COVID has significantly impacted leisure and business travel and the hotel industry. Regardless if your expectations are that the crisis will lead to long-term changes to the industry or, alternatively, that there will an eventual return to the old normal, in the short to medium term the effects of COVID will be profound: travel has plummeted and most hotels are shut.
And while lenders to the hotel sector, be they banks or loan investors, face a number of considerations common to other CRE loans, hotel loan portfolios require additional focus both because of their complex operational characteristics and the disproportionately severe impact that the crisis has had on the sector.
Defaults and Forbearance
At this stage most borrowers will be in default of one, or all, of their loan facility’s undertakings, financial covenants, and interest/principal payment terms. Covenant waivers and temporary payment forbearance will be necessary and in the mutual interest of borrowers and lenders in almost every instance, and in some jurisdictions payment moratoriums have been legislated. While larger, complex, highly levered or already distressed situations will require detailed attention, lenders should establish high level waiver and forbearance guidance applicable across their hotel loan portfolios to facilitate and expedite implementing what will be a broadly portfolio wide “standstill” period. At this stage we would expect most lenders will be in this explicit or de facto holding pattern across much of their book.
As lockdown and travel restrictions are lifted, travel will resume, hotels will seek to re-open and the industry will start to recover. Key to a successful recovery will be the combination of the desire, willingness, and ability of guests to venture forth again. When this will happen and over what period is the big question, and the answer may not be the same for all hotel categories. This re-opening will, in due course, allow the timing and extent of the industry’s recovery to be better understood and future revenues, costs and cashflows to be more reliably projected, allowing new covenant and payment terms to be negotiated.
In some situations a more substantive financial restructuring than any currently implemented limited forbearance measures will be required, and inevitably lenders will find themselves the economic owners of a significant number of assets and businesses i.e. where existing equity has been wiped out and value breaks in the debt. Despite this, in most circumstances lenders should defer and, if possible, seek to minimize the number of situation where they onboard hotel assets, in particular where the existing legal owners and operators are adding value either through quality of management or provision of capital.
The benefit of delaying taking over assets, which would likely be a mistake in a more standard workout scenario, is that in this case it will be beneficial for lenders to see how individual properties, hotel sub-categories, locations and the overall travel market recover post-COVID. For example, what were key success factors pre-COVID may prove less relevant going forward (e.g. will high occupancy rate targets be realistic), and the relative success of different operating models/segments will vary (e.g. the “stack’em high” budget vs. low density luxury categories). The recommendation of minimizing, at least relative other real estate segments, the onboarding of hotel assets is a function of their complexity and operational nature, though in order to preserve value there will unavoidably be situations where some lenders will need to take ownership of properties.
Therefore, on the decision tree of how lenders should manage their hotel loan portfolio, segmentation and triage will be an iterative rather than one-off process, and a measure of “planned procrastination” will be beneficial in making more informed decisions. However there is unfortunately a branch on the decision tree that will come up quicker on some transactions than would ideally be the case: new money.
Working Capital and New Money
Regardless of the situation lenders find themselves in – debtholders to a temporarily distressed but viable borrower, creditors with economic ownership, or actual legal owners of enforced assets – they will shortly be presented with the challenges and issues associated with reopening hotel properties, which in many instances will require funding. Working capital is a key issue across the sector as even when closed, and almost certainly on reopening, hotels will need to fund expenses while generating little if any revenue. Many governments have made available support to businesses including employee furlough schemes, tax deferrals and holidays, and government guaranteed loans (in passing the interaction of the latter with existing credit facilities should be analysed and understood from both a legal and commercial perspective). Lenders will nevertheless need to consider requests to allow access to revolving credit facilities and overdrafts and/or to provide new money facilities to support hotel businesses through to recovery.
The challenge is that these decisions will need to be made when it is hard to gauge the long term viability of some properties, with the uncertainty of how COVID might permanently change the industry adding to the usual difficulties of undertaking projections in a distressed situation.
Open or mothball?
For marginal situations the critical decision therefore is when is it going to be viable to re-open in a manner that is value accretive, or is better to keep the property mothballed for a period, potentially using the time to make needed changes to the property and re-opening when it is more feasible? This is a question of not only expected occupancy and room rates, but also the operating costs and requirements in the post-COVID operating environment. What is the new break-even point, and how does that compare to the cost of mothballing a property for an extended period?
To answer these questions requires analysis at both a macro and micro level.
At a macro level reopening will not only require the legal framework that permits hotels to operate safely and efficiently, but it will also require operating procedures to be in place that inspire guests to have the confidence that it’s safe to travel both to the individual property and also to the destination. In most jurisdictions we are seeing the hotel industry work together with other travel service providers and governments to ensure that business and leisure travel can resume, with appropriate safety measures in place, as soon as it is safe to do so, and that this message is delivered to the traveling public.
At a micro level answering the re-open/mothball/breakeven question requires a detailed analysis of the financial, operating, legal and health & safety aspects of a property’s re-opening and short-term business plan. At the end of this paper we provide a check list of the factors for lenders to consider as they review re-opening/short term business plans and associated new money requests. While the list may seem long and specialised, a thorough assessment is essential in more marginal situations to avoid throwing good money after bad.
The Longer Term
Navigating through the re-open/mothball/new money branches of the decision tree is an important near-term process that lenders will need to undertake. However it is unfortunately only the beginning of the difficult decisions for some portfolio positions. While attractive properties with conservative capital structures may require only a limited restructuring of their obligations, properties that are less prime, more highly levered or suffer disproportionately from the longer-term effects of the crisis will require more significant restructuring and/or new equity. Many of the latter category will inevitably end up with lenders as their economic and legal owners, putting lenders in a more complex part of the forest with an even longer and more complex check list. Undertaking appropriate analysis and making sound decisions at this stage will allow lenders to minimise these situations.
Elif Egeli Nisanci
Hotel Re-Openings and Short-term Business Plans: Factors to Consider
Governments are adopting a gradual approach to reopening economies combined with the imposition of new rules and guidelines.
What are the new regulations?
- What are the occupational health and safety requirements for both guests and staff?
- Are there inspections or certifications required?
Are there limitations on occupancy?
- Food and beverage
- Other facilities (pools, spa, kids club etc.)
What COVID screening or certification do you require for
- employees, and
What disclaimers or waivers should you require from staff and guests?
An updated business plan is required, with detailed cashflows that consider the additional start-up costs and capacity constraints in place.
-Is it worth opening the hotel with reduced permitted capacity?
-For instance, if a property catered principally to international business travellers, it might make sense to keep it closed due to the impact of quarantines, budget restrictions, insurance limitations, and as corporate travellers reassess the need for travel versus video conferencing there may not be significant demand.
· Is it better to mothball for a period until demand recovers? or
· Is it time to consider converting the property to an alternate use?
Issues that need to be considered include:
-Can the property afford to hire back its employees?
· Due to occupancy restrictions, it is unlikely to need all its staff so what is the new resourcing required?
· Are there union rules on who can/should be hired first?
· Are there government support schemes and how do they impact staff hiring/retention?
-Are there sufficient funds in the operating account for restarting payroll, utilities, purchasing orders etc? If not, are there government schemes or new equity available, or will lender support be required to fund this?
-What are the revenue streams?
· Rooms (at permitted capacity)
· How long it will take to put rooms back in inventory after each stay given additional cleaning?
· Cancelation policy – can the property afford fully refundable reservations to be cancelled anytime?
· Will restaurants be open – guests may not want to go outside to eat as they perceive less risk inhouse
· Revisit menu – supplies to be ordered locally
· No more buffets
· Room service
· Minibars – will people feel safe
· Will spa and gym areas be permitted to be open and what services can they offer and under what conditions?
· Changes required for pool and beach areas, other common spaces?
· Meetings / events – will there be demand and given restrictions on crowds does it make sense to open?
· Valet parking and other ancillary services – are they permitted and under what condition will they be allowed?
-New operating costs
· Additional cleaning requirements?
· PPE for employees?
Operators and Management Agreements
Where there is a sperate operator, their performance will be critical to successfully navigating through re-opening / recovery. Lenders should review operator management agreements in place.
-Are any COVID related amendments required/proposed/agreed, does the lender have to approve amendments?
-Do economic and performance terms need to be adjusted?
-Are there payment terms/deferral provisions that allow cashflow to be preserved?
-What are the lender’s and/or the operator’s rights to assume or terminate the agreement on enforcement/insolvency/change of control of the property SPV?
Sales and Marketing Considerations
A re-evaluation of the property’s sales and marketing plan is necessary to see if it is still effective post-COVID as we are likely to see different channels recovering at different rates.
Direct and personalised marketing is likely to be the most effective channel as consumers are likely to stick with brands and locations that they feel they can trust.
Re-focus on those segments most likely to recover in the short term – domestic markets are much more likely to recover before international:
· Which segments will recover and when corporate travellers, large groups, FIT?
· Corporates may have realised they do not have to travel as frequently, corporate travel insurance or OH&S concerns may not allow as much travel and workforces will have shrunk.
· Large travel groups – will probably not be allowed or be capacity restrained
· FIT or leisure guests – will recover first but due to safety (cleanliness, crowd control, and fear of getting stranded) and shortage of money will be more selective
· Focus on repeat guests who know and trust your brand and property.
· Short distance car travel may recover before airline travel, therefore your local market maybe key as people go local rather than international this season.
Technology systems will need to be updated to allow for changes in booking and operating procedures in the new environment.
Revenue management will need to be revisited to allow for additional costs including likely increase in out of order rooms and last-minute reservations
· Travelers will wait to see latest city data, travel restrictions and quarantine guidelines before they book
· Properties need to calculate their breakeven points and offer promotions/packages accordingly
· How do you price in the likely increase in demand for fully refundable bookings?
· Ease of making, changing, cancelling reservations
· OTAs in line with website information
· Guests may use OTAs for comparison, but they may want to speak with the hotel directly when receiving final information particularly about health and safety in the local area and therefore more capacity maybe required for handling direct bookings
· Touchless check in, arriving/entering to room, settling the bill and exit as much as possible
Architecture and Security issues
Physical changes will be required that have both a direct cost but also physical constraint impact on profitability.
– Are testing or temperature stations required?
– Are additional sanitation facilities required?
– Is more space required in common areas for social distancing and does this become a constraint on hotel capacity?
– How do you factor in social distancing in BOH- for instance can you institute one-way systems so staff do not constantly pass each other?
– Elevators – how many people at a time, cleaning after each use?
– Remove extra unused OSE from the rooms – less items to touch and clean
– Room service, housekeeping, laundry, gym lockers and showers, saunas, steam rooms and luggage service –is it safe to continue (and will guests think so), how do you need to modify?
– What additional PPE is required for employees?
– Should the property be converted to another use, then what are the demand factors
· Offices – demand will decrease
· Student housing – demand will decrease
· Elderly housing – confidence needs to return and demand may decrease
· Health related – research, hospitals etc. – are the elevators and rooms door large enough for wheel in beds, BOH is enough for social distancing, are the conversions temporary or permanent?