Buying a hotel is a prolonged, multi-step process. Among the many steps of a hotel acquisition process are identifying an asset, getting to the owner, and arranging financing. Once you settle on a hotel, it’s important to submit a competitive Letter of Intent (LOI) that will be attractive to the Seller and provide you with the time and necessary protections to get the deal done. Among the items you should negotiate are:
- Binding or not
- Purchase price
- Due diligence period
- Security deposit
- Conditions to closing
- Closing cost allocation
- Contract execution
- LOI response timeframe
Binding or Not
One of the first items to specify is if the LOI is binding or not, i.e., is this a specific offer or is this expressing an interest to generate a conversation? While this is investor specific, some Sellers will not consider non-binding LOIs because they may perceive that the Buyer may not be confident. However, some Sellers will entertain non-binding LOIs to determine if there may be an opportunity to engage in a transaction they may not have initially considered.
Requesting exclusivity from the Seller throughout the negotiating process can also be an indicator that the Buyer is serious about the offer. This can promote good faith negotiations between both parties because the Seller is no longer entertaining other offers.
There are many ways to arrive at a purchase price and this is of course the most important part of the transaction. If you have been negotiating a price ahead of time, nothing will kill a deal like changing the agreed to price when the LOI is submitted. If the price was not negotiated ahead of time, pricing guidance can be helpful to present a credible offer that will not be immediately dismissed by the Seller.
Due Diligence Period
The length of time you have to close the transaction can be dependent on several factors including lender requirements – assuming you already have financing lined up – or unique needs of your capital partners among other things. A 30-day or 60-day due diligence (DD) period is common but so is the option to extend the DD period. Buyers tend to want longer DD periods to provide as much of an opportunity to get all arrangements lined up whereas Sellers tend to want shorter DD periods so they have certainty that the transaction will close.
The amount of the security deposit is one aspect of the negotiation. At a minimum the security deposit is typically $100,000 but can sometimes also be a very low percentage of the purchase price, below 1%. It is also important to determine at what point the security deposit goes hard, i.e., it becomes the property of the Seller even if the transaction doesn’t close. Sellers will want the money to go hard as soon as possible whereas the Buyer will want to push out the date at which the deposit goes hard.
Conditions to Closing
Every deal is unique so there could be any number of conditions to closing a deal. Standard terms include the ability of the Seller to deliver the property free and clear and the ability of the Buyer to satisfactorily review all of the items required during DD. For example, does the deal require that the Buyer assume the Seller’s loan? Is the Seller providing separate financing to get the deal closed? Make sure that any of the unique aspects of the deal are written on the LOI.
Closing Cost Allocation
Be sure to specify whether the Buyer or Seller is paying specific costs throughout closing. Among these costs are the cost of a title search, recording documents, and escrow fees. Who is responsible for expenses, utilities, and real estate taxes among other items? Will these expenses be pro-rated? Are the parties responsible for their own attorney fees? If there is a broker as part of the transaction, who is responsible for paying the broker’s fee? It’s important to provide as much clarity as possible for all parties.
If the Seller accepts the LOI, it’s important to determine who will draw up the contract, also known as a Purchase and Sale Agreement (PSA). The Buyer may want to have its counsel draw up the contract whereas the Seller may have a contract that is more amenable to its needs. Either way, be sure to specify who is responsible for generating the PSA. And don’t forget to have the LOI specify the maximum number of days between the date of LOI execution and the date when the PSA must be presented to the other party. This shows good faith and helps to move the process along. Negotiating specifics of the PSA is a topic for another post!
LOI Response Timeframe
The last critical item to mention is that there should be a timeframe by which the LOI needs to be executed by the Seller. An open-ended LOI serves no one’s best interest; it’s better to know whether a deal will be executed or not so all parties can determine if they can move forward or move onto other opportunities. Generally, 5 business days is a reasonable timeframe but there may be factors necessitating a shorter or longer timeframe.
This is not necessarily a comprehensive list, but it includes some of the most important parts of an LOI. Remember that an LOI is only one part of the process as the PSA will ultimately be the legal document to cover the transaction. But the LOI serves as the guiding document to get the process between Buyer and Seller off to a good start. And throughout the process, be sure to work with your counsel so you are keeping yourself and your partners in legal compliance.
At the end of the day there are a ton of moving parts when handling a hotel transaction. Submitting a strong and professional LOI can set up a strong relationship between the Buyer and Seller that will make the ability to strike a deal that much more likely.