Investors with significant experience buying and selling triple net real estate often evaluate prospective investments by analyzing predictable rent schedules, tenant (and guarantor) financial statements, and cap rates. This framework, while effective for traditional single-tenant assets, is not readily transferable to the hotel sector.
A hotel is not merely a real estate investment—it is an operating business conducted within a real estate asset. As a result, the legal, financial, and operational considerations differ in fundamental ways. Here are several key distinctions that net-lease investors should carefully evaluate when considering a hotel acquisition.
Aaron Robinow, Dorsey & Whitney LLP
Valuation Methodology and Cash Flow Variability
Net-lease investments are typically underwritten based on contractual rent and evaluated relative to prevailing market cap rates. The existence of a long-term lease with fixed or predictable rent provides a stable basis for valuation and facilitates relatively straightforward comparisons across assets. Net leases also generally make the tenant responsible for all or most property-level expenses, resulting in a more predictable free cash flow to the owner.
By contrast, hotel revenues are not contractually determined and instead fluctuate based on operational performance and demand. Room revenue is generated on a nightly basis and is subject to variability driven by occupancy levels, average daily rate (ADR), seasonality, and broader economic conditions. In addition, the hotel owner is responsible for all operating expenses, maintenance, and capital expenditures.
As a result, hotel buyers lack a directly comparable standardized metric equivalent to contractual net operating income for purposes of applying a cap rate. Instead, valuation may be derived from multiple measures, including net operating income, EBITDA, or fee cash flow after management and franchise fees. Underwriting a hotel purchase therefore requires sensitivity analyses and scenario-based projections rather than reliance on a fixed income stream.
Accordingly, investors must adopt a more dynamic valuation approach that accounts for both market-based and operational volatility.
Diligence: Asset Performance, not Tenant Credit
In a NNN lease transaction, diligence is principally focused on the creditworthiness of the tenant and any guarantor, as well as the enforceability and structure of the lease. The investor’s risk profile is therefore closely tied to the tenant’s ability to perform its obligations under the lease.
In a hotel acquisition, there is no tenant. Instead, the investor assumes direct exposure to the operating performance of the asset.
Due diligence is therefore centered on historical financial statements, operating data, and the physical condition of the asset. However, such data must be evaluated with caution, as historical performance may not be indicative of future results. Investors must also consider a range of additional variables, including changes in room supply within the market, shifts in demand drivers (such as business travel and tourism trends), non-recurring events reflected in historical results, and variations in management quality and operating strategy.
As a result, legal and financial diligence must be supplemented by a robust assessment of market conditions and forward-looking demand projections.
Capital Expenditures and Ongoing Property Obligations
A defining feature of NNN lease structures is the allocation to the tenant of responsibility for most or all of maintenance, repair, and capital expenditure obligations. This structure limits the landlord’s need to contribute additional capital during the lease term.
Hotel ownership entails a fundamentally different allocation of responsibility. The owner bears primary responsibility for all maintenance, repairs, and capital improvements costs necessary to maintain the property’s physical condition and competitive positioning. In addition, management and franchise agreements commonly require the owner to fund capital reserve accounts, typically in the range of 4% to 5% of gross revenue.
Branded hotels are also subject to periodic property improvement plans (PIPs), which mandate upgrades to furniture, fixtures, and equipment, as well as broader renovations to ensure compliance with brand standards. These capital cycles are recurring and can be significant, often occurring on a 5–7 year cycle for soft goods and a 10–14 year cycle for more substantial improvements. These obligations must be carefully modeled, as they directly affect both cash flow and long-term asset value.
Management Agreements and Operational Control
Net-lease investments are generally characterized by limited landlord involvement in day-to-day operations, with the tenant retaining operational control subject to lease restrictions.
In the hotel context, the owner’s role in operations is central to value creation and preservation.
Investors typically engage a third-party manager pursuant to a hotel management agreement, although some owners elect to operate themselves, sometimes through affiliated management platforms. These management agreements govern the operation of the hotel and address, among other matters, staffing, operational policies and procedures, owner approval rights, management fee structures (including base and incentive fees), performance standards, and termination rights.
The selection of a well-qualified manager and the negotiation of a management agreement with proper alignment of incentives and expectations are critical to the owner’s return on investment.
Franchise Agreements and Brand Considerations
Most hotels operate under a brand affiliation pursuant to a franchise agreement with a major hospitality company, such as Marriott, Hilton, or Hyatt.
These agreements provide substantial benefits, including access to centralized reservation systems, brand recognition, and marketing support. However, they also impose material obligations, including the payment of initial and ongoing franchise fees, compliance with detailed brand standards, and required capital improvements and renovations.
In connection with an acquisition, investors must typically address the termination of the existing franchise agreement and the negotiation of a new agreement. This process often involves property improvement plans and other conditions required to obtain brand approval. Buyers must also carefully coordinate the timing and process of franchise application and approval.
In Sum
For private and institutional investors with experience in NNN lease acquisitions, hotel ownership represents a transition from a contractually driven investment model to one that is operationally intensive and performance dependent.
This shift implicates not only different financial metrics, but also a fundamentally different allocation of risk, responsibility, and control. Successful execution in the hotel sector requires a nuanced understanding of hotel management, franchise relationships, capital planning, and market dynamics, in addition to traditional real estate considerations.
Investors contemplating such a transition should engage legal advisors experienced in the hospitality industry to guide them through the due diligence process, identify and mitigate risks specific to hotel acquisitions, and provide strategic insight in negotiating transaction terms and documentation.
Aaron Robinow is an attorney at Dorsey & Whitney LLP who advises clients on complex commercial real estate transactions, with a focus on the hospitality sector. Dorsey & Whitney LLP’s Hospitality Industry Group counsels clients on a wide range of hotel and restaurant matters.
