Purchasing a Hotel with a Group of Investors?

This article, originally published in Western Hotelier Magazine, discusses a few of the considerations one may consider when investing in a hotel alongside a group of investors.

Contact our hotel appraiser if you have questions specific to your hotel investment.

Do the Benefits Outweigh the Risks?

It’s becoming common for groups of investors to pool resources (i.e., cash, borrowing capacity, time and experience, relationships and contacts, etc.) to acquire commercial real estate assets, particularly hotels. This article outlines some of the benefits and risks associated with the acquisition of a hotel as a group, including an overview of key questions investors should ask before they partake in this type of investment.

Why Invest as a Group?

Hotels as an asset class generally deliver superior returns relative to traditional commercial real estate asset classes such as multi-family, office, retail, and industrial. These higher returns, however, reflect the incremental risks attached to owning and operating a hotel as a going-concern. Investors lacking specialized knowledge and experience in the lodging industry may be able to capitalize on the expertise of like-minded investors. Benefits of investing as a group include, but are not limited to:

Acquiring a property that you as an individual may not have the financial or operational capacity to acquire on your own;
Leveraging the relationships, education, and experience of other investors who may have expertise in construction, hotel management, real estate, finance, accounting, law, etc.; and
Executing an investment strategy geared towards maximizing levered equity returns on a risk-adjusted, after-tax basis.

What are the risks?

When you invest with a group there are multiple stakeholders with ‘skin in the game’, creating an opportunity to realize synergies and reduce risk. However, some investors may view losing the ability to unilaterally dictate key investment decisions as a risk that outweighs any potential synergies. Additional risks of investing with a group (as opposed to investing on your own) can include the following:

The inability to sell your ownership interest at a time of your choosing, including the potential ‘minority discount’ that may apply to your ownership interest should you choose to sell your interest in isolation as opposed to waiting for the group to exit the investment;
Irreconcilable differences of opinion with respect to strategic decisions such as the timing and scope of capital improvements, rebranding, etc.;
Unexpected capital obligations due to other investors within the group failing to fund their proportionate share of operating and/or capital contributions; and
Misalignment of interest(s) amongst investors, particularly active investors (those involved in hotel and/or asset management functions) and passive investors (those who only contribute capital).

What Questions Should I Ask?

When investing in a hotel, on your own or with a group, there are obvious questions pertaining to its current, and potential, market value. Retaining professional assistance in this regard is highly recommended as appraisers, brokers, lenders, etc. can provide valuation information throughout the process. Notwithstanding, there are several questions an investor may want to ask specifically when investing with a group, such as:

What are the legal and income tax implications associated with the structure of the investment? (i.e., incorporation, partnership, joint venture);
Who are you investing alongside and how much control do you have over key investment decisions?
Does the investment strategy (i.e., length of the investment horizon, strategic capital expenditures, etc.) of the group align with your personal strategy?
What financial controls and governance practices will be put in place to ensure transparency and accountability?
Are hotel management and asset management responsibilities clearly defined, who is responsible for completing these tasks, and what/how will remuneration for these individuals/groups be established?
Will you be personally liable for all debts and obligations of the investment group or will your risk be limited to your capital contribution?
Will profits be shared proportionately amongst investors, and if not, are performance/incentive fees considered equitable based on the roles and responsibilities of the parties?

Conclusion

The risk/reward relationship of investing in a hotel on your own can be materially different as compared to investing in a hotel with a group. Understanding the nuances of investing with a group can go a long way in enhancing your investment returns while also reducing the risk of unintended, timely, and costly legal disputes that may arise due to inadequate planning and foresight.

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