Extend and pretend will hit the brick wall
 
Extend and pretend will hit the brick wall
14 JUNE 2011 6:35 AM

The extend-and-pretend function for hotels will be disabled this year by the Gatekeepers of Hotel Loan Health (franchisors Marriott, Hilton, Starwood, IHG, et al.). What can lenders do?

Hotel defaults are different animals than other real-estate products. Soon this will become painfully apparent. How? The Extend and Pretend function for hotels will be disabled this year by the Gatekeepers of Hotel Loan Health (franchisors Marriott, Hilton, Starwood, IHG et al.). Lenders and servicers can kick the can—a process that has been good so far for preserving asset value—all they want, but they don’t control a major component of hotel value: the franchise. What’s a deflagged Marriott worth? Less than half. Caveat Lendor.

Franchisors’ patience, like carpet on hotel floors, has worn thin from years of neglect. The hospitality business is recovering rapidly, so they are declaring an end to the truce and are putting owners on notice that PIPs (required Product Improvement Plans ) MUST be adhered to. If not, the flag goes away. Terminal cancer for a hotel’s value.

Here’s what will happen: Joe Ego purchased a branded hotel in his hometown in 2007 for US$60 million and borrowed US$50 million. Now the hotel is worth US$40 million (sorry folks). Extend and Pretend has worked because the borrower and the lender have a common interest—they need time for value to recover. So far so good. But the critical third party, the Franchisor, has a conflicting interest. It has customers who are loyal because of the consistent quality of their hotels, i.e. a brand, and the brand’s competitors are remodeling and updating. To keep its customer base loyal, the Franchisor must demand that its hotels are remodeled also. So the Franchisor notices Joe that a US$5-million PIP is due. Joe has no dough, or if he does, he will not contribute it to a hotel in which he currently has no economic value. So although the loan was extended two years with a token pay down, the asset value on which the loan is based will fall below the loan amount as soon as the property is deflagged.

What can lenders do? First of all, make absolutely sure the notice requirements the Franchisor agreed to in the loan documents are current and valid. Alert Master Servicers to your need for this information. Do whatever you can to preserve the flag. First tack is to work with the Borrower. If that fails, the next step depends on the loan—balance sheet lenders can foreclose and either sell, JV or do the PIP themselves (with professional assistance). Special Servicers are limited by REMIC rules and the Pooling and Servicing Agreement’s limitations on advancing and may find it difficult to do the PIP within the Trust so foreclosing or finding a new capital source to team up the Borrower may be the only alternatives.

If you would like to learn more, we are planning a seminar on PIP Costing, Negotiation and Implementation so send me an email and I will get an invite out.

Steve Van has 33 years of hospitality experience. He is President and CEO of Prism Hotels and Resorts which he founded in 1983. Prism manages all major brands including Marriott, Hilton, Doubletree, Westin, Crowne Plaza, Holiday Inn, Radisson and Preferred Hotels and Resorts. Mr. Van was Hilton Doubletree Developer of the Year and serves on the Doubletree Owner’s Advisory Council.

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  • nagiblakhani June 14, 2011 5:08 AM

    An excellent article - a problem that is now beginning to surface and may well be the next major heartache for the industry: with limited/no access to additional capital other than, maybe, leasing for some FF&E, and lenders feeling more confident of securing a quick sale, the pressure is going to be high on owners.

  • Baddniss June 14, 2011 5:33 AM

    An excellent article (in theory)...but what is predicted here simply wont happen IN REAL LIFE. The flags are under such intense pressure to grow their mgmt fee income that they simply wont walk away from major hotel projects over PIP issues any more. They will THREATEN to do it, but they wont pull the trigger on large deals. This wont happen because they know 3 of their competitors will jump on this mgmt contract within 24 hours. Welcome to the REAL world...

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