Caveat Emptor: Wilderness Lodge Buyers, Do Your Due Diligence
These critical steps should be considered before acquiring a wilderness lodge.
If you’re not familiar with the concept of caveat emptor, it puts the onus of inspection and transaction risk firmly on the purchaser. Decisions made during the acquisition process are directly related to a buyer’s ability to achieve a desirable result and good underwriting & due diligence practices are imperative.
Wilderness lodge buyers must understand both the assets (real estate, equipment, customer list, goodwill) and the market (Broader tourism market and the lodge industry). They must be able to identify risks, determine areas where they can add value, estimate financial returns and manage expectations, typically all within in a limited amount of time. The process of strategically evaluating potential acquisitions, while managing the many aspects of the due diligence process is overwhelming even for the most experienced of industry professionals. Following these critical steps will help you create a positive outcome:
Assemble the right team early on
Wilderness Lodges are unique from all other forms of real estate—from their operation to valuation and everything in between—and they require industry-specific expertise. Assembling a team of experienced professionals is crucial to ensure the transaction goes smoothly and your investment is sound. Here’s a list of key professionals you should consider including in your team:
- Real Estate Agent that specializes in hospitality properties. They can help identify opportunities, negotiate prices, and provide insights into the market.
- Attorney (Specializing in Commercial Real Estate and Hospitality Law) to ensure all contracts are legally sound. Helps with regulatory and compliance matters specific to wilderness lodges, such as labor and employment laws.
- Accountant (CPA) or Financial Advisor to conduct a thorough financial analysis, including due diligence on the lodge’s financial history. Helps project future earnings, profitability, and tax implications.
- Appraiser to provide an independent assessment of the lodge’s value based on its assets, location, condition, and revenue.
- Mortgage Lender or Broker to assist in securing financing. May specialize in hospitality lending, helping you understand loan options, rates, and terms.
- Contractor for if renovations are needed to assess the building’s condition and help estimate the costs and feasibility of improvements.
- Tax Specialist Ensures the transaction is structured in a tax-efficient manner, considering local, provincial/state, and federal regulations.
By assembling a team of these professionals, you will be well-prepared to evaluate the financial, legal, operational, and strategic aspects of your wilderness lodge purchase.
Plan an exit strategy prior to acquisition
When buyers are considering purchasing a wilderness lodge business, planning the exit strategy is crucial from the outset. This ensures that buyers can maximize the return on investment, mitigate risks, and have flexibility in case market conditions or personal circumstances change. Buyers should have an idea of how long they intend to hold the property, typically most buyers intend on operating the property for 10+ years.
A common problem I see with very long-term owners is that they run out of enthusiasm for the business and let revenue decline.
By having a well-structured exit plan in place before purchasing a wilderness lodge, buyers can make more informed decisions and adapt as needed to market conditions or personal circumstances.
Understand what is being sold
Reviewing the sale documents with an eye toward what you are buying is as important as understanding what is not included in the sale. Is it fee simple or a land lease? Is all income attributed to the lodge property or for example does some of the income come from a cottage on a separate legal lot that is not being included? Are there outposts being acquired as part of the sale? Are all of the necessary licenses and entitlements being included in the sale? Let your expert(s) review the acquisition documents and opine on the value of the assets.
Identifying what might be missing
Usually after a Letter of Intent is signed, buyers will receive confidential financial and related operating information and likely will—and should—focus on developing a reasonable projection of future financial performance, factoring in their strategic plan for the lodge (capital investment into the buildings and equipment, management change, enhanced marketing, etc.), namely all of the value upside they believe they can achieve in a given deal.
Equally important for buyers is to consider what may be missing from the historical financial statements. What “unsustainable” cost containment was implemented to boost net operating income for the benefit of maximizing sales price? Have the owners not been paying themselves a management salary in order to boost EBITDA? Have they not been reinvesting annually into repairs and maintenance? Will property taxes and insurance be affected by the sale? Are the boats and motors or other equipment leased?
Have your experts opine on potential liabilities and increased costs associated with new ownership. Revisit the capital budget and pro forma (again) and make sure the deal remains feasible.
Check out this article for typical EBITDA ratios for wilderness lodges
Understanding the Day-to-Day
Buyers who are new to the wilderness lodge industry might be lured to invest based on an unrealistic vision of the lifestyle, while failing to dive deep into what the day-to-day actually looks like.
There’s a lot of people out there that have a passion for the outdoors and for this reason they have an interest in operating a wilderness lodge. I think it’s great to tie your passions/interests/hobbies into your career any way that you can. But I think of more importance is to gauge your passion for entrepreneurship and hospitality because that is what is going to carry you through the grind of a season and the ups and downs of the industry.
Ensure the pro forma isn’t chasing the deal
When evaluating a wilderness lodge acquisition, it’s essential to ensure that the financial proforma (i.e., projected financial statements like income, cash flow, etc.) is realistic and not designed to “chase the deal,” meaning it should not be overly optimistic just to justify a purchase decision. Here’s how to avoid this:
1. Validate Assumptions
- Revenue Projections: Review assumptions for occupancy, vacation package prices and ancillary revenue sources like food and beverage, merchandise, etc. Compare these to the historical performance of the property and competitors.
- Expense Estimates: Ensure operating expenses, including labor, utilities, maintenance, and supplies, are accurately projected. Sometimes, expenses are underestimated to boost the proforma.
- CapEx and Renovation Costs: Accurately estimate necessary capital expenditures (CapEx) for renovations or improvements. Skimping on CapEx can make the proforma look better but lead to future unexpected costs.
2. Conservative Stress Testing
- Downside Scenario Planning: Develop multiple scenarios, including conservative and worst-case outcomes. This includes lower-than-expected occupancy rates, vacation package price stagnation, or unexpected economic downturns (think Covid-19).
- Sensitivity Analysis: Evaluate the proforma under various stress tests, such as increased interest rates, higher-than-anticipated operational costs, or delayed market recovery. Look at how small changes impact key metrics like net operating income (NOI) and cash flow.
3. Review Industry Benchmarks
- Operating Margins and Ratios: Use industry-standard benchmarks for expenses like those in this article. If the proforma significantly deviates from these, dig deeper into why.
4. Independent Third-Party Review
- External Appraisal: Get an independent appraisal from a reputable firm. This should include a review of both the physical property and financial projections.
- Feasibility Study: In some cases, engaging a third party for a market or feasibility study can provide an unbiased view of whether the proforma aligns with the property’s potential.
5. Use of Realistic Financing Terms
- Interest Rates and Loan Terms: Be realistic about the financing terms in the proforma. Ensure that interest rates, loan amortization periods, and other financing terms are consistent with the current lending environment and your access to capital.
- Debt Service Coverage Ratio (DSCR): Ensure that the DSCR is realistic and sustainable, even under potential downturns in revenue. A high DSCR in the proforma might indicate too much reliance on optimistic income projections.
By thoroughly evaluating the wilderness lodge proforma and challenging its assumptions, you’ll avoid being caught in an overly optimistic projection designed to chase the deal.
Realistically calculate your full cash requirements
Purchasing a wilderness lodge business involves various costs beyond just the purchase price of the property. Estimate the full cash requirements to buy the lodge up front and update them as you get better information.
- Down Payment: Typically, 30% of the lodge’s purchase price if using a conventional bank.
- Legal Fees: For contracts, leases, and regulatory compliance.
- Property Appraisal and Inspection: Evaluating the condition and value of the property.
- Working Capital: To cover operational expenses during the transition period such as payroll, utilities, and vendor payments.
- Rebranding/Marketing: If you plan to change the lodge’s brand or marketing strategy, this could involve new signage, website redesign, and advertising.
- Licensing and Permits: Renewal of licenses for alcohol, health, safety, and other operations.
- Deferred Maintenance: Costs to fix existing wear and tear that previous owners may have neglected.
- Upgrades/Renovations: If the property needs improvements or modernization to meet market expectations.
- FF&E (Furniture, Fixtures, and Equipment): Replacement or upgrades to essential items like beds, furniture, equipment, etc.
- Transfer Taxes: Fees for transferring property ownership.
- Contingency Funds: It’s always a good idea to set aside a contingency fund (5-10% of the purchase price) to cover unexpected costs, delays, or market changes.
In the end, buyers should resist the urge to commit too early or become too vested in a particular lodge. Remain skeptical throughout the process and be willing to walk away.
Lastly, be prepared to answer this question over and over: Do we still want this property and, if so, at what price?
Use the discussion forums linked to here to ask questions you might have to the community.
This article has been prepared by Frontier Hospitality Advisor for general information only. Frontier Hospitality Advisor makes no guarantees, representations or warranties of any kind, expressed or implied, regarding the information including, but not limited to, warranties of content, accuracy and reliability. Any interested party should undertake their own inquiries as to the accuracy of the information. Frontier Hospitality Advisor excludes unequivocally all inferred or implied terms, conditions and warranties arising out of this article and excludes all liability for loss and damages arising there from.