by Doug Carleton of Business Lenders, LLC
Let your mind roam ahead in time for a moment. You have put your property on the market and you now have an offer. The buyer is going to apply for a mortgage. Let me suggest to you how what you are doing today, or not doing, can affect your borrower’s loan application and, possibly, your sale. When the time comes to sell, you can have a package of information that is not only a good sales package, but which will also include information that will be beneficial to the lender as well as the appraiser when analyzing your property for a loan.
When you sell, if you only have three or four rooms, there is a good possibility that your buyer might be able to get a residential mortgage because of the ease of turning the house back into a residence (alternative use, in lenders’ terms). A residential mortgage is usually based largely on the value of the real estate and the borrower’s ability to pay the mortgage from his/her personal income. This would dramatically simplify your sale because the primary information the lender needs is the value of the property and the borrower’s income.
If you have been running your B&B as a profit-making venture and have five rooms or more, then your buyer is probably going to have to get a commercial loan (SBA or conventional). For a commercial loan, a lender needs a great deal more information because it is the business and its ability to generate enough cash flow to support a loan that is being analyzed. Because a commercial loan is more complex than a simple residential loan, here is where you can go a long way toward helping to facilitate that process and possibly speeding up your sale.
Think about starting to put together a sales/lender package now while you have plenty of time to collect, correct and enhance information about your B&B. Start by asking yourself some questions:
1. Has your property changed any since you bought it (renovations, more rooms, etc.)?
2. Was it a “lifestyle” purchase that turned into a business?
3. Have you added any lines of business, such as weddings or business meetings?
4. Do you cater to a different kind of traveler now?
5. Have demand-generators in your market area changed?
6. Has your competition changed?
With these questions in mind, here is a suggested outline of a sales package that would also be very useful to a lender. All of these items will also appear in one form or another in the appraisal of your property, so the more quality information you can provide the better.
1. Identification of the property: Give a detailed description; include the size of the house or inn, size of the property, number of rooms, legal description (deed book and page number), and include a plat. Photographs can be of great value. When a buyer applies for a loan to purchase your property, usually the lender will know nothing about the property other than what is in the loan application. The lender may go to your website, where you probably have some pictures. But that won’t be but so effective. By having a portfolio of pictures of your property, you can highlight features that you could seldom do on your website. You may have some spectacular views, or you may have a magnificent property that is on the National Register of Historic Places, or something else. Several photographs included in the package that ultimately goes to the lender may be very valuable. You are selling your buyer, but you are also selling the lender.
2. Market area analysis: Highlight any important facets of the area economy that influence real estate values. For example, is the area growing, stable or declining? Why? This can affect the general value of your property apart from its value as a business. If the area is stable, or even declining in some way, it’s better to deal with it up front and show why it has not had a negative effect on your business. Local economic development offices are frequently a good source of this type of information.
3. Neighborhood description: The “neighborhood description” can cover a fairly broad area with a B&B, depending on where you are. What is nearby that attracts people to your area, and therefore, your B&B? In many cases, it is something very specific, like water, or mountains, or birds, or a nearby college. This information is extremely important to your package because it is probably what will continue to draw travelers to the inn for your buyer. Lenders and the SBA know that many times when a business changes hands, a business that was successful under one owner is not automatically as successful under a new owner. Since what draws people to your area is not likely to change, the lender can feel a higher degree of confidence that a change of ownership will have no effect on why people come to the area and to your B&B.
4. Lodging trends and market analysis: You should include an analysis of local hotel/motel supply and demand. This is not necessarily easy to do, but between chamber of commerce and tourism bureaus (both local and state) and the Internet, you should be able to piece together a picture of how well the lodging market is doing in your area. Even though it may not have any impact on your specific property, it does give a lender an idea of the desirability of the market in general. If the hotel market is strong, that could make a lender feel more favorably disposed toward your inn. The converse is also true.
Discuss your competition. What other lodging choices, both B&B and hotel, do visitors have in your area? Competition within the B&B industry itself could be an issue sneaking up on the industry that is going to become more of a factor in the future in buying and lending decisions. In some states there are already a large number of B&Bs and country inns, offering more choices than ever for prospective travelers. For example, if a lender discovers that there could be forty-plus B&Bs and inns in Charleston, S.C., or close to five hundred inns in Maine, or well over four hundred in Texas, he might become a little more interested in how you deal with the competition in your area. And this is before even taking into account the additional competition from hotels and motels.
The B&B industry is maturing and becoming more mainstream as a choice for a lot of travelers, particularly business travelers and especially women business travelers. As a result, to a lender looking to finance the sale of your property at some point in the future, you may find yourself being looked at as part of the total lodging industry rather than as a unique subset. So it is more important than ever for you to build a strong case now for the continued success of your B&B.
Another thing to consider is whether there is seasonality to your market. Is it a year-round area or highly seasonal? This can have a strong impact on a lender’s feelings about a business, and being able to show how you deal with that will be to your benefit. The buyer’s lender wants that mortgage paid twelve months a year. And if you shut down for three, you’d better be able to convince the lender (through your buyer) that there will be enough cash flow in the high season(s) to cover the low seasons.
5. Financial information: There are certain financial documents that the buyer’s lender will require from your business. The last three years’ business tax returns and financial statements (profit and loss and balance sheet) are the primary ones. Your operating statements should also be in lodging industry format (PAII has an excellent chart of accounts) rather than just some general format. An interim profit and loss statement and balance sheet current to within 90 days will also need to be included. And almost as important are three years and current interims of occupancy percentages and ADR’s, with the last twelve months broken down month-by-month. Remember, for all the beautiful sunsets/mountain views/water views/people/breakfasts etc., you are still in the lodging business. You sell room nights, just like an airline sells seats. And if you don’t sell enough room nights to generate sufficient cash flow to support the payments on a buyer’s loan, financing for the buyer may be hard to come by and you may wind up holding a portion of it yourself. The quality and detail of your operating statements could have a direct effect on the price you ultimately get for your property.
There is seldom too much information for a lender. The more details they have, and the more information about why this business is successful, apart from the numbers they look at, the better the chances for a successful conclusion to your sale. This is especially true if the lender is not from your area.
There is an another important point that needs to be brought up here. Are you taking a salary as owner, and, if so, is it showing as one of the expenses on your profit and loss statement and tax return? If you are not, perhaps because you have outside income or for some other reason, a lender is probably going to impute a salary for the new owner unless they can prove outside income. If that happens, it will come straight off your profit number with a serious negative effect on your sales price.
For example, suppose you were not showing a salary and the lender decided to impute a $25,000 salary for a new owner, which would lower your reported profit by $25,000. One reason a lender will do this, and it is legitimate, is as a contingency against having to put someone in to run the business if things don’t work out with the new owner. Or, the new owner might need a salary from the business. If the cash flow from the business covers this number as well, then the lender is much more comfortable. But if an appraiser is using a 10% capitalization rate as part of the appraisal, lowering your profit by $25,000 will lower the value of the inn by $250,000!
Selling might be the farthest thing from your mind right now (except on certain days). But it is going to happen eventually. A minimum amount of work now could go a long way toward maximizing the value of your current investment.