many hotel purchases in the last two years where this was not the case. If the note is secured by a major hotel, the note buyer should analyze all employee positions, including general manager, concierge, front desk manager, chief engineer, F&B director and director of sales. Is the hotel the subject of a union campaign? Unionization increases hotel operating costs by as much as 38%, and lowers the quality of hotel service. Employee morale will likely be at a low, so the note buyer should be prepared, following foreclosure, to implement a program to boost employee morale and implement an employee policy handbook and benefits package.
  • Brand issues. Keep in mind that the franchise brand owner has to approve any new hotel owner. The brand may insist on the pay back of all unpaid fees as a condition of keeping the franchise. The brand may require a costly property improvement plan. These will impact the value of the loan. Determine whether the current brand is the best one for the hotel. If the brand is holding down hotel value and should be replaced, have a strategy to replace the brand. This can be challenging, and should be discussed with legal counsel with substantial experience with removing the brand.
  • Hotel systems. The note buyer should also review the cost of keeping or changing hotel concepts, protocols and systems. The note buyer should assume it will have to correct and/or complete the hotel’s budgets and financials (which will not be easy if the current owner has mismanaged the hotel) and implement new revenue management and cost containment systems, reservations systems and booking engines. The sophisticated hotel loan buyer will understand the process and have a plan ready to be implemented.

Remember: Hotels are more than just real estate.

5. Review your tax plan with an expert

Finally, do not forget tax considerations. Many note buyers end up restructuring the notes with the current hotel owner/debtor. Most of the tax consequences from restructuring a secured loan will belong to the debtor, but certain actions can hurt the note buyer, some of them significantly. Experienced note buyers will review its plan with a tax lawyer or accountant. Again, because hotels are different from typical real estate, it is important that you consult legal counsel with experience in tax planning for hotel loan or hotel asset ownership.

It’s a good time to buy hotel notes

Truth be told, there are many more than 5 key considerations for buying hotel secured notes. Do not let that be daunting. Purchasing hotel debt can be exceptionally attractive — but not for the inexperienced note buyer or hotel novice. There are too many complex issues that simply do not exist with distressed debt secured by ordinary commercial real estate. Experience is the key. With seasoned hotel advisors behind them, the experienced note buyer can carefully and fully understand the issues at hand and how they impact the note purchase and business plan.

There are lenders and special servicers itching to get hotel loans off their books, and note buyers eager to unlock the value that is languishing in distressed hotels across the country. For lenders and buyers alike, 2012 could be a very good year.

HOW TO BUY A HOTEL — Free handbook

Until the free handbook on HOW TO BUY A HOTEL is published (expected in Summer 2014), you can access all the materials on this subject at Look on the right hand side of the home page and click on “Buying & Selling a Hotel.”

Here are a few of the articles on the subject under this topic:

Buying a hotel? Financing a hotel? 10 things every borrower should know. (part 1)

The hotel purchase and sale agreement — What is the value of the seller’s representations and warranties to a hotel buyer?

Seller representations and warranties in a hotel purchase agreement — What are the big issues today?

How to buy a hotel — What you don’t know about undocumented workers could really hurt you!

HOW TO BUY A HOTEL Handbook: Franchise issues in hotel purchase and sale transactions

5 Things to remember when buying hotel notes

Hotel Lawyer on 2012: A good year to buy a hotel (and a bad year, if your hotel note is due)

Buying a Hotel? Don’t buy an ADA lawsuit or DOJ Investigation

Hotel Lawyer: So,You Think You Want to Buy a Hotel?

This is Jim Butler, author of and hotel lawyer, signing off. We’ve done more than $87 billion of hotel transactions and have developed innovative solutions to help investors be successful in bidding for hotel acquisitions, and helping investors and lenders to unlock value from troubled hotel transactions. Who’s your hotel lawyer?
MGM.Photo.jpgGuy Maisnik is a hotel lawyer with nearly three decades in commercial real estate transactions. He is a partner and Vice Chair of JMBM’s Global Hospitality Group®, a member of the JMBM Chinese Investment Group® and a partner in the JMBM’s real estate department. Guy advises clients on hotel transactions, representing lenders, opportunity funds, banks, special servicers, owners, REITs and developers in hotel transactions, including senior and mezzanine financing, workout and debt restructure, strategic portfolio acquisitions, co-lender, participation and securitization arrangements, joint ventures, management agreements, buying, selling and ground leasing of hotels, complex mixed used resort development, fractional and timeshare.

For troubled hotels, Guy develops and executes strategies for CMBS and whole loans, and REOs. He also assists investors with recapitalization of distressed borrowers and purchases of troubled assets. Guy has assisted major lenders in revising and structuring their hotel lending programs and documentation, including their hotel construction lending. Guy’s practice is both domestic and foreign; he has advised on hotel and real estate matters throughout the United States, Canada, Mexico, South America, Middle East, Caribbean, Western and Eastern Europe, Asia and Scandinavia. For more information, please contact Guy Maisnik at or +1 (310) 201-3588.
Our Perspective. We represent hotel lenders, owners and investors. We have helped our clients find business and legal solutions for more than $125 billion of hotel transactions, involving more than 4,700 properties all over the world. For more information, please contact Jim Butler at or +1 (310) 201-3526.

Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group®. Jim is one of the top hospitality attorneys in the world. GOOGLE “hotel lawyer” and you will see why.

Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them.

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