Smart Buyers Find Bargains In 'Special Situation' Deals

Smart Buyers Find Bargains in 'Special Situation' Deals

by Jeff Wilder

Reprinted from Advanstar's Hotel & Motel Management Magazine

Our office is a magnet for hotel owners who want to buy or sell. Naturally, our brokerage staff is on the lookout for profitable businesses that are equitably priced so we can successfully market them to the hotel purchaser.As you can imagine, most owners have little incentive to sell profitable businesses at a fair price. Therefore, few deals are bought "on the numbers," though the emphasis today is certainly on the hard-earnings potential of an asset.Often, brokers must search for value in "special situations." Looking at such deals usually requires overlooking current earnings that are either dismal or nonexistent.

Uncovering Potential

Sometimes, however, a sow's ear can be turned into a silk purse. Our job is to see that potential, show it to a purchaser and provide the rationale for the acquisition. Since few investors are willing to put cash into illiquid real estate at an 8 percent or 10 percent yield, we must show them that value can be created in reasonably short order to make the acquisition worth doing. Here's a special-situation example that is fairly common today. A friend of mine structured a tax syndication several years ago and bought a modern, 200-unit hotel near a major airport in the East. After investing more than $1 million in improvements, he had a property with only $3 million in indebtedness. Unfortunately, the modernization took longer than expected, he incurred greater f&b losses than anticipated and marketing efforts were behind schedule.Though the hotel's earnings are now improving, the balance sheet still shows excessive short-term obligations to accounts payable, taxes and so forth. His first-mortgage lender and limited partners are unwilling to advance fresh cash to clear these obligations.

Financial Woes

Those of us who run lodging properties know that once you begin accruing extraordinary accounts-payables, it is very difficult - if not impossible - to get current. You always are paying old bills, have difficulty getting credit, and spend time with bill collectors instead of going on sales calls.My friend is caught in this trap. Financial pressure on the business creates personal anxiety and unhappiness. He understands the inn's potential and gives it a probable value of more that $5 million with a $3 million debt. Yet the pressure of $500,000 in unpaid liabilities likely will force him to throw in the towel and sell the hotel. He'll probably sell it for about $4 million, clear up the $500,000 in back payables and return $500,000 in equity to his limited partners. By doing so, he'll be forced to leave $1 million in intrinsic equity on the table for the buyer. The hotel buyer will have to look past the poor profits for 1986 and 1987, understand the reasons, see the potential and snap up the acquisition. As most buyers don't want to hear stories, few will delve into the "whys" of poor performance. They'll automatically look at recent profit-and-loss statements and make an offer based on those results. But they probably won't invest the necessary time to analyze the hotel's true potential.

Smart Buyers Will Profit

The buyer who does invest time to analyze value and understand the seller's position, then contracts to purchase, will be making a $1 million profit by acquiring a $5 million value for only $4 million. I believe there are numerous situations like this one in today's marketplace. While most investors are looking at historical earnings and discounting potential as a "maybe," the truly conservative purchaser is probing for value. He's coming up with winners at bargain prices by applying some intellectual curiosity in his acquisition program.