Creative selling solutions in a changing hospitality market
In today’s volatile real estate market, the opportunity to utilize creatively structured transactions has become more and more frequent in the hospitality industry.
The commonly used 1031 tax-deferred exchange involves a real estate transaction in which a seller will purchase another property within a certain amount of time to protect or defer capital gains. The replacement property must be similar to the previous property or of “like kind.”
A hotel sale exchanged into investment real estate qualifies under the regulation. There is no immediate tax on the exchange, but the tax is deferred and must be paid at the outright sale of the property. This means that instead of paying taxes on each property as it is sold, only the last sale will require a tax payment.
A tenant-in-common, or TIC, property — a popular form of ownership in which multiple purchasers enter into a co-ownership of a property. For example, if a property is split among five purchasers, each is responsible for a fifth of all aspects of the investment, from taxes to profits. This type of purchase allows an investor to acquire commercial property with a low investment, which can allow the investor to own a percentage of multiple properties.
It is important to note that a TIC purchase does not bar one person from buying more than one section of the ownership and co-owners may not be aware of other owners’ identities.
A strategically structured 1031 exchange that integrates credit tenant financing may be one of the most effective ways to maximize cash proceeds of a property sale. This type of exchange and subsequent financing with non-recourse debt can allow the seller to withdraw proceeds untaxed. The purchaser would guarantee to the financer that the property would be leased, structured as a triple net lease, or NNN.
The benefit of an exchange for credit tenant property is that the owner has no responsibility regarding the maintenance costs or the actual management of the property, providing secure, management-free cash flow with outstanding liquidity and high leveragability.
Credit tenant property presents unique advantages, performing like corporate bonds while preserving the benefits that real property offers. Additionally, credit-based financing enables the exchanger to maximize the cash proceeds of a sale through post-exchange refinancing proceeds. It is possible to finance over 90 percent of the value of the sale, and then use the refinancing proceeds to purchase new property without deadline restrictions, and at full basis.
Other favorable strategies
Wrap-around mortgages are another popular option for financing in tough markets.
A form of seller financing, a wrap-around mortgage occurs when a purchaser makes payments on the previous owners’ debt as well as an additional loan that amounts to the purchase price. The buyer will make payments to the seller, will then make payments on their original mortgage. This can be highly beneficial to the seller, who can charge an additional percentage on the buyers’ payments to the original mortgage.
A seller may insist that the purchaser cannot prepay the loan without a penalty, but buyers may object to such a condition because it inhibits their right to refinance or even sell the property.
Hospitality real estate professionals will commonly suggest this process for a buyer who cannot acquire a mortgage, does not have the funds to pay closing costs, or wishes to create an installment sale for the seller.
Another favorable strategy in hospitality real estate transactions is the use of the SBA 504, the U.S. Small Business Administration’s loan program designed to help small and mid-size businesses obtain property.
SBA 504 features a traditional bank mortgage on 50 percent of the cost and the SBA takes a second mortgage for 40 percent. The buyer must then supply the remaining 10 percent into the purchase costs.. SBA loans are generally locked in at a favorable rate for a term of 20 years.
Lease/purchase agreements also are excellent alternatives in both soft and active real estate markets. Many hotel and other business entities are established so a corporation or LLC might own the real estate and a separate entity may own the operating business. This would allow the owner to sell the operating business separately and then lease the real estate, most often under a purchase agreement to allow for the sale of the real estate to occur sometime in the future.
As long as the hotel price makes economic sense, hospitality real estate will continue to provide incredibly viable investment opportunities. However, while current financing alternatives have recently been diluted, closing a transaction will often call for creative financing solutions.
Earle Wason, CCIM, is president and owner of Portsmouth-based Wason Associates Hospitality Real Estate Brokerage Group. He can be reached at 603-539-5545 or email@example.com.