The Chesapeake Point of View

Due Diligence Uncovers Red Flags, Potential

Due Diligence Uncovers Red Flags, Potential

May 31, 2013

With a record number of hotels going into receivership during the last few years, and a marketplace that’s transitioning from a slow recovery to a potentially more robust period of economic growth, the hotel industry is at an important pivot point.
For owners and operators contemplating the purchase of a hotel or looking to turn around an underutilized or underperforming property, informed decision-making is vitally important. Asking the right questions—and enlisting the help of hotel management and consulting professionals familiar with the property, the market dynamics and the intricacies of acquiring and turning around underperforming properties can provide valuable answers to essential questions. Questions like what to buy, what not to buy and what management strategies will provide the most return on investment.

Opportunity knocks
While industry professionals certainly know this—it is worth repeating: Doing your due diligence before purchasing or investing in a hotel is critically important. Any time owners are looking to make a move, they should do everything they can to make sure that the price tag accurately reflects the value of the asset, and that there are no unexpected maintenance/renovation surprises waiting to shock them. No owner wants to discover after the fact that there are unanticipated (and potentially costly) structural or functionality issues.
Due diligence extends far beyond the physical condition of the asset. Operational and financial details of the property, including what types of contracts the property has signed (and whether or not those contracts will constrain your management decisions in the future), are all highly relevant and should be examined carefully before acquisition.

Asking the right questions
Every owner/operator/developer engages in some kind of due diligence. The reality is that some due diligence is better than others. The value in this process comes not from doing it, but from doing it well; not from asking questions, but asking the right questions. There are hundreds of items on a well-designed due-diligence checklist, and each one of those priorities can lead to countless follow-up questions and additional details. To some degree, this is a social exercise. Talking to the current GM and his or her management team can yield some important insights, highlight red flags and uncover potential opportunities.

Buyer beware
The best and most experienced hotel management professionals understand how to engage in a more critical and potentially more informative due diligence process. They go beyond the checklist to uncover important information that can make (or break) a deal and have a lasting impact on the performance of a newly acquired property. Part of the story that rarely gets mentioned is what happens when due diligence reveals significant problems or concerns. Too many management companies make it a point to not ask the tough questions, simply because they want the management business from the prospective owner. If your management team is uncovering unanticipated problems shortly after acquisition, that’s a warning sign the due diligence process was less than thorough.

The best management professionals will counsel the prospective owner not to buy a flawed property even if doing so means that they will not get a management contract out of it. Sometimes the best deal is the one you did not do and a trusted management company can save you a lot of time, money and headaches by being honest with you about a property.

Opportunity knocks again
Due diligence goes both ways, of course. Skillful review of a troubled hotel can reveal just as many potential positives as hidden negatives. If you do not ask the right questions, however, you might not appreciate how many untapped revenue opportunities exist at the hotel and might not recognize the potential that is right in front of you. If you discover that inefficient, wasteful or counterproductive management practices and pricing strategies are in place, then that may be a sign that the hotel’s earning potential is far higher than the current bottom line indicates. If there are extravagant service extras with a price tag that far outstrips the potential gains in terms of guest experience, that is a place where some modest changes can have a big financial impact.

Turnaround is fair play

The reward for that entire pre-acquisition due diligence comes once the hotel is under new ownership and new management, and you can start to implement much-needed changes. Overcoming a bad reputation is extremely difficult. There is no magic formula, and a reputation— bad or good—is built one customer at a time. Here is where the insights gleaned during the due-diligence process can pay off and where an experienced management team with a history of elevating underperforming hotels can apply their expertise in earnest. Because TripAdvisor and other online social media websites have an important role shaping public perception of hotel properties, it might be a good idea to gauge customer sentiment before you even talk to a management company. If their other hotels are receiving poor reviews, is there any reason to think that your property will be any different?

Experience matters
Before, during and after the acquisition (and possible renovation/rebranding) of any hotel, a trusted hotel management company that can provide guidance and uncover hidden business potential of your proposed asset can be invaluable. Obviously no company or person is infallible but under careful, expert guidance many common missteps can be avoided. Do not discount the transformative impact that sound management can provide for your hotel. This means that enlisting the help of experienced management professionals with a proven track record of success is arguably the single most important piece of due diligence for any prospective owner.