How Does Due Diligence Work?

2 min read

Due Diligence Hotel Investments

2 Variables: (length of time & amount) Two important variables in a purchase and sales agreement include the amount of time that is being requested in the due diligence period and the amount of the due diligence deposit funds. While these are two major variables, there are several other variables worth considering. Developers should always consult and discuss other variables with a local attorney when negotiating purchase, sale, or due diligence instruments.

Due diligence time is a very critical time for a potential buyer or investor.  This is the period of time in which a buyer or investor is going to find out whether their plan is feasible and worth moving forward. The questions you need to ask and tasks that must be completed during this review process can include:

  • Whether your development is financially feasible: How much will your development cost?
  • What interest rate will you borrow money at?
  • What is the predicted return on your equity investment?
  • It’s also a time that you’ll want to inspect the land and the structural integrity of it. Various engineers will conduct soil borings and lab studies to determine geotechnical and site plan data and how that may affect or bring about hidden construction costs.
  • Will the city or local municipality allow it? Often times, developments can be restricted by regulations of the city or local municipality. It could be the case that only specific types of developments such as office space or hotel constructions can be built in a given area which must follow specific zoning rules. This is also known as entitlement process.

Due Diligence Time Period

Depending on the amount of time you need to complete all of these tasks, it can affect your deal. Shorter due-diligence periods are more attractive to sellers, therefore it is more likely to demand and receive a price reduction if your proposed due-diligence period is relatively short. The same goes the other way. If the amount of time being requested in the due-diligence period is long, it will probably require a higher purchase price to induce the seller to agree.

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Due Diligence Dollar Amount

The second variable in a due diligence deposit is the size, or the dollar amount, of the actual deposit itself. This variable allows the investor to do a variety of things. Sometimes you can propose to modify the terms and amount of your deposit. You can make the deposit refundable or non-refundable, essentially changing the amount of risk you are willing to take. Oftentimes, the risk you take with your due diligence deposit can have an impact on the amount and terms of the actual purchase price in the contract.

A quick example might help clarify how this works:
Imagine there is a piece of land that I would like to buy for $1.2m, but the land is listed for sale at $1.3 million. To induce a seller of real estate to sell the land to me at the lower $1.2 million price, I may offer a $100,000 non-refundable due diligence deposit to the seller. Many times, that seller will be induced by the chances that I don’t close on the deal and the potential of earning easy $100k. You can customize these terms, allowing your money to go non-refundable after a specific amount of time in the total due-diligence period, or right away. Again, some of this depends on the risk you are willing to take. Sometimes, offering a non-refundable deposit is a way to stick out among other buyers. If you are competing against a diverse group of buyers, offering a non-refundable deposit is a sure way to get the seller’s’ attention. Sometimes the land appears to be very risky and seems like there might be topographic or geotechnical issues with the land, and you may want to specify that your due-diligence deposit will remain fully refundable until you have had time to research potential problems with your civil engineer.

Where does your due-diligence deposit stay? It should technically be deposited into escrow with a mutual joint order escrow agreement. This ensure that your money is in safe/neutral hands and can not be accepted or deposited without a joint order from all parties. But this can also be customized. If you intend to offer a non-refundable deposit, the deposit can sometimes be sent directly to the seller or seller’s attorney. As always, make sure to hire a local attorney to advise you through any transaction.

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4 Great Benefits of Hotel Crowdfunding

4 min read

4 Great Benefits of Hotel Crowdfunding

EquityRoots.com uses crowdfunding as a finance tool to raise capital for premium branded franchised hotels. We harness the buying power of the crowd to create investment opportunities in institutional grade assets that were once only available to REITs, insurance companies, and established players in the hospitality industry. Our crowdfunding technology allows even the smallest of investors to invest alongside professional real estate developers, hotel owners, and other like-minded investors. It’s a system in which everyday folks can tap into serious sources of capital for investment purposes. This capital can be structured as equity, debt, mezzanine debt, and sometimes even convertible debt – security instruments that are designed to yield a return for investing. There are plenty of advantages in crowdfunding investments. Here are just a few!

1. Diversifying Risk.

Hotel investors can diversify risk by investing in fractional interests in different hotels across the country. Hotel investors can select hotels under different brands in various states. Our EquityRoots platform allows investors to select multiple assets, and buy shares or investment units in different projects and properties, diversifying your investment risk by brand, by the market, by different geographic regions, or simply by the different types of hotels, whether it is an extended stay, limited service or full-service hotel.

2. Owning Pieces of Institutional Grade, High-Quality Developments.

Typical hoteliers and hospitality groups commonly pursue 80-120 room properties in secondary or tertiary markets. This is where barriers to entry are often less and construction costs are generally lower. However, in higher density urban markets such as Chicago and New York, hoteliers face much higher barriers to entry and construction costs are significantly higher. Consequently, many hospitality groups aren’t able to penetrate into those markets. Primary urban markets have institutional grade assets that typically cost $20-50 million and although they can take many years to develop, it’s worth the hassle. Institutional grade assets tend to have the highest average daily rates, highest occupancies, and strongest profit opportunities for their owners and investors. But because of their size and other barriers to entry, these deals sometimes become out-of-reach not just for everyday people, but also for proven hoteliers. This is where crowdfunding kicks in to provide leverage and opportunity that hotel investors otherwise would not have access to. By pooling capital from crowd, EquityRoots’ crowdfunding platform allows everyday folks to compete for higher-grade, higher-quality deals. Crowdfunding is now gaining access to deal flow usually reserved for institutional players like REITs and insurance companies, giving even new hotel investors a chance to enjoy the ownership of some of the most profitable opportunities.

 

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3. No Middlemen and No Commissions.

The crowdfunding process is very simple and efficient. Under specific exceptions to the securities registration requirements, broker’s fees or commission fees for buying and selling the investment are not permissible. Crowdfunding aims to make every penny of your dollar count in the investment, instead of letting middlemen walk away with your money.

4. Local-Concrete Investments You Can See.

Investing in property and buildings that you can see and visit is yet another advantage. Hotel investments are different than paper stocks and bonds; paper certificates that we can never see and often trade on speculation. Real estate is an investment that you’ll always be able to see. It has real property interest and physical improvements on the land. A family can walk into a hotel, point to it, and feel a sense of ownership. It’s a more rewarding investment experience than collecting paper certificates in a file cabinet.

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Should I Invest in a New Hotel or an Existing Hotel?

5 min read

Should I Invest in a New Hotel or an Existing Hotel?

Do I invest in a brand new hotel, or in an existing hotel? Real estate investors often find this decision difficult when first expanding their investment portfolio to include hotel assets. When deciding between hotel investment opportunities, knowing the distinctions between new and old hotel assets can serve you well. Combine that knowledge with information about the cost basis, time, quality, and potential disposition value of each deal, and you have the foundational tools you need to make smart investment decisions.

For starters – there are two types of investments available for hotel investors. Hotel investors can choose to invest in a new construction project. This is where a hotel developer takes the time to design and build a brand new hotel. On the flip side, hotel investors can choose to invest in an existing hotel, usually in the form of a renovation project. Renovations could include structural upgrades to a building, but may also involve a change of a hotel’s brand name. For example, a developer might want to take a pre-existing Country Inn & Suites and convert it to a Staybridge Suites.

The benefits of new construction hotels might seem apparent to many first time investors. After all, the hotel asset that you invest in will be brand new, often coming with the newest amenities. However, existing hotel renovation projects also have their fair share of benefits.


New Construction Hotel Investments

New Construction Hotel Investments

Investing in a new development project can be a risky but rewarding investment. It is truly a unique experience, being able to invest in a project that you can see from its designing stages, to the groundbreaking, and to the final construction phases.

Advantages to New Construction Investments

New construction developments have numerous benefits, including:

  1. Modern Design: Everything is new! The guest experience and floorplans of today’s hotel prototypes are more efficient and modern than older hotels. Guests are satisfied and leave great travel reviews, encouraging additional business.
  2. Market Leaders: New construction hotels typically beat out the older competition in the area. These new assets often become market leaders in rate and occupancy in large part because business travelers don’t mind spending more money to stay in newer hotels.
  3. Lean Operating Margins: Operating margins in new hotels tend to be leaner than their older counterparts because the newer hotel is less susceptible to extensive maintenance and repairs.
  4. Higher Disposition: When selling a newer hotel after owning it for a few years, it is common to see offers that are higher than those that would be made for old hotels. REITS and institutional buyers demand the best performing assets and often pay the highest value to new or newer hotels.

Disadvantages to New Construction Investments

However, savvy real estate investors know that depending on the individual deal, new does not always mean better. New construction hotels have their own share of risks:

  1. Longer Process: The development process often takes 6-18 months of hard work with engineers, attorneys, and architects. Only after the development undergoes several rounds of approval does the project move forward to construction, which often takes another 16-24 months of time.
  2. Income Delay: New hotel assets are not taking in any income during that development and construction process.
  3. Building Codes & Zoning Laws: Government review can have a huge hand in restricting the hotel design. Different local governments vary greatly in what is allowed or not allowed in construction. With a brand new hotel, it can add on additional work and approval rounds with city officials, all which can lengthen the amount of time until opening day for that hotel.
  4. Difficult Construction Financing: Construction financing is generally more scarce expensive than existing hotel acquisition loans. There are plenty of lenders for existing hotels, but not as many for new-construction loans.

Existing Hotel Investments

Existing Hotel Investments

When real estate investors decide to invest in the renovation of an existing hotel, they must compare the cost basis of acquiring the hotel to the cost benefit of changing flags or renovating the property into a different brand. In other words, how does the price of investing in the hotel compare with the potential return of the renovated property? This comparison is especially important if the existing hotel is located in an extremely busy market, center-city location, or in a market where vacant land is scarce.

Advantages to Existing Investments

Existing hotel investments offer many benefits that are distinct from new hotel assets, including:

  1. Clear Performance History: Investing in or purchasing an existing hotel with an operating history provides an accurate look at how the hotel is performing right now. This can give you a clear picture of what the return on your investment currently looks like before renovation.
  2. Reduced Development Costs: Due to rising costs of construction and scarcity of land in strong markets, the building a new hotel is easier said than done. With an existing hotel asset, you do not have to shell out for materials to build an entirely new building.
  3. Faster Income: Assuming that the hotel asset is cash flow positive, investors can recognize income 12-24 months sooner compared to new construction hotel investments. Again, hotel investors benefit from a shorter waiting period before the hotel operates.
  4. Shorter Development Period: Pre-existing hotel assets have already undergone the entitlement, design, and development process from its initial construction, so developers and investors can save valuable time.
  5. Assuming Financing: The acquisition cost for an existing hotel can be significantly below new construction replacement cost. Additionally, existing hotels often have financing that you can assume from the previous owner. It’s convenient not having to go searching or negotiating for a loan when you can readily assume a quality loan.

Disadvantages to Existing Investments

With older hotel buildings (and for real estate assets in general), maintenance and other disadvantages can lower the value of your investment. Investors must be careful to make sure that the price of acquiring a pre-existing hotel does not outweigh the cost of simply constructing a new hotel. Other downsides to existing hotel assets include:

  1. Outdated Infrastructure: Many older hotel buildings lack adequate electrical, plumbing, or mechanical systems to keep up with the demand of today’s travelers. Investors can often spend just as much money replacing these systems as they would installing brand new ones.
  2. Limited Branding Options: Older hotels may be limited on branding options, as some brands (particularly high performing ones) may have additional restrictions on which buildings they are willing to allow their branding on.
  3. Lower Disposition Value: Renovated or repositioned hotels will most likely sell for a substantially lower premium than newly constructed assets.
  4. Higher Maintenance Costs: Older, existing hotel assets will cost more to maintain than new construction hotels.

 

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Conclusion

Both new and existing hotel assets come with their own set of pros and cons, and investors should take into account their financial goals when considering investment decisions. If investors seek to supplement their short-term cash flow, then the types of investments that work best for them will be different than if those investors were seeking to maximize their long-term gain. Beyond looking at the type of hotel investment, looking at other variables including “equity multiples” can provide valuable information.

Equityroots recently found value in partnering with Intercontinental Hotel Group (IHG), licensing two of their most iconic brands, Holiday Inn and Holiday Inn Express in a dynamic dual-brand design. The development was able to identify Class-A vacant site in a market with barriers to entry, it was an easy decision to pursue new development given the circumstances.  New development projects and investments often require a higher degree of patience compared to existing hotel acquisitions, but the added layer of patience is often rewarded during the exit strategy.

Equityroots.com is website owned and operated by Equityroots, Inc., a Delaware Corporation and real-estate developer specializing in select service and full service hotel development.  For more information on hotel investments, visit us at www.equityroots.com or sign up for our monthly newsletter at the bottom of our homepage.

Sources

“Hotel Investment: How to Finance the New Supply.” Hotel Online. Apr 11, 2014.

Jones, Michael. “What Does it Take to Start a Hotel?”  Forbes. Feb 23, 2013.

LaSalle, Jones. “5 Forces Driving Hotel Investment.” Building Design and Construction. Feb 5, 2013.

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