Asset-Light Strategy Issues in the Development Space

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While asset-light strategies have been used for decades in the hotel industry, the strategy and how to implement it are a bit more complicated in the development space, whether for a hotel or time-share company. A typical asset-light approach is to spin off the ownership of the real estate while the company maintains a degree of control over the asset either by franchising it to an owner which will, in turn, manage the property or by entering into a long-term management agreement with the acquiring entity.  In turn, real estate assets may be moved off the balance sheet in the time-share industry by using a separate trust. In any case, the risk is a loss of control over the assets necessary for operations, which is mitigated to a significant degree by the agreements referenced above and through careful crafting and alignment of financial incentives.

Arguably development transactions in which the company reacquires the asset are not so much “asset light” as “capital efficient” given that the real estate is not permanently moved off the company’s balance sheet. Instead, it may be best to think of it as “renting” a third-party investor’s balance sheet during construction of the projects and during the take down period for completed projects in exchange for a fixed return, only to later move the real estate onto, or back onto as the case may be, the company’s balance sheet once development has been completed in the case of new construction, or pursuant to a capital efficient take down (purchase) schedule. Added to the loss of control addressed above, the company also faces the risk that the finished product will not be what the company originally envisioned (not brand standard), the risk that the asset could be sold to a third-party competitor, or worse yet, that the developer, or more likely its SPE, could file for bankruptcy during development and the company could lose its rights recover the property via a bankruptcy proceeding.  

These additional risks may be mitigated to some degree through carefully drafted agreements that strike a balance between removing the asset from the company’s balance sheet during the construction period (for new construction) or take down period with specified purchase dates for completed construction, while maintaining adequate control over construction/take downs and the ultimate purchase and sale.  Relevant company rights would include the right to control construction, a right of first refusal, a schedule for acquiring the finished product(s), and a seat at the table in a bankruptcy proceeding (preferably as a secured creditor). No solution is perfect, however, and it is important to note that the financial risk of the transaction will likely remain with the company. There are also transactions costs to consider.  Those risks and costs, however, may in some cases be more than offset though through the benefits of a achieving a higher ROA, scheduling the timing of payments for a more efficient use of available funds, and the potential increase in share price that an asset-light strategy often brings.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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