By Tim Franzen, Ginsberg Jacobs
Nearly 30 years as a principal sponsor of hundreds of hospitality real estate investments have shaped how I approach legal due diligence. Hotel deals rarely fail because someone missed an obscure legal technicality. They fail because buyers, lenders and even counsel didn’t fully understand the business implications of key property and operational issues.
The franchise agreement that looked standard triggered a property improvement plan. The management contract that seemed reasonable made the operator nearly impossible to remove. The union agreement exposed the owner to unexpected pension liabilities.
The following due diligence priorities aren’t exhaustive, nor are they a substitute for experienced legal counsel. But if you can confidently address each of them before going hard on a hotel acquisition, you’ll be in a far stronger position than most investors.
1. Understand what you’re actually buying.
Hotel acquisitions involve far more than real estate. In addition to land and buildings, you may be acquiring management agreements, franchise rights, liquor licenses, union obligations, equipment leases and vendor contracts. Hotels are operating businesses, not just real estate assets.
Before closing, your legal team should identify what transfers automatically, what terminates and what requires third-party consent. Pay particular attention to licenses and permits that don’t automatically convey. Liquor licenses, for example, can take months to transfer in some jurisdictions and create significant operational challenges if not addressed early.
2. Know your franchise agreement.
The franchise agreement is often the most important document in a branded hotel acquisition, yet it is frequently underexamined.
Key questions include:
• Can the existing agreement be assumed, or will the brand require a new one?
• What does the property improvement plan (PIP) require, and has the scope been fully negotiated and priced?
• What approval rights does the brand retain over renovations, operators and ownership transfers?
• Is the brand offering key money, and what concessions are required in return?
• Have all franchise-related costs been incorporated into your underwriting, including marketing, reservation and other systems?
3. Read the management agreement like a litigator.
The management agreement deserves the same scrutiny as a major loan document. The operator relationship is often the most important variable in hotel performance, and the management agreement determines how much control an owner has.
Two issues deserve particular attention: How difficult is it to remove the operator, and under what circumstances? Equally important are the economics, including both base and incentive fees. Termination rights should be practical, and performance tests should be meaningful rather than watered-down benchmarks that effectively guarantee the operator’s position regardless of results.
4. Conduct thorough environmental due diligence.
Hotels often have environmental histories spanning decades, including underground storage tanks, dry-cleaning operations, fuel systems and other potential sources of contamination. A Phase I environmental assessment is essential, but it may not be sufficient. If recognized environmental conditions are identified, additional investigation may be necessary.
For development projects, understanding site conditions before construction begins is critical. Environmental remediation can quickly derail a project’s economics. Investors pursuing public incentives such as tax-increment financing, tax credits or brownfield grants should also confirm compliance with applicable environmental requirements.
5. Verify entitlements.
For existing hotels, confirm that operations are fully entitled and that planned renovations or use changes won’t require new approvals that could delay or derail your business plan. Nonconforming uses deserve careful review: A hotel operating under grandfathered status may lose that protection if renovations exceed certain thresholds. Likewise, proposed additions such as bars, entertainment venues or other amenities may require discretionary municipal approvals that are far from guaranteed.
For development projects, start the entitlements process early. Municipal approval timelines, especially in urban markets with active neighborhood opposition, often take far longer than anticipated. Build realistic timelines and carrying costs into your underwriting.
6. Scrutinize assumable financing and ground leases.
Assumable debt and ground leases remain with the property and can significantly affect future operations. CMBS loans frequently contain restrictive covenants governing renovations, management changes and operational decisions. These restrictions must be compared against your business plan and potential future strategies.
Ground leases deserve special attention. Key provisions include rent escalations, renewal options, permitted uses, lender protections and restoration obligations at lease expiration. These terms can make or break a hotel’s long-term value.
7. Understand the labor picture.
Labor is typically a hotel’s largest operating expense, and workforce-related legal issues can be among the most complicated. Before closing, investors should understand:
• Whether employees are covered by collective bargaining agreements and what obligations apply to a successor owner
• Potential WARN Act implications if renovations or operational changes could result in layoffs
• Any pending EEOC claims, wage and hour disputes or workers’ compensation matters
• Union contract provisions governing staffing, discipline, work rules and management transitions
Unionized properties require particular attention. Certain collective bargaining agreements may contain provisions that significantly affect operational flexibility or create obligations that survive a transfer of ownership.
8. Start securing liquor licenses and permits early.
Liquor licenses are highly jurisdiction-specific and rarely transfer automatically with the property. Because many hotels rely heavily on food-and-beverage revenue, a liquor license should be treated as a critical business asset. The licensing process often takes longer than anticipated. Investors should determine early who will hold the license — whether the ownership entity, an affiliate or the management company — and begin the transfer or application process as soon as practical.
Similarly, confirm all operating permits — including your certificate of occupancy, food service licenses, health permits and signage approvals — are current and transferable. Investors should also confirm that no unresolved municipal code violations exist and address responsibility for any required corrections before closing.
9. Address tax structure up front.
Ownership structure has enormous long-term tax implications, and the time to optimize it is before closing. This is particularly true for hospitality assets because of the interplay between real property ownership, operating lease structures and the tax treatment of furniture, fixtures and equipment.
Cost segregation studies can generate meaningful tax savings by accelerating depreciation, but they need to be considered within the broader ownership and tax strategy. Work together with your tax advisors, accountants and transactional attorney during the diligence period, not during the post-closing cleanup.
10. Tailor the closing checklist to the transaction.
Every hotel transaction is different, and cookie-cutter closing checklists miss things. A ground-up development involving public incentives, construction financing and pre-opening agreements requires a different process than the acquisition of a stabilized branded hotel with in-place financing and existing operations.
Your legal team should build the closing checklist from scratch for your deal, identifying every open item, responsible party and deadline. Third-party consent requirements often become the longest lead item as closing approaches. Identify them early and start the consent process as soon as the deal has sufficient certainty to justify it.
The best hotel investors don’t treat legal diligence as a box to check. Instead, they use it to stress-test their business plan and identify risks before capital is committed. Experienced counsel should challenge assumptions, uncover blind spots and help investors understand the practical consequences of the documents they’re signing. Those who rush to “check in” before fully vetting a deal may face the true cost of overlooked risks long after closing.
Tim Franzen is a partner and chair of the hospitality real estate practice at law firm Ginsberg Jacobs LLC in Chicago. This article originally appeared in Heartland Real Estate Business magazine.