Operating performance from hotels has generally decreased substantially from the peak in 2007 as a result of the economy.  Additionally, property values have decreased further with the cap rate decompression that resulted from the capital markets issues.  In many cases, this created untenable situations for otherwise credible and capable hotel owner/operators.  Many a lender has found itself in the untenable position of being upside down in a hotel loan and needing to move the loan/property out of its portfolio in a very difficult market.  Although the current borrower may be the best alternative for maintaining or turning around the asset, they are in no financial position to buy back their loan.
Here is where the sale leaseback fits in.  An investor acquires the property from the bank and leases it back to the current owner.  Unlike a more traditional sale-leaseback, this is a distressed situation.  Therefore, the risk adjusted returns for these investors may be substantially higher than traditional debt costs.  However, the heavy discounting in pricing that may occur in acquiring the property from the bank may more than offset the higher costs in the eyes of the troubled borrower.  To illustrate how this might work, the following is based on a recent negotiation:
  • A limited service hotel was acquired in 2007 for $2.3M
  • The owners place a $1,750,000 mortgage on the property
  • The borrower defaulted and the property ended up in special servicing;
  •  The borrower is still operating the property
  •  The current property appraisal is $1.1M
  •  The Lender has indicated that it will sell the property for $750k all cash.

 An investor has proposed to acquire the property from the bank as proposed and cover transaction costs plus limited cap ex funds; in total investing $800k.  In turn, they propose to lease the property back to the former owner for a term of five years at a rental rate that provides an absolute net 10% return to the investor.  Additionally, the tenant will have the right (and does have the intent) to buy the property back from the investor at a price that yields the investor an unleveraged 15% IRR.
From the Lender’s standpoint, they sell the asset all cash and exit the deal.  From the investor’s perspective, they are acquiring desirable real estate at below replacement cost on a passive basis.  The lease provides for certain covenants to protect and preserve the asset.  If there is a default, the eviction process is deemed desirable by this investor to a foreclosure process.  The yield is attractive to the investor.  Further, they intend to place 50% leverage on the property post acquisition to substantially increase their yield and are covering their acquisition costs in the transaction.  I should point out that part of the underwriting included an assessment of the risks of becoming the operator should the tenant default.  A careful review of the operator and certain limited guarantees accompanied the proposed lease.
Finally, from the current owner’s perspective, they resolve their distressed debt situation.  They maintain operation control of the property with the potential to benefit from upside in net cash flow in excess of the lease payments. Additionally, they maintain their management fee income.  Their buy-back provision enables them to get back into the property at a substantially lower basis than their original investment.  Lastly, little to no underwriting is involved as they know the property and are perhaps in the best position to assess the risks.
NAI Hospitality is finding the sale leaseback to be of significant interest to our investor clients and a creative and credible solution for our owners/operators.

About the author

Scope of Service Experience Paul's real estate expertise includes brokerage, equity & debt financing, development, and investment of office, industrial, retail and hospitality properties. He has serviced his client's real estate needs throughout the United States, Canada, Latin America and the Caribbean. He has been featured speaker & panelist at major real estate conferences including The Global Property Forum- Toronto Canada 2007 & 2008 ; Eiendomsdagene -Kvitfjell, Norway 2009; Queen's University Executive Seminar on Corporate & Investment Real Estate, Toronto, Canada 2009 and The Nordic Business Arena-Stockholm, Sweden 2009. Education BS & MS degrees The Pennsylvania State University Background & Experience Paul has been in the commercial real estate business for 26 years. His transaction volume includes over $1 Billion of leasing, sales, development, financing & investment of commercial real estate. Paul has been a principle in the DFW broker member of New America Network (predecessor to NAI Global), and a founding partner of its first Mexico City broker member in the 1990's. He has been a past Chairman of NAN Investment & Industrial Councils and has served on the network's national advisory board. ... Click here to read more about Mr. Reitz