The owner's guide to hotel development

Tara Marlow.

The beginning: An Opportunity…
Hotel investors are constantly on the look out for an opportunity. When one presents itself — whether by way of a development site, an existing building under construction (or already constructed), or an operational hotel — the process starts.

On page 86, I have prepared a diagram outlining in basic form the various stages of a hotel development, together with identification of what’s involved at each stage.

This diagram cannot capture all the issues that may need to be dealt with, (for this a lengthy book would be required), but hopefully provides an informative overview.

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The structure that I have commented on also assumes a stand-alone hotel. In the event the hotel is part of a mixed-use development, or forms part of a building which also includes residential and/or commercial components (which will not form part of the hotel and therefore will not be managed by the hotel operator), the structure necessarily becomes more complex. Additional issues and considerations will be involved in these circumstances.

Due diligence
The next step is to undertake a thorough due diligence exercise.
This will require the involvement of various professionals, including hospitality consultants, lawyers, surveyors, architects, accountants, insurers, government liaison representatives and a multitude of potential hotel operators.

The due diligence process forms the foundation upon which the project will evolve and the hotel will be built. It is a vital part of the process and sufficient time, resources and effort should be given to it.

The due diligence process can be broken down into separate components, comprising the following:

• Market research covering the geographical location of the project, competition of the proposed hotel, demographic information, potential customer analysis, the political and economical environment of the region, financial analysis of existing hotels in the vicinity of the proposed project, together with trading and employment framework etc

• Land and ownership investigation, to discover whether there are any potential problems with the land (survey and environmental issues), restrictions on the title or 3rd party interests etc, which may affect the development

• Investigation into development issues such as planning, access, utilities and licensing requirements — to understand what will be required, hurdles to be overcome and whether it will be possible to build the hotel as required

• Corporate structuring considerations: how does the acquisition impact the owner’s corporate structure, is the project located in a different country, is a local company required, do property ownership restrictions apply to the owner, what corporate governance requirements need to be complied with internally?

• Financial due diligence and planning: what is the tax regime in the location of the project, how does this impact the owner’s existing operations and corporate structure, can profits be repatriated, does a foreign investment regime apply to the owner’s investment, what duties will be payable where goods/materials/services are imported, what are the estimated development and construction costs, can workers and materials be procured locally or do they need to be imported, what borrowing requirements does the owner have, what security will a lender require, and general consideration of lending arrangements to be agreed?

• Business plan and risk analysis (summarising all aspects of the due diligence for the project)

• (For non-operational assets), hotel operator expressions of interest: it is always beneficial to involve the hotel operator at the earliest stage possible, to obtain their feedback and opinion of the proposed project and the location, together with confirmation of their interest to manage the hotel (subject to agreement of terms).

Where the asset proposed for acquisition is an operational hotel, the due diligence process as outlined above will be required to a large extent. Additionally, detailed analysis of the hotel operation and management itself is required as follows:

• Review of existing hotel management agreements and consideration of whether sale of the asset will trigger termination of these, or whether the agreement (and thereby the operator) may be assigned to the owner — does the operator have a first right of refusal to purchase the hotel?

• Consideration of the commercial terms of the operator’s appointment, including fees, exclusivity arrangements, the existence of a performance test, freedom to dispose of or grant security over the hotel etc

• Review of the existing hotel management team and performance of the hotel to date

• Review of financial records and audited accounts to establish the trading history of the hotel, income and expense levels and resulting profitability for the owner

• Inspection and survey of the hotel itself: what is the condition of the rooms and common areas, is a refurbishment required?

• Is the back of house in good order?

• What is the quality of the FF&E: is there a need for a large scale replacement to take place?

• What is the age and quality of the infrastructure and plant — have these been maintained properly, what are the likely costs where replacement and/or repair are required, what warranties over the plant and equipment will be transferred to the owner?

• HR and employees: does a trade union exist, how does the employment legislation regime of the country in which the hotel is located impact operation, what are the likely owner’s costs associated with employment of the hotel staff (such as pension and insurance contributions etc), are there any pending legal actions or tribunals against the hotel or the existing owner?

• Review of all the supplier and service agreements entered into by the hotel: what are the obligations and liabilities?
• Review of the hotel’s insurances and claim history

• A detailed analysis of whether the hotel or existing owner is (or is likely to be) a defendant in any legal action, what are the existing and potential legal liabilities of the property and its owners?

On the assumption that all due diligence investigations, surveys, the business plan, financial forecasting and risk analysis are acceptable, then acquisition of the asset can take place and the process will then move into a more detailed development stage.