Financials

by Peter Scherman of The B&B Team

When you’re thinking of refinancing to make capital improvements to your inn, there are many questions to ask. In the analysis of finance and construction costs, anticipated revenues, and future value of the tangible assets, one question that is often overlooked is this: How will improving the physical plant impact the future marketability of your inn when you sell?

The resale market for inns can be broken down into three basic categories. First, there are homes from which someone operates a bed & breakfast for fun, some additional income, and tax breaks. Second, there are somewhat larger homes with stronger businesses that generate a significant amount of lodging income, but which have a potential market as a high end residence. And third, there are large B&B’s and full service inns and spas which are strictly businesses and, essentially, commercial property, valued almost entirely for their ability to generate income.

The third category of properties is ideal for refinancing for capital improvements which can enhance their ability to increase revenues — and, therefore, value — and are not addressed here. The first two, however, are. Consider this: you have a lovely three to five guest room B&B in a nice area, make a respectable, if modest, living from the B&B business, and you are at a crossroads. You’d like to earn more and have decided that you are either going to “improve” the property to grow your business, or sell it and buy something larger. Capital investments are generally considered improvements, but they may not improve your chances of selling. The reason is simple. If, for instance, you turned your five bedrooms into eight or ten, or you added a commercial kitchen and a restaurant, both intended to increase your business (which they may well do), you will have fundamentally changed the nature of what you own and caused you to travel down a new path.

Your new property with ten guest rooms and/or a small restaurant (or other business requiring a physical change to the property) may no longer be attractive as a home in the residential market where people pay a price based on the supply and demand for housing in an area. Market factors may have caused the value to be much higher as a residence than could be supported by any lodging income after improvements. The residential market is very broad and, in recent years, home values have increased dramatically with no reduction in demand for these homes. However, with your new, “improved” property, you now have to generate enough income to support your investment plus add revenue-based value, as you have now converted your residential real estate to commercial, with the commensurate change in valuation approaches. You may or may not be able to grow the revenues sufficiently – even if it is enough to pay back the loan – to increase the value beyond what it may have been previously. You will have certainly narrowed the pool of potential buyers when the day comes to sell. But if you do your homework and know what your goals are, growing your inn may be the best business decision you’ll ever make.

To help with the “go, no-go” decision when contemplating a major capital improvement, consider hiring an experienced inn consultant to help you assess the potential return on investment, both from a cash flow as well as a marketability standpoint.

by Peter Scherman of The B&B Team

You have been dreaming for years. Those glossy magazines and snazzy web sites with those wonderful, historic lodgings, glorious gardens, and inviting rooms are a regular mainstay. Your travels have taken you to places where you were greeted by strangers who treated you like old friends. You slept on feather quilts and abundant pillows, awakening to the aroma of fresh coffee and baked breads, then shared breakfast with others like yourselves: road warriors of the bed & breakfast circuit. You just love these quaint and ornate homes, the unfaltering hospitality, the sumptuous meals. After all, entertaining has always been a love of yours and you think, “We could do this!”

Cut to six months later: you’ve been talking to innkeepers about the Innkeeping lifestyle, and they told you it wouldn’t be easy. You attended one of those seminars, and they told you it wouldn’t be easy. You’ve been taking stock of what it would really mean to quit that job or take early retirement and live on an innkeeper’s “salary,” and now you realize it won’t be easy. But this is Innkeeping! You’ve always wanted to do this. It can’t be that bad, or why would so many take the plunge?

Good question. It’s a question that all prospective innkeepers must ask themselves. Just for a moment, let’s assume that you have satisfied yourself that you are, indeed, cut out for Innkeeping. You would like to be your own boss, even if your life will be guided by your guests. You can still decide to close for a week (if you plan ahead) to take a vacation. You can always be closed on Mondays if you want. You are prepared for the cut in income, figuring you can get by fairly modestly, and besides, you have a little something extra from wise investments or pensions. You’ve been checking out ads on countless web sites looking for the perfect bed & breakfast for sale, have actually received information and consider yourself to be actively “in the market.” Well, maybe a couple of years away. That’s OK. It’s better to plan ahead and know what you’re getting into.

You are really serious about buying an inn now, and you want to make an offer but need to figure out exactly how to finance the purchase. This is where the dream of owning a bed & breakfast can start to slip away unless you’ve done your homework and planned adequately. Because financing is where most contracts fall apart.

A bed & breakfast inn is a hybrid entity. Alas, it’s neither a “house” nor a “hotel.” If it were just a house you wanted to buy, a lender would look at your available cash for down payment and closing costs, would review your income and “other debt,” would work with certain ratios to determine how much of your income could be used to finance a home, and could tell you, within a very narrow range, how much you could afford to pay for a house. No furniture. No business. You keep your job. That assumes, of course, that the house appraises out for the purchase price and your credit is squeaky clean.

For a hotel or motel, or maybe a convenience store or other business, a lender will look at the business, will examine and analyze the cash flow, will determine the value based on actual and projected cash flows, will consider how much you can put down initially (they generally want 30% plus with reserves for operating capital, etc., though there are exceptions). If all of this pans out, and you can convince that lender that you know what you’re doing (past experience in the same business, hopefully) you might get the loan and be on your way.

But a bed & breakfast? What’s that? It’s a bit large as a home, a significant portion of which will be used for business. This, of course, creates some interesting tax considerations when applying your rollovers, but that’s another story. A bed & breakfast is typically very heavily weighted by the real estate component as opposed to the business component, where that convenience store is often just the opposite. Nevertheless, the dream B&B you’ve found may, in fact, have a fairly decent cash flow. If it does, there are a number of avenues you can pursue. The first, and by far the easiest (though hardly the most common), is owner, or seller, financing.

If an innkeeper has owned the inn for a number of years, especially if they converted it into a B&B from a house, they may have experienced a substantial amount of appreciation and have little or no debt. Often these owners are interested in moving on and will consider owner financing as a good investment. Like any lender, they will want to know your credit history, see a credit report, have a complete, certified financial statement from you, and will be confident that the cash flows from the business will cover debt service and living expenses on top of operations. However, don’t expect many sellers to finance 90% of the deal. Maybe you can buy a house with 5% or 10% down payment, but it’s unlikely that many innkeepers will finance that much. Keep in mind that, like a bank, security is paramount. You will be purchasing the real estate, the personal property (fixtures, furnishings, etc.) and probably will be paying for intangibles (good will) as well. Your initial investment will likely have to cover the intangibles, the personal property, and a substantial portion of the real estate. That can amount to a sizable outlay. You need to keep something in reserve for improvements you may want to make and to cover you in those slow early months.

Let’s say your seller doesn’t want to finance, and many don’t. They have other plans for their money. If the business is really solid and can be documented (current innkeepers take note!), the next best bet is often a local bank. Despite strict regulations about lending parameters, many bankers still take an interest in local ventures and, especially, real estate. If the loan is “non-conforming” but there is value in the property and a sufficiently large down payment to protect their investment, money may be forthcoming as a portfolio or “in-house” loan. An introduction to the local banker by the current innkeepers (if they’ve had a good relationship) can be a good way to get started, especially if there’s been any bank financing in the past.

If your intention is to acquire a full service inn with a restaurant, then the Small Business Administration (SBA) may be the best way to go. There are a number of banks and non-bank lenders who process SBA loans, some better than others, so shop around. Doug Carleton, who is an approved SBA lender and member of The B&B Team of Professionals, is one of the best. Remember two things above all else: restaurants have a very high failure rate, and most lenders are leery of making restaurant loans unless you have a track record to demonstrate your expertise. Also, SBA loans can be slow (depending on the bank) and expensive due to the SBA guarantee fees, so you need to be prepared for a process that may take six months and the expenditure of several thousand dollars in surveys, environmental studies, etc. Often times, however, the fees can be financed, and, if you are prepared and working with a good lender, the process can be expedited. Some SBA loans are assumable, so be sure to ask if the current owners have an SBA loan and look into its assumability.

As to bank financing, there are some lenders who will extend “no doc” (no documentation) loans. With 20%-40% down payment on the real estate, they will assume that you won’t walk away from the property, and if you do, their investment will be covered. How you pay for it, in their mind, is your problem. Please note that I said “real estate” not “bed & breakfast.” That down payment will apply to the appraised value of the real property, and you will have to pay for the personal property and intangibles separately. In the end, there’s still quite a lot of cash going out. [NOTE: since this article was written, “no-doc” loans are no longer available.]

You’re starting to feel depressed. You’ve exhausted the banks, the SBA lenders have turned you down, the owner owes too much to finance you (or just wants cash), but you really want to buy and the seller really wants to sell. What to do now? One possibility, and this is usually a last resort, is the use of an investment company that specializes in the purchase of mortgage notes. In reality what happens at closing is that the owner finances the sale. He simultaneously sells the note to an investor (for a discount), the original loan is paid off, the seller goes away with cash, and you own the property but will be making your payments to the new investor who holds the note. The best way to make this arrangement work is to plan ahead with a note investor so that the interest rates, the amounts paid, the size of the discounts, etc. can be juggled to reach a happy medium that works well enough for everyone. In these cases, most likely the buyer will have to pay a bit more, the seller will walk away with a bit less, and the investor will be very happy! But if it works, who’s to complain?

Needless to say, there are many ways to finance a bed & breakfast or country inn, but none of them is without problems. Almost all will require a sizeable capital investment up front. In every case the entire financial picture of the purchaser must be taken into account. Are there other assets? Is there independent income, either from investments or retirement? Will one of the purchasers be working an outside job or telecommuting? If you are working with a knowledgeable inn broker, be prepared to provide enough information that he or she can find a property that has the potential of meeting your personal and financial objectives. In the end, the best advice is to plan ahead, become informed, and be realistic. If you do, you’ll be happily on your way to Innkeeping! Good luck!

by Rick Newman of Commercial Capital Network, LLC

Updated October, 2018

All Bed & Breakfasts/Inns are unique by design. In fact, it is that unique quality that separates one Bed & Breakfast/Inn from the next. Innkeepers invest their energy and capital over time to create a welcoming and hospitable environment that is special to them, their community and valued guests who appreciate the inn and the experience the owners provide. While the charm and ambiance of an inn add to a patron’s experience, such intangibles have only an indirect effect on its actual commercial value.

An Inn’s commercial value will ultimately be determined by a combination of the real estate value, cash flow, good will, and furniture, fixtures and equipment (FF&E). Together, this value will be its value as a “Going Concern”. It is important that you are comfortable with this value before making an Offer to Purchase or a Contract of Sale. Realtors who specialize in marketing and selling Bed & Breakfasts/Inns have access to comparable sales data and property specific financial information that should support the asking price and may be made available to “Qualified Buyers”. Lastly, we can analyze the financial data to be sure that income from the property can support the debt service relative to the down payment and your investment objectives.

The Contract of Sale is the controlling document in a purchase and should reflect terms that are practical, relative to the down payment and financing terms for which you are best qualified. The value of the business’s “Good Will” and FF&E may be assigned separate values from the real estate in the Contract of Sale. Try to avoid this if possible, as loan programs that accommodate financing anything other than real estate are less flexible and sometimes difficult to obtain. It is always a good idea to consult with us before entering into a Contract of Sale, since a lender who is familiar with bed & breakfast properties can pre-qualify you specifically to the property you have identified.

Most Contracts of Sale contain a mortgage contingency clause of 30 to 45 days, the exception being cash transactions, 1031 exchanges of equal value, or sales where the seller has agreed to be the primary lender. The contract will also contain inspection clauses for items such as insect infestation, plumbing, HVAC, electrical, and the structural integrity of the building(s). During this due-diligence period, it is also common to incur attorney, survey, and title fees.

It is therefore important to note that should the appraised value be determined to be less than the contract sale price, that value will be used to determine the actual loan-to-value, rather than the contract price.

If this should occur and the parties cannot agree on a revised value or contract terms, the buyer risks losing all or a portion of his/her due-diligence expenses.

Value Determination: The lender will require and order an appraisal of the property. Appraisal fees generally range from $2,400 to $5,000 depending on the nature of the property and customary charges in a geographical area.

Down Payment may be as little as 15% for qualified buyers, although interest rates typically increase proportionate to the Loan to Value (LTV). Funds from 401ks or IRAs can be used as a down payment on a B & B/Inn. The programs are quite complicated, but can be managed professionally by a qualified plan facilitator.

A resume containing experience in the hospitality and/or restaurant industry will be extremely beneficial, as the lender must determine that the borrower’s work history is sufficient to maintain and/or improve the cash flow of the business. Transferable skill sets may be used to offset this requirement

Credit Scores are extremely important to a lender in evaluating the merits of a loan. Your credit (or FICO) scores have a direct impact on the rate, term, and loan program for which you qualify. Note: Individual lender guidelines may vary. For a copy of our Credit Guide, please visit our web site at: www.InnFinancing.com

Conventional Commercial Loans: Because each property is unique in some way, each financing option must be analyzed carefully to determine which programs are available in your state and what options will suit the property you desire to purchase. A Conventional loan application package will contain such information as the Contract of Sale, 3 years business tax returns, an interim financial statement, bank statements, and a business plan. In addition, for all partners with an interest greater than 20%, a credit profile, 2 years’ personal tax returns and resumes will be required.

• For “Viable Inns” (inns that cash flow principally on the business income however, underwriting may use global Debt to Income Underwriting DTI)
• 75% to 80% Loan to Value (LTV)
• 20 to 25 Year Term
• 2% to 3% in Closing Costs
• Cash Flow 1.2 to 1.3% Debt Service Coverage Ratio (DSCR)

SBA FINANCING OVERVIEW

The 7a Program allows for financing of all types of business needs from purchasing real estate and fixed assets to working capital and business acquisitions. SBA’s 7(a) Loan Guaranty Program offers the actual lender, Bank or Non-bank, a loan guarantee currently up to 85% of the loan amount for hospitality properties as they are considered a higher risk property type. The SBA guarantees or insures the lender against loss resulting from a default and collateral shortfall. This guarantee allows the lender to provide for financing not ordinarily offered using conventional policies.

The SBA 7(a) loan program highlights are:

• Up to 85% financing
• Fully amortized loans with no balloons
• Terms to 25 years
• Loans up to $5 million
• Loans may be assumed
• Variable and fixed rate financing at 1.25% to 2.75% over prime –
• 3 and 5 year fixed may be available
• Closing costs 3 to 4%
• SBA Loan Guarantee Fee – 3% of loan amount

The SBA 504 loan program highlights are:

The SBA 504 Program provides a method to finance real estate expansion projects through long-term, fixed-rate financing and is differentiated from the 7(a) program in that it is offered in partnership with a participating lender (Bank or Non-bank).”

The 504b loan program consists of two loans. The first loan and lien position is offered by an authorized lending institution (Bank), and the second loan or second lien position is offered by the SBA via the efforts of a certified development company (CDC). Most CDC’s are private organizations used by the SBA to process the 504-loan application and assist borrowers in obtaining proper funding which meets their needs.

504b eligible project costs include:

• Land and building acquisition
• Site improvements
• Building improvements
• Professional fees, including architect, appraisal, environmental
• Other costs, including title insurance, survey, points and interest on interim loan
  

The main advantages of the SBA 504 program are as follows:

• Loans to 15 Million
• Small equity injection, as little as 15% toward the total eligible project
• Long-term financing available, up to 25 years on loan 1 and up to 20 years on loan 2
• Very favorable, fully amortizing fixed-rate pricing
• Most closing costs are eligible for project financing
• SBA 504 loans may be assumed

Note: Individual lender guidelines may vary. The information above is only for general information purposes only.  For more information, please visit our web site at: www.innfinancing.com