Bridging the gap between franchisors’ and lenders’ interests

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by RUSHI SHAH

As a hotel owner, you are already well versed in how operating as a franchisee can benefit your business. You have the autonomy to manage your hotel (or use the independent management company of your choice), and your cash flow is fueled by contributions from the brand’s marketing team, central services and all-important reservations engine. And the backing of a strong brand doesn’t just attract guests – it also attracts lenders, opening doors to better options, including long-term non-recourse financing without personal guaranties.

HOW DOES MY FRANCHISE AGREEMENT AFFECT MY HOTEL’S FINANCEABILITY?
Most non-recourse permanent loans are pooled together and securitized into bonds purchased by investors in public markets, who demand a predictable return on investment and are acutely conscious of the quality of loan collateral included in every bond pool. As a result, what is outlined in your franchise license agreement (including the hotel brand, length of term, termination options and contractual increases in fees) will weigh heavily in lenders’ and investors’ decisions to fund the loan. In the eyes of bond investors, a hotel’s franchise agreement is similar to a retail property’s lease.

Because non-recourse loans are secured by the property and not the borrower’s personal guaranties, lenders and investors reward hotels with flags higher up the chain scale. They believe hotels, bolstered by a strong brand’s more valuable reservation engine and increased marketing muscle, will be better equipped to successfully ride out the storm when economic conditions get rough. For you, this translates into better rates, lower reserve requirements, higher proceeds, increased flexibility in negotiating terms and more lender options.

DOES THE TERM OF MY LOAN AND FRANCHISE AGREEMENT NEED TO MATCH?
Since loss of flag is likely to lead to loss of property value, non-recourse lenders prefer that your franchise agreement is as long or longer than the loan term. Lenders want peace of mind that the commitments protecting your property’s income stipulated in your franchise agreement remain in place for the life of the loan. Examples include predictable franchise fees, strict property improvement plans (PIP), centralized services, the ongoing use of the reservation system and protective area restrictions that prohibit the brand from allowing a hotel under the same flag to move in and cannibalize your hotel’s demand drivers.

WHAT IS THE RELATIONSHIP BETWEEN MY FRANCHISOR AND MY LENDER?
Your franchise agreement is with your franchisor brand, but your loan is with the lender. In order to bridge the gap between the franchisor’s and lender’s interests, lenders will require a “comfort letter” from your franchisor.

A comfort letter ensures the rights afforded the current hotel owner by the franchise agreement will translate to the lender or the lender’s designated receiver in the event the borrower defaults on the loan. It typically allows the lender/receiver to continue to operate a hotel (at least for a short time until it can be sold) under the brand and owner’s current franchise agreement. This includes continued utilization of the brand’s reservation system and dictates that the lender receives sufficient time to remedy or “cure” any non-compliance. This protects the property’s cash flow, which in turn protects the investors’ return on investment. In addition, lenders will require language that releases the lender/receiver from the franchise agreement when the property is sold, and ask for assurances that the purchaser can apply for a new franchise agreement with the brand. The comfort letter also confirms whether the franchisee is in good standing with the franchisor at the time of closing.

IF MY FRANCHISE AGREEMENT EXPIRES BEFORE MY PROSPECTIVE LOAN MATURITY DATE, IS MY HOTEL STILL ELIGIBLE FOR A LONG-TERM NON-RECOURSE LOAN?
If you want to lock in the savings of long-term interest rates with a 10-year non-recourse permanent loan and your franchise agreement expires before the new maturity date, your hotel may still qualify. Every deal has a story and there may be mitigating factors that make up for the potential risk of losing your flag. An experienced intermediary will be able to determine if there is a combination of term, rate, reserves, proceeds or other factors that will convince a lender an exception is reasonable.

If a lender isn’t willing to budge on the expiration requirement, you could choose to renew your franchise agreement before your loan closes. Some owners may be leery of this path if the renewal triggers a hefty PIP requirement that they would prefer to postpone, but a skilled intermediary can usually structure your loan to finance the PIP at the same low rate. Rolling in the PIP can actually improve the optics of the deal, as the lender appreciates that a portion of the money they are loaning you will improve the property.       ■

Rushi Shah is CEO at Conlon Capital, a commercial mortgage banking firm formed by a merger with Aries Capital, which specializes in CMBS and other non-recourse lending solutions. Over the past 26 years, the Conlon and Aries teams have collectively funded over $8B for hotel, multifamily and other commercial properties. Shah held previous positions at Northern Trust and is a member of AAHOA’s Founding & Allied Member Committee. Shah holds an MBA from The University of Chicago’s Booth School of Business.

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