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With today's economic turmoil, it might seem appealing to acquire the loans of hotels you want to own. After all, many lenders are in trouble and looking to unload loans to improve their balance sheets, so the opportunities do exist. Moreover, the pricing can look attractive, as you can usually get a better price buying the loan than you could buying the hotel outright after the lender gets the hotel back. However, "buyer beware," as there are a number of pitfalls in buying hotel loans.
At the outset, you need to know what you are buying. If you are buying a loan, you must ensure the lender selling you the loan has properly perfected its security interests in the hotel and its cash flow. This was a huge problem when buying loans from the Resolution Trust Corp. years ago, as many of the loans it sold had deficiencies, such as a failure to perfect an interest in the hotel's cash flow. Although most of those errors have since been corrected, problems still exist in some loans.
You also need to prove you own what you bought. Thanks to the bad press surrounding mortgage foreclosures, courts are now focused on making creditors prove they own the loans they bought. You must be able to trace all steps in the ownership chain or you may find yourself with no rights against the borrower.
Despite recent changes to the law to make bankruptcy more lender-friendly, most bankruptcy judges remain debtor-oriented and will allow the owner a reasonable period of time to sell his or her hotel or present a plan to restructure its debt. As a result, your loan may end up in a bankruptcy lasting from four to 12 months and maybe longer. During this time, if the hotel is worth less than your debt, you probably will not get paid any interest. You need to factor that lack of return into your offer for the loan.
If you buy a loan, you must be willing to own the property, especially if you are buying mezzanine debt secured by just a pledge of ownership. In that case, be prepared to foreclose on those ownership interests, and then step into the shoes of the owner and assume all of its obligations to creditors. You may even need to put the hotel into bankruptcy to prevent foreclosure by the mortgage holder. As a result, you have to determine all of the hotel's debts, as they may become your obligations.
Finally, pursuing collection on a loan can be expensive. Plan to spend at least six figures on your lawyers, valuation experts and others battling it out with the owner if the hotel ends up in bankruptcy court.
The bottom line is buying loans can be an effective way to ultimately obtain ownership of a hotel. However, it is important to be realistic in setting the price that you will pay for that loan.
David M. Neff ( dneff@perkinscoie.com), a member of the International Society of Hospitality Consultants ( www.ishc.com|~ ), is the Co-Chair of the Hotels & Leisure Group at Perkins Coie LLP. He is based in Chicago.
