The hotel industry is bound to see a flurry of property sales when the next economic downturn hits. Opportunistic investors tend to take out hotel loans during harder times in anticipation of a sell-off. Once a new owner buys the property, however, there’s risk to the underlying collateral. Hotels are often not maintained appropriately and their conditions rapidly deteriorate.
Almost every hotel will be thoroughly inspected prior to a sale by a commercial building inspector. These inspections, known as property condition assessments (PCAs), provide a detailed snapshot of the property’s condition at the time of the sale, but tend to reveal little about a hotel’s ongoing operations and maintenance program. Typically, though, a new buyer needs more than a property-acquisition report. Even new hotels can deteriorate quickly, lowering their values and putting underlying loans at risk.
Commercial mortgage brokers working with these types of projects should be aware that lenders are now requiring focused inspections of hotels to ensure the collateral remains stable over the long term. This is another type of inspection known as an engineering review, and they are often performed by experienced hoteliers.
Like PCAs, these inspections reveal specific problems with the property, but they are conducted for a different purpose. The inspectors will do a deeper dive into the condition of the hotel and uncover problems that might not be found in a PCA. They also evaluate a hotel’s maintenance program, and ultimately produce a blueprint and schedule for the hotel’s operating engineer to keep the property in good working condition.
“ Lenders are now requiring focused inspections of hotels to ensure the collateral remains stable over the long term. ”
Your investor clients will need a plan to ensure that the property is maintained appropriately once they buy the hotel and take over the operations. A maintenance blueprint ensures that the investment holds its value.
These reviews also can save tens of thousands of dollars on hidden costs that may not be uncovered by a PCA. It is not unusual for a hotel loan to be compromised due to hidden mechanical, plumbing and structural problems that develop over time due to a flawed operations and maintenance schedule. These issues can cause extraordinary operating or capital expenses that affect cash flow, asset value and equity.
An engineering review is performed by a contractor, but one who has different skills than the typical commercial-property inspector for a PCA. This contractor typically is a hotelier with experience on the operations side, and they may spend two full days at the property. The focus of the review is on the operating condition of the hotel. The end goal is to produce a maintenance schedule for the property engineer that extends the life of the hotel’s components.
The report itself is usually seven to 10 pages long. The reviewer will investigate the condition of each piece of equipment and every area of a hotel. Unlike a PCA, which takes a bird’s-eye view of the hotel’s condition, the engineering review is a ground-level investigation. For instance, while the PCA will provide the age of each heating, ventilation and air conditioning (HVAC) unit and its life expectancy, it will not check the filters, the frequency of change or the condition of the coil condenser, etc. The engineering review includes such particulars as the temperature of water when it leaves the boiler and whether bathroom exhaust systems are working correctly.
Engineering reviews are suitable even for newer hotels. A hotel’s condition can begin to degrade within three years of opening. Any size or class of hotel is a good candidate for a review. Although the risk increases with larger hotels, all hospitality properties share common areas such as kitchens, laundries and guest rooms. The cost of these reviews is reasonable. Typically, engineering reviews cost half the amount of the typical $2,500 to $5,000 charge for a PCA.
Many hoteliers have been scaling down their engineering departments to reduce costs. These hotels are cutting back in terms of staffing, compensation and training, leaving their maintenance departments understaffed and underqualified. The lack of training, staffing and diligence is causing an alarming devaluation of collateral due to deteriorating conditions.
Many 100-room hotels today, for example, employ just one full-time chief engineer or engineering supervisor. Often, this individual lacks the experience and training to match the title. Larger hotels typically employ a chief engineer and other part-time workers who perform maintenance, but they also may have a host of unrelated duties, such as answering guest calls and dealing with vendors.
Some hotels are not doing any planned maintenance at all. In the case of one hotel, an owner spent millions of dollars on renovations, but the hotel declined rapidly because it was not maintained. An engineering review revealed multiple issues, including wear and tear to the fixtures and furniture. Bathroom exhaust vents were not working properly, causing mold and moisture to grow behind the walls.
HVAC filters were not changed or cleaned after the recommended three months. This clogged the coils on the units, blowing black particles through the vents and onto ceilings. It also decreased the efficiency of the HVAC units, significantly lowering their life spans. In short, after just one year, this newly renovated hotel was no longer “like new” as promoted in online reviews.
• • •
An engineering review provides a holistic look at a hotel. There is a ground-level inspection of the property, the maintenance systems and processes in place. The review also examines the engineering workspace and record keeping, as well as any training gaps and staffing needs for the chief engineer, the maintenance team and even the hotel’s general manager.
An engineering review is an ideal complement to a PCA during a presale assessment. Positioned alongside a PCA, a thorough engineering review can uncover a vast array of problems before they become deal killers for mortgage brokers and their clients. The deep-dive review fills in gaps in PCA inspections. And it allows the potential buyer, seller or lender to fully understand any mechanical or maintenance risk in full detail.