Alternative deal structures can help bridge valuation gaps

In negotiating property sales, price valuation often becomes a stumbling block to deal making. But there are a number of interesting alternatives to a straight sale that allow transactions to close that otherwise might not have.

Let's say that you're at the point in your hotel negotiation where there's a 10-percent to 15-percent gap between opinions of value. Consider using deal-making tools such as operating leases, land leases, percentage clauses, purchase money mortgages and third-party financing to overcome a valuation gap.

An income stream, either actual or projected, may be worth $4 million to one side and $4.5 million to the other. This might result from an honest disagreement over capitalization rates, tax implications, emotions or avarice.

Why not avoid the issue of establishing an overall sale price for some of the transaction's elements in an effort to reach agreement? Do this by renting the building in which the hotel exists, instead of buying or selling it. Or, by separating the building from the land by buying (or selling) the structure and creating a long-term ground lease arrangement on the land. $400,000 a year in building lease income, or $100,000 a year in ground rental, with future rent increases tied to a formula, are sure to be valued differently in the mind of each negotiating partner. I think $400,000 a year is worth $4 million; you think it's worth $4.5 million. It doesn't matter as long as we both are happy with a $400,000 annual rent.

Additionally, were the building to be leased or sold, so long as it's not currently highly leveraged, that too permits a slug of cash to be generated, which almost always acts as a deal lubricant. If the property is leased, then the fee owner has the opportunity to withdraw capital tax free by refinancing collateral with, or subsequent to, the leasing transaction. Or, if the hotel building is sold and the underlying land kept and leased to the new building owner, then the proceeds of the building sale are treated at very low capital gains rates, and the ground lessor retains the opportunity of receiving additional future earnings from ground rent, again with him applying his own personal value to that income stream.

Valuation differences often result from something as basic as one's unique income tax situation. For instance, I'm a general partner in a partnership that has owned a hotel for many years and has a negative tax basis of $2 million. Were a sale to occur at a price of, say, $5 million, our partnership would have to pay income tax on $7 million, which is $2 million more than we'd be receiving in sale proceeds. I might or might not mention this to a buyer, but it surely will impact how much money our partnership wants for the property.

Another consideration is what a seller is to do with the after-tax proceeds. Hotels generally sell at a 10-percent to 12-percent capitalization rate, or eight or 10 times earnings. So, after paying the capital gains taxes, were one to put the money in the bank, it would be at 2 percent to 3 percent interest. Though many people consider a cash sale to be of most interest to a seller, that's not always the case.

hmm@advanstar.com

Jeff Wilder is president of Wilder Ventures LLP, a New York City-based asset management company, and an adjunct professor at New York University. E-mail him at jswilder1@aol.com.

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