Before You Buy Distressed Hotel Properties

Since the COVID-19 outbreak, demand for hotel rooms remains low, and the resulting loss of revenue is leading to foreclosures. According to a May 2020 report by Trepp, LLC, over 500 hotels are currently in foreclosure. While these assets may appear attractive to opportunistic investors, the extraordinary circumstances of the coronavirus pandemic demand extraordinary due diligence. Buyers wishing to capitalize on discounted hotel properties should employ the due diligence assessments recommended for all property acquisitions, plus additional assessments to address risks associated with COVID-19.

Standard Due Diligence for Hotel Acquisitions

Property Condition Assessment (PCA): a PCA will give you an accurate picture of the condition of the building and its systems, including deficiencies that require immediate repair and projected expenses over the term of the report. If your acquisition involves change of brands and/or a Property Improvement Plan (PIP), the PCA may allow you to save some money by coordinating necessary repairs and maintenance with the implementation of any remodeling or redevelopment required by the PIP.

Environmental Site Assessment (ESA): ESAs should be standard practice for any commercial real estate transaction. The level of ESA you choose depends on your financing and your risk tolerance. In some circumstances, a desktop environmental report may suffice, but only a Phase I ESA will protect you from environmental liability under CERCLA provisions. Your due diligence consultant can help advise you as to the appropriate level of environmental screening for your transaction.

ALTA Survey: A combination of boundary survey, title survey, and location survey, the ALTA survey is usually required by lenders for all CRE transactions. It can also protect you from future liability in the form of boundary line disputes, encroachments, or easement claims.

Zoning Compliance Report: The zoning compliance report will tell you whether your property conforms to local zoning codes. Beyond property use, zoning codes often address setback requirements, height limits, and other property characteristics. Note that a standard zoning compliance report does not determine the feasibility of a proposed change of use—it only determines the compliance of the current conditions at the site.

Unique Considerations for Hotel Acquisitions During COVID-19

Hotels Under Construction: If you are purchasing a hotel that is under construction, whether renovation or new construction, carefully assess the status of the project. Impacts on construction due to COVID include work stoppages, work that is placed in stand-still mode, impacts on labor – both prior, current, and near term—and material supply concerns. As a purchaser, you will want to confirm that the contractor and project is on schedule and on budget. A Construction Status Report will give you a clear image of the current situation.

Dormant or Vacant Hotels: While your PCA will address many of the conditions resulting from a prolonged period of dormancy, you may wish to engage a Certified Industrial Hygienist (CIH) to inspect your asset for a variety of underlying issues, such as indoor air quality, mold, or legionella. These become more serious concerns the longer a building remains unoccupied.

Cleanliness/Safety: Particularly in hotels adapted during the pandemic for non-traditional uses—such as quarantine centers, homeless shelters, or temporary medical facilities—buyers will want to ensure the cleanliness and safety of their property. There is still no validated, commercially available surface test for COVID-19, but proxy testing can be used to evaluate cleaning effectiveness. ATP (Adenosine Triphosphate) surface testing can provide real-time confirmation of whether a space meets established cleaning criteria. In the event the ATP testing results do not meet established criteria, a Certified Industrial Hygienist (CIH), Certified Safety Professional (CSP) and/or a trained industrial hygiene team member can provide guidance to develop appropriate cleaning protocols, as well as assist in the contractor selection for future cleaning.

While predictions vary on when the hotel market will recover, the high demand for distressed properties is a good sign that the market may bounce back relatively quickly. Whatever your hold period or exit strategy, thorough acquisition due diligence will give you solid footing to achieve your investment objectives.