How Hotel Sale Leasebacks Work
Hotel investments that are a win-win for both the investor and hotel owner.
How can you sell your hotel but keep your hotel?
There is a way: Under a sale-leaseback agreement, popular in Europe’s hospitality scene, the seller of a hotel becomes a lessee to a new owner, maintaining a brand flag and management agreement but avoiding certain economic risks and alleviating concerns over potential oversupply in top markets.
It’s a Win-Win
Sale-leasebacks are a good strategy for certain hotel developers who want to cash out early: They get no recourse under the lease, and the buyout is at a fairly high level (between 90-100 percent) of the fair market value of the hotel. These deals also provide an opportunity for a buyer looking to keep a hotel’s managers in place, and to also get a return on the leasehold.
The deal, from a real estate standpoint, is relatively straightforward. The sale includes a transfer of title and then a leaseback to the existing seller as a tenant under a master lease. For the Hyatt deal, a tax credit structure required a master sublease to the entity, although this is not necessary for every sale-leaseback. That gets collapsed after the tax credit period burns off and that master sublease gets terminated.
The leaseback, then, is for the term of a management agreement, and if the management agreement is extended, the term of lease can also be extended. It’s basically a nonrecourse lease. There’s a security deposit in the form of cash and a letter of credit in these deals, depending on the stabilized [Net Operating Income], depending on the operating history and depending on the level of risk the seller wants to undertake. These security deposits help guarantee against failure to make payments under the lease if the NOI is not sufficient.
Sale-leaseback deals usually have third-party management agreements under franchise flags. All of those features remain in place in a sale-leaseback transaction, If you have a typical sale, those would sometimes get terminated. Under a franchise agreement, there’d be a termination payment. Sometimes the buyer would want to keep franchise in place. Under the management agreement, if it was a third-party sale, typically, the buyer would want his own management company or another third-party management company.
In this structure, the structure stays basically the same with the management company agreement and the franchise agreement staying in place. They aren’t affected by the sale, and the seller becomes a lessee under the long-term leaseback…At the end of the deal, if you look at the real estate, the operation looks almost exactly the same as before the sale.
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Are There Any Disadvantages?
There are no real disadvantages. A sale-leaseback deal lets a developer cash out and get a sale earlier than they might otherwise. But there are other benefits to all of the parties. You get a hotel investor who’s got an experienced operator/franchisor/management company to operate an asset and gain a return on investment. It’s usually an investor who is not in the business of operating assets like this. They’re buying a management team to operate an asset—if they’re satisfied with the quality and qualifications and the capability of the team they’re buying the asset from.
Better yet, there are no real disadvantages for a hotel investor in a sale-leaseback deal. Other than the rent stream or the security deposit (if there is one), the lessee/seller has no financial risk, but there’s a return paid on both sides.
The only risk in this kind of deal is if hotel doesn’t do as well after sale as it might have done before the sale and the seller/lessee decides to terminate the lease and walk away from the deal. It’s an economic risk they take knowing the management company is there for the long term, the franchisor is there for long term, and they get a good owner-operator.
The sale-leaseback model is more typical in Europe than in the U.S. but now It’s coming here because investors overseas are looking for assets in the U.S., and they’re using a structure they’re comfortable with. This seems to appeal to certain types of developers who want to cash out. It keeps the developer in place and it makes the investor comfortable. They’re buying an operation. They don’t have to reinvent the wheel and they’re comfortable with the structure.