Mass sales by Japanese nationals are flooding the real estate market, giving U.S. and foreign investors a wide choice of properties. Banks have their choice of investment partners, too. And, a growing economy that has helped improve bank profits has also created an ideal environment for renewed lender interest in underwriting hotels. The hospitality industry has historically represented a mixed blessing for lenders. Bankers are not in the business of running hotels-and neither are some operators, who have been seduced into believing otherwise. If bankers know what to look for in weighing the potential benefits against the perils of assuming such investments, they can either back off from a risky venture or spot signs of trouble in their asset portfolios in time to take corrective action.

Consider the following points:

Workouts on nonproductive assets are more likely to end up successful if you have an in-house staff or outside consultants who understand both hotel and banking principles.

In one recent case, a lender financed a hotel purchased by a businessman who knew little about the industry. The flagship hotel chain had let the lodging slip into default, and the new owner covered the shortfalls, paying $300,000 to put it back into the flagship's system.

After receiving an operating loan, the recession hit and the borrower couldn't meet his mortgage payment. He asked to renegotiate the loan, and the bank called in an asset management consultant, a former hotelier, to audit the property. He found that the operator did not have a front-office manager or director of sales and marketing, and was also lacking a business or sales and marketing plan. On top of that, he was managing the property himself.

The consultant advised the borrower to retain a management company and hire good help. He took the advice, and the bank rescheduled the loan. If you doubt the ability of borrower to operate a hotel, but the investment shows strong potential, confer with professionals skilled at heading off problems that could lead to loan default. In another instance, a consultant was hired to analyze the fee arrangement between a flagship and premier 400 room hotel, and found that the flag's fee schedule needed to be renegotiated.

After examining the operator's financial statements, the consultant discovered that the dining room was losing $400,000 a year. Between the subsequent reduction of flag fees by nearly $600,000 a year, and closing down the dining room in favor of profitable coffee shop service, overall costs decreased by $1.1 million in 1993. Sixty percent of U.S. banks hold nonperforming hotel loans, and portfolio managers must recognize the slow hemorrhages that drain hotel profits. One property that reassessed its operating expenses after experiencing a dip in profits found that outsourcing laundry service saved $275,000 a year. The lessons of the 1980s taught the banking industry that it must be circumspect in extending hotel loans. The bottom line is that it takes an experienced hotel and banking professional to be able to forecast and diffuse problems, before they burn up profits.

American Banker - Monday July 31, 1995