Demystifying the closure analysis
 
Demystifying the closure analysis
10 APRIL 2020 7:33 AM

Hotel owners need to evaluate many scenarios before making the critical decision to close or stay open.

Hotel owners are currently faced with the daunting decision of whether to keep properties open, suspend operations or close the doors for a period of time during the COVID-19 crisis.

Further compounding this decision are the number of stakeholders involved (lenders, brands, operators, employees, labor unions, etc.), continually evolving local and federal regulations, and the uncertainty of what the recovery trajectory will look like, both from a health and economic standpoint. Still, owners must make a decision that ideally balances short-term cash and related priorities while ensuring the hotel will be well-positioned for successfully ramping back up once demand returns.

As asset managers, witnessing occupancies across our more than 70 hotels throughout the U.S. dropping down to the 5% to 10% range, we are on the front line helping hotel owners evaluate the merits of closing or temporarily “suspending operations” versus attempting to stay open. Owners are asking questions these days such as:

  • “Will the hotel be in a better financial position if it closes?“
  • “What will it cost to re-open?”
  • “What are the risks to staying open vs. closing?”
  • “What is the difference between ‘closing’ and ‘operational suspension?’”
  • “How will closing impact recovery potential?”

Consider many factors when performing closure analyses. First is timing. While nobody can definitively predict what timeframe is most appropriate to consider a temporary closure, based on prevailing guidance, we are working with assumptions ranging from three to six months, depending on asset type and location. Timeframes are highly relevant to the decision-making process and must be revisited often to adjust strategy accordingly, as the situation and impact evolves.

From a financial standpoint, our approach is grounded in a zero-based budget mentality in terms of analyzing costs related to the potential suspension period, as well as the eventual ramp-up period. Expense assumptions are developed in coordination with operators to detail the various fixed costs incurred if the hotel were to temporarily “suspend operations,” including such expenses as:

  • 24-hour security to protect the physical asset;
  • Base-level utilities to maintain properly functioning equipment and building systems and prevent exposure to mold and other risk factors;
  • Sensitivity analyses around ongoing negotiations for deferment of fixed expenses including property taxes, insurance, rent and debt service, among others; and,
  • Re-hiring, training and additional costs related to the hotel’s re-opening.

From there, we focus on the salaries of those staff members essential to retain (often at reduced salaries given the situation) to best position the hotel for success when it reopens. These positions typically include the GM, director of sales, the chief engineer and the director of revenue management, depending on the size and complexity of the operation. In addition to the salaries of the positions retained, the employee benefits (paid time off, medical benefits, payroll taxes) of both the employees retained and those furloughed or temporarily laid off, all affected by federal and state WARN acts (with the most restrictive of the two applying), also need to be considered, as well as union requirements where applicable. Finally, considerations must be given to the eligibility requirements for various government relief packages.

“Stay open” analyses involve evaluating the required incremental daily costs above and beyond the temporary suspended operations scenario (i.e. actually servicing guests), such as front-desk staff, housekeeping and maintenance staff. The stay open decision, which must be closely monitored and re-evaluated constantly, often comes down to whether a hotel has sufficient demand from any source (traditional or new) to cover the hotel’s incremental daily operating costs. The decision to stay open might also be viewed more favorably in instances where it avoids potential lender default or other risk hurdles.

Across our asset management portfolio of approximately 70 hotels, approximately 25% have suspended operations or closed, as of 1 April, with the balance of properties remaining open for business. Some of these closures have been related to local government mandates and others at owners’ discretion. In all cases where the estimated net financial impact is similar under both scenarios, the decision to suspend operations or stay open has come down to more qualitative factors, such as the operator’s bench strength (or lack thereof) in the immediate area in the event the remaining skeletal staff needed to be quarantined due to illness or exposure, owner risk tolerance, employee safety, lender requirements, and the local market’s emergency need for accommodations.

Other critical factors in the closure decision-making and financial mitigation process include:

  • Engaging counsel to advise on agreements: In addition to the temporary suspension agreements with the operator and/or brand, any agreements with the union, retail tenants and large group contracts should also be reviewed by counsel. Engaging in such conversations may necessitate a pre-negotiation agreement to protect owner interests.
  • Communicating with lenders: Early and often is the key here, and under the guidance once again of legal counsel. Be prepared with a comprehensive plan (legal docs, notifications, pre-negotiation agreements, forbearance request with a cash flow forecast demonstrating the need, specific steps that need to be taken by the operator in a temporary suspension, etc.) to present to your lender, and request waivers for any failed covenant tests to avoid being in default prior to entering into any negotiations. Other areas where some brands have provided relief, such as allowing the use of FF&E funds for working capital needs, may also require lender approval.
  • Developing an action plan with the operator: Not just for suspending/closing, but also for re-opening. Use the temporary suspension period to revamp areas of the operation (market positioning, restaurant menu/concepting, service standards, etc.) to come out of the suspension even stronger than the hotel was pre-closure. Consider a regional-focused sales strategy for the near term since people are expected to stay closer to home and remain wary of flying.
  • Revisiting sales strategies: Sales strategies employed today will directly influence a hotel’s ability to recover. Although operations may be reduced or suspended, significant sales activity is still happening. Sales teams are actively fielding requests to re-book cancelled groups, as well as accommodate other segments looking to book for Q4. Taking an optimistic view, there is the possibility of some compression as we come out of this and hotels could benefit from pent-up demand and the pricing and layering of groups in Q4 and Q1 2021 may require new parameters to optimize recovery. Maintaining the right staff and required oversight in this area cannot be overlooked.
  • Reviewing potential for a business interruption claim with the insurance company.
  • Evaluating and pursuing government stimulus programs: These include programs such as the SBA’s recently announced Payroll Protection Program, the deferral of employer-related payroll taxes through the end of 2020.
  • Intense cash management: This includes negotiating modifications surrounding the handling of CapEx reserves with the brand and lender.

As with all aspects of hospitality investment, there are no broad-brushed answers. The criteria (financial or otherwise) and the resulting decision for a hotel to close or remain open will vary by owner and asset. The important thing is for owners to seek out expert guidance and maintain a big-picture strategy to manage through this unprecedented time and, most importantly, take the actions today that will best position their hotels for maximum success tomorrow.

Derek Olsen in an EVP at CHMWarnick. The company asset manages more than 70 hotels comprising approximately 29,000 rooms valued at roughly $15 billion, and currently advises on development projects valued at over $2 billion. CHMWarnick’s hotel owner advisory services include asset management, lender/receivership, hotel planning and development, acquisition due diligence, owner-entity accounting, management/operator selection and negotiation, capital planning and disposition strategy. For more information call 978-522-7000 or visit www.CHMWarnick.com.

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