The Crisis and Inns, Part I apparently hit a raw nerve. We had many thoughtful responses and many thank you emails for our news encouraging ongoing financing opportunities.  However, some of you mentioned the very real problem both prospective buyers and sellers have with shrinking funds for down payment and working capital. Whether equity is (was) tied up in stock market influenced investments or, perhaps more commonly in home equity, it has for the moment diminished. This has understandably created anxiety among buyers and anxiety is not a vehicle to spur action.

This dilemma is compounded by the number of Inns currently on the market. Hilary Jones, owner of the Inn consulting firm Inngenium, reports that there were 931 Inns actively for sale on the internet in early 2008. Given that many small Inns are marketed through residential listings, the real number is undoubtedly over 1,000! While what follows is mostly oriented toward sellers, creative thinking on the part of buyers will prove a valuable tool in finding and buying an appropriate Inn or Bed and Breakfast.

So what is a seller to do? What most are doing is listing the property at a price that has no basis in reality and leaving it in the hands of a broker to languish among the hoards of other Inns for sale. The most important first step in a successful transfer process is to price the Bed & Breakfast or Inn correctly. We strongly urge anyone contemplating a sale in the foreseeable future to have a comprehensive Valuation done by a professional consultant. That Valuation will not only help you to price your Inn correctly in the marketplace, it will also identify areas, physical and financial, to be improved to enhance the sale prospects down the road. This is not an appraisal, which might be too oriented toward the real estate side than the business activity. While Valuation is a specialty of Inn Consulting Partners, there are other consultants qualified to provide a valid Valuation.

Properly priced Inns will have a strong leg up in the market, but it is a crowded environment. It is again important to get the proper professional help to position the Inn correctly in the market place and to qualify and motivate interested buyers. It is also important to have a USP (Unique Selling Proposition). For some fortunate few that may be a location in a strong destination location or on a coast. (Oceans preferred.)

For most, the USP will be providing incentives in the form of terms of purchase. Most Innkeepers, when they contemplate a sale, initially assume they will be paid out in full. In truth, in most sales the owners play some part in the financing. Let us look at some of those scenarios:

1. Secondary or Subordinated Owner Financing.

   In this case, the primary financing is with a bank, but because of limited resources for down payment, or a historic cash flow that is short of full coverage of the projected debt service, there is a gap between bank financing and down payment. The owners then pick up that slack, usually in the 10 to 15% range of the purchase price. Because this financing is usually related to weak cash flow, the terms of the owner financing are often very favorable in the first few years. For instance, there might be a moratorium on payback for up to 6 months, and/or interest only at a favorable rate for the first 2 or 3 years. Owners usually provide a 20-year payout term but with a full payout in 7 years. The risk is high, but the reward is that the Inn is sold. With proper help in qualifying the buyer, the risk is acceptable.

2. Primary Owner Financing.

   This option is used far less often than it could be. If you have a viable business, it is properly priced, and the buyer is qualified, there is a very favorable balance between risk and reward. A good investment will provide sellers with an excellent return and a regular income. It will also provide some tax advantage, in that the gain will not be taxed until the money is actually received. Most people are not aware that, if the current mortgage is less than say 50% of value, it does not have to be paid off in the sale. The seller still owes a note to the current mortgagee, and that note is still secured by the Inn. This is really a three cornered deal. The Seller is the mortgage and note holder with the buyer. The seller in turn owes the bank and the bank still has the security of the Inn to guarantee the note to the seller, who no longer owns the Inn. The buyer must agree to this arrangement, and since it enables them to buy the Inn, it is happily agreed to. I believe that if owners who are in a position to do the financing chose to do so, we would see more Inn sales. But look to the next possibility to create even more sale opportunities.

3. Purchase of buyer’s home by seller.

   Most Inn buyers come to the table with the equity in their home as the principal source of cash for down payment and working capital. But in today’s housing market, many homes are hard to sell or temporarily so depressed in price that it does not make sense to sell. Consider this scenario. The buyer wants to buy but wants a contingency on the sale of their house. The seller whose mortgage is currently very low will, upon sale, have a significant amount of cash with no need to reinvest in a house or a business. So the Seller buys the Buyer’s house (maybe even at a premium over current value), rents it out (or lives in it) until the market rebounds, which we know will happen eventually. I suggest the possibility of a premium, because at the other end the buyer will be so thankful for the largesse of the Seller that they will not negotiate the price of the Inn.

Lest you think this is Bill gone beyond the pale, this reminds me of a situation several years ago. (After thirty years, I have lots of situations.) A couple had a contract to purchase an Inn on Cape Cod. Everything was set, including the financing, but the couple did not have enough available funds to meet the down payment requirements. They did have a condominium in Hawaii that was caught in a market glut due to a recession in Japan. After much discussion, the Sellers bought the Buyers’ condominium in Hawaii, providing the Buyers with the funds they needed to complete the purchase. The Sellers put the condo in a rental pool, actually used it themselves for a couple of vacations, and sold it when the market turned up. (And the market will turn up eventually.) There was little or no loss on the transaction. Sellers did not have to do financing, the Inn was sold in a timely manner, and the gesture was grand enough that the buyers did not bicker about the price. The downside risk was much less than other solutions and the Inn was sold.

There are many other creative solutions, no doubt many more than I have thought of. Without elaboration, there is the possibility of a lease with option, and one I have not been party to, but seems logical. That is to sell the business and its assets, but retain ownership of the real estate. This could also include an option to purchase in the future. There are currently over a thousand Inns and Bed and Breakfasts openly on the market and a very limited pool of understandably nervous Wannabes. It is clear that just going into that market without any hooks puts you in a pool with a 20-year inventory.

While the above has been addressed primarily to sellers, a smart buyer may want to initiate the ideas outlined above to inspire creative approaches and a sale that might otherwise not happen. A final word. This is so important that it might behoove you to get professional help in examining these options. (You know; professional drivers, closed course, do not try it yourself!)

These are certainly troubling financial times.  Innkeepers (Present and Future) have wondered aloud about the impact of the current crisis on their ability to conduct business.

In truth, there are two financial worlds that function independently of each other, rarely crossing paths. One is the Wall Street based mega investment banking world that creates such products as “credit default swaps.” If you do not know what they are, fear not. No one else does either. Despite that, there are 62 trillion dollars in credit default swaps outstanding (From “Dept. of Magical Thinking”, The New Yorker Magazine, Sept. 29, 2008)

The other banking world is the less visible smaller community and state based banks, which stay close to home, hold no sub-prime mortgages and do not lend to Bezerkistan. These banks are conservative and healthy, with money to lend and the demand is currently soft. They are looking for good loans.

These are the banks that for years have financed our Inn transfers. If a deal makes sense there is a local bank ready to participate. Many of the loans we have managed have SBA 504 loan participation through a Certified Development Corporation. In cases where the cash flow is weak, seller participation in the financing is required.

Over the past several years, this second, quieter banking world has been supportive of our smaller, quieter segment of the hospitality industry. This has not changed. If you are thinking about or are ready to move (in or out), this is as good a time as any. Calls to several commercial loan officers have reassured me that these community banks are very much in business. Interest rates are relatively low and our traditional sources of financing are ready willing and able.

As I was writing the above, I spotted an article in our local paper, the Brattleboro (VT) Reformer, that strongly supports my view. It is worth some repetition.

The article begins by noting that “Vermont Banks have witnessed a steady rise in deposits during the last few months.” The article points out that Vermont Banks do not sell “exotic” loans. Overall, “Vermont banks did not get into the sub prime lending and remain well-capitalized with additional money to lend.”

Chris D’Elia (President of the Vermont Banking Association) said the trend among community banks was not unique to the Green Mountains. From his discussions with other local banks across the country, the community financial institutions have maintained a stable business during a nationwide crisis. “It does appear that consumers in other states are looking to local financial institutions as a place to put their money into and to do business.”

Of course the larger economic outlook is of importance to all of us. However, the segment of the banking industry we have relied on for loans and support is healthy and ready to continue to provide the capital lifeline we need.