Hotel Sales – How to ensure an effective financial due diligence process

After a post debt crisis downturn in 2023, the gap between buyer and seller price expectations narrowed significantly and the U.K. hotel transaction market sprang back into life in 2024, with transaction volumes reaching £5.75bn – more than double that recorded the previous year and the highest level of activity in the sector since 2018.  This recovery has continued into 2025 with a multitude of deals seeing both portfolios and single hotels changing hands, reinforcing the sector's position as a mainstream real estate investment category.

However, our experience of the last 18 months suggests that a large number of hotel transaction processes, particularly single assets and smaller portfolios, have become unduly elongated due to a failure to anticipate the information that a buyer will require in order to complete the deal, particularly in respect of financial information.  The reasons for this?  In our view it is often a combination of sellers being reluctant to risk incurring advisor fees with no guarantee of a successful transaction, some brokers not appreciating the additional information needs of bidders for an operational real estate business, and an underlying sense of caution amongst buyers which has seen deal materiality fall and even more granularity of information being required.  All too often this sees buyside financial diligence processes which should really be completed in 3-4 weeks taking more than twice this time, and issues being uncovered which result in substantial value chips, the impact of which could often have been mitigated by the sellers with early warning.

So, what should owners and brokers be doing to facilitate a more efficient transaction process?  Firstly, know your own numbers: sophisticated buyers will be looking to identify underlying EBITDA and strip out distorting one-offs, so get ahead of the game.    The more proactive a seller is in identifying such items and providing proper support for their quantum, the more credible (and hence value enhancing) they will be.  Too often on the buyside we see no attempt being made by sellers to identify any adjusting items, or perhaps even worse, carrying out a last minute trawl for favourable adjustments with little attempt to properly substantiate them, which hits credibility from the start.

Such "quality of earnings" adjustments aside, hotel P&L and related KPI information is usually readily available and granular analysis is relatively straightforward.

However, obtaining explanations for specific movements can be unduly painful, and sellers really need to better identify upfront the monthly trends, in particular, anything obviously outlying.

Balance sheet information in contrast, is frequently only formally reported at financial year-end, and we often find little information provided upfront.  Sellers need to be cognisant that buyers will require granular balance sheet account detail, irrespective of the type of completion mechanism adopted, including the most recent month-end and also ideally for at least the last twelve months.  This is particularly important if a target working capital mechanism is proposed – in which case the impact of quality of earnings adjustments on the balance sheet needs to be considered (the question will get asked!)  This is potentially beneficial in any case as it enables the seller to steer the completion discussions to a Target WC mechanism over a NAV, thereby enabling the early presentation of adjustments to target working capital that work in a seller’s favour - although, as with quality of earnings, such adjustments need proper support in order to withstand buyer scrutiny.

One final consideration to be made before formally instigating a sale process, is the choice of completion mechanism.   Whilst a Net Asset Value (“NAV”) is the most common mechanism for individual hotels, we are increasingly seeing target working capital mechanisms being proposed, which given hotels generally operate with negative working capital will act in a seller’s favour (valuations will generally be based on the headline asset value).  The downside is that this does necessitate more preparation for the seller and usually additional advisor cost.  Locked box mechanisms, which provide sellers with more certainty of value at completion and avoid a potentially elongated completion accounts preparation process, remain rare, but should generally be given more consideration by sellers.