MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
FROM: Grace Nakamura, Associate, Real Estate Practice Group, Calderwood & Harkness LLP
TO: Douglas Fairchild, Partner, Real Estate Practice Group Angela Fontaine, Partner, Real Estate Practice Group
CC: Rafael Dominguez, Associate, Real Estate Practice Group
DATE: January 22, 2023
RE: Analysis of Hargrove & Whitley Appraisal Report — Coral Palms Grand Resort & Spa, Key Largo, FL
CLIENT: Verimark Hospitality Group Inc.
MATTER NO.: 1021-00007
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I. Executive Summary
This memorandum presents our analysis of the appraisal report prepared by Hargrove & Whitley Valuation Services LLC ("H&W"), authored by Scott Tremaine, MAI, MRICS, and dated January 20, 2023, with an effective date of value of January 6, 2023 (the date on which the appraiser conducted a physical inspection of the subject property). Calderwood & Harkness LLP ("C&H") received a copy of the appraisal report on January 21, 2023, and has conducted an initial review of the report's key assumptions, methodologies, and conclusions as they relate to the proposed refinancing transaction for our client, Verimark Hospitality Group Inc. ("VHG").
The appraisal was commissioned by Pinnacle Atlantic Capital, LLC ("PAC") as a condition precedent to funding the proposed $160,000,000 first mortgage refinancing loan to Coral Palms Resort Holdings LLC (the "Borrower"), an indirect wholly owned subsidiary of VHG. The appraisal requirement is set forth in Section 5.2 of the Commitment Letter dated December 9, 2022, between PAC and the Borrower (the "Commitment Letter"), which mandates a full narrative appraisal compliant with the Uniform Standards of Professional Appraisal Practice ("USPAP"), the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"), and PAC's internal underwriting guidelines.
H&W's appraised value conclusion for the Coral Palms Grand Resort & Spa is $192,000,000. This figure stands in stark contrast to VHG's internal valuation of $235,000,000, resulting in a valuation shortfall of $43,000,000, which represents a deficit of approximately 18.30% below VHG's projection.
The impact of this shortfall on the proposed refinancing is severe. At the $192,000,000 appraised value, the proposed $160,000,000 loan amount implies a loan-to-value ratio ("LTV") of approximately 83.33%. This ratio materially exceeds the maximum LTV of 68.0% prescribed by the Commitment Letter. The maximum loan amount supportable at the 68.0% LTV cap, based on the $192,000,000 appraised value, is $130,560,000 ($192,000,000 × 68.0%), representing a reduction of $29,440,000 from the $160,000,000 originally contemplated. This reduction effectively eliminates the approximately $32,265,000 net cash-out distribution to VHG that was a primary economic driver of the refinancing and raises questions about the feasibility of the transaction at any loan level.
We note that the debt yield metric remains compliant: VHG's trailing net operating income ("NOI") of approximately $18,400,000, divided by the proposed $160,000,000 loan amount, produces a debt yield of 11.50%, which exceeds the 9.5% minimum debt yield covenant set forth in the Commitment Letter. However, because debt yield is a value-independent metric (it measures the return on the loan amount based on property income, not property value), it does not cure the LTV breach. PAC's underwriting will require compliance with both the LTV and debt yield covenants, and the LTV failure will govern the loan sizing outcome.
Based on the foregoing, PAC is expected to reprice the loan significantly. VHG should anticipate reduced loan proceeds, an increased interest rate, and potentially more restrictive structural terms, including enhanced recourse provisions, additional collateral requirements, or the imposition of more conservative reserve requirements.
This memorandum identifies specific areas of the H&W appraisal that may be subject to challenge and recommends that VHG retain an independent appraisal review consultant to prepare a detailed critique of the H&W report. We have identified several assumptions employed by H&W that appear conservative relative to the property's demonstrated operating performance and the broader market for luxury resort properties in the Florida Keys.
Update: On January 24, 2023, following our recommendation, VHG retained Claybourne Advisory Group LLC ("Claybourne"), a New York–based real estate advisory firm with significant experience in hospitality valuations, to conduct an independent review of the H&W appraisal. Claybourne's engagement is expected to produce a detailed analytical report that will serve as the foundation for VHG's formal appraisal challenge to PAC.
II. Background — The Transaction and Appraisal Context
A. The Proposed Refinancing
The proposed refinancing transaction is structured as a first mortgage loan with the following key terms and parties:
Borrower: Coral Palms Resort Holdings LLC, a Florida limited liability company and an indirect wholly owned subsidiary of VHG. The Borrower is a single-purpose entity organized under the laws of the State of Florida and holds fee simple title to the Coral Palms Grand Resort & Spa (the "Property"). The Borrower's sole member is Coral Palms Intermediate Holdings LLC, a Delaware limited liability company, which is in turn wholly owned by VHG.
Guarantor: Verimark Hospitality Group Inc., a Delaware corporation listed on the Nasdaq Stock Market under the ticker symbol VMRK. VHG's guaranty is structured as a limited recourse or "bad boy" carve-out guaranty, pursuant to which VHG guarantees the Borrower's obligations solely with respect to certain enumerated non-recourse carve-out events, including fraud, intentional misrepresentation, misapplication of rents, voluntary bankruptcy filing, and environmental liability, among other customary carve-out triggers.
Lender: Pinnacle Atlantic Capital, LLC, a Delaware limited liability company. PAC is an affiliate of Greystone Peak Asset Management LP, a diversified alternative asset manager with approximately $12 billion in assets under management across real estate debt, equity, and structured credit strategies. PAC's real estate lending platform focuses on transitional and permanent financing for institutional-quality hospitality, multifamily, and mixed-use assets.
Proposed Loan Amount: $160,000,000.
Purpose: The proposed loan proceeds are intended to be applied as follows: (i) refinance and retire the existing first mortgage loan in the outstanding principal amount of $118,500,000 held by Tidewater National Bank, N.A. (the "Existing Loan"); (ii) fund upfront reserves, including tax, insurance, and capital expenditure reserves; (iii) pay transaction costs, including closing costs, legal fees, appraisal fees, and title and escrow charges; and (iv) distribute an estimated net cash-out of approximately $32,265,000 to VHG. The Existing Loan was originally in the principal amount of $125,000,000, was originated on June 1, 2019, matures on June 1, 2024, and bears interest at a floating rate of SOFR plus 2.25% per annum (converted from LIBOR via a benchmark transition fallback amendment dated March 15, 2022).
Original Pricing: The Commitment Letter provides for a fixed interest rate of 5.35% per annum for a five-year term. The loan is structured with an interest-only period during years one and two, followed by amortization on a 30-year schedule during years three through five. Two one-year extension options are available, subject to satisfaction of the following conditions: (i) trailing twelve-month debt service coverage ratio ("DSCR") of not less than 1.25x as of the extension request date; (ii) no event of default then existing or continuing; and (iii) payment of an extension fee equal to 0.25% of the then-outstanding principal balance.
Commitment Letter Sizing Constraints: The Commitment Letter establishes two primary sizing constraints for the proposed loan: (i) maximum LTV of 68.0%, based on the lender's appraised value of the Property as determined by an appraisal ordered by PAC; and (ii) minimum debt yield of 9.5%, calculated as the Property's trailing twelve-month NOI divided by the funded loan amount.
At VHG's internally projected value of $235,000,000, the proposed $160,000,000 loan amount would produce an LTV of approximately 68.09% ($160,000,000 ÷ $235,000,000). PAC had agreed, in connection with the issuance of the Commitment Letter, to waive the de minimis excess above the 68.0% threshold, which amounted to approximately 9 basis points. The debt yield at VHG's projected NOI of $18,400,000 divided by the $160,000,000 proposed loan amount equals 11.50%, which comfortably exceeds the 9.5% minimum. The transaction was therefore viable at VHG's projected value, subject to the minor LTV waiver.
B. The Property
The subject property is described as follows:
Property Name: Coral Palms Grand Resort & Spa
Address: 99000 Overseas Highway, Key Largo, Monroe County, Florida 33037
Folio Number: 00460780-000100
Legal Description: A portion of Section 27, Township 60 South, Range 39 East, Monroe County, Florida, as more particularly described in that certain Warranty Deed recorded in Official Records Book 2847, Page 1122, of the Public Records of Monroe County, Florida.
Property Type: The Property is a full-service luxury oceanfront resort hotel with an integrated conference center, full-service spa, marina, and ancillary commercial uses. The Property is situated on approximately 22.4 acres of oceanfront land along the Atlantic Ocean in Key Largo, the northernmost island in the Florida Keys chain. The Property benefits from direct ocean access, a private beach, and panoramic waterfront views.
Key Physical Characteristics and Statistics:
• Guest Rooms and Suites: 342 keys, including a mix of standard guest rooms, premium oceanview rooms, junior suites, one-bedroom suites, and presidential suites. Room sizes range from approximately 425 square feet (standard king) to approximately 1,800 square feet (presidential suite).
• Meeting and Event Space: Approximately 28,500 square feet of flexible meeting and event space, including a 12,000-square-foot grand ballroom, multiple breakout rooms, boardroom-style conference rooms, and outdoor event terraces.
• Spa: Approximately 18,000-square-foot full-service spa facility, including treatment rooms, hydrotherapy amenities, a fitness center, yoga studio, and retail spa boutique.
• Marina: 42-slip marina with capacity for vessels up to approximately 80 feet in length, with fueling services, pump-out station, and dockmaster services.
• Food and Beverage Outlets: Three on-site food and beverage outlets, including a signature oceanfront fine-dining restaurant, a casual beachside grill and bar, and a lobby lounge and coffee bar.
• Parking: 1,200-space structured parking facility (multi-level parking garage), providing ample parking for resort guests, event attendees, and marina patrons.
• Gross Building Area: Approximately 412,000 square feet.
• Site Area: Approximately 22.4 acres of oceanfront land.
Construction and Renovation History: The Property was originally constructed in 2006. A comprehensive renovation was completed in August 2021 at a total cost of approximately $47,000,000 (approximately $137,000 per room). The renovation scope encompassed a complete redesign and refurbishment of all guest rooms and suites, public areas, lobby and reception spaces, meeting and event facilities, food and beverage outlets, pool deck and outdoor amenity areas, and building systems upgrades. The renovation was designed to reposition the Property as a premier luxury resort destination in the Upper Keys submarket and to compete effectively with branded luxury resort product in the broader South Florida market.
Management and Branding: The Property is independently operated under the "Coral Palms" trade name. There is no national brand franchise agreement or third-party management agreement in effect. The Property is self-managed by VHG's hospitality operating subsidiary, which employs a dedicated on-site general manager and executive team. The independent operating model provides VHG with greater operational flexibility and eliminates franchise and management fees that would otherwise be payable under a branded arrangement. However, as discussed further in this memorandum, H&W has applied a capitalization rate premium to account for the perceived additional risk associated with the Property's independent (non-branded) status.
Fee Owner: Coral Palms Resort Holdings LLC.
C. Trailing 12-Month Operating Performance (T-12 Ending September 30, 2022)
The Property's trailing twelve-month ("T-12") operating performance, for the period ending September 30, 2022, as reported by VHG and verified against the Property's audited financial statements and STR reports, is summarized as follows:
• Occupancy: 71.3%
• Average Daily Rate ("ADR"): $389
• Revenue Per Available Room ("RevPAR"): $277.36 (calculated as $389 ADR × 71.3% occupancy)
• Total Revenue: Approximately $62,800,000 (inclusive of rooms revenue, food and beverage revenue, spa revenue, marina revenue, meeting and event revenue, and other ancillary revenue)
• Net Operating Income ("NOI"): Approximately $18,400,000
The T-12 operating performance reflects the first full twelve-month period following the completion of the comprehensive renovation in August 2021. As such, the T-12 results capture the initial stabilization of the renovated property and represent the baseline from which VHG projected continued operating improvement. VHG's management team has indicated that forward booking pace as of year-end 2022 was strong, with group bookings for the first half of 2023 running approximately 12% ahead of the prior-year pace. This forward-looking data was not, to our knowledge, provided to H&W at the time of the appraisal.
D. The Appraisal Requirement
The Commitment Letter required, as a condition to closing, the delivery of a full narrative appraisal of the Property, prepared in compliance with USPAP, FIRREA, and PAC's internal underwriting guidelines. The appraisal was required to be ordered by and addressed to PAC (not the Borrower), in accordance with standard institutional lending practice and regulatory requirements. PAC commissioned H&W to prepare the appraisal, and the engagement was undertaken directly between PAC and H&W without the Borrower's involvement in the appraiser selection process.
Appraiser: Scott Tremaine, MAI, MRICS, a principal of Hargrove & Whitley Valuation Services LLC. H&W's offices are located at 3300 PGA Boulevard, Suite 120, Palm Beach Gardens, Florida 33410. Mr. Tremaine holds the MAI designation from the Appraisal Institute and is a Member of the Royal Institution of Chartered Surveyors (MRICS). According to his qualifications statement appended to the appraisal report, Mr. Tremaine has over 22 years of experience appraising hospitality properties in Florida and the Caribbean.
Physical Inspection: Conducted on January 6, 2023. The inspection included a tour of the guest rooms, public areas, meeting space, spa, marina, parking structure, back-of-house areas, and exterior grounds. The effective date of value corresponds to the date of the physical inspection.
Appraisal Report Delivered: January 20, 2023.
III. Summary of H&W Appraisal Conclusions
A. Value Conclusion
H&W concluded a market value for the Property, as of the effective date of value of January 6, 2023, of $192,000,000 (One Hundred Ninety-Two Million Dollars).
The appraisal was prepared on the basis of a fee simple interest in the Property, subject to existing short-term operating leases for certain food and beverage outlets and the marina facility. These operating leases are between the Borrower (as landlord) and third-party operators and are structured as percentage-rent arrangements with guaranteed minimum annual rents. H&W treated these leases as part of the ongoing operations of the resort and incorporated the associated revenue streams into its income projections.
H&W determined the highest and best use of the Property, as improved, to be its continued use as a luxury resort hotel. H&W concluded that the existing improvements represent the highest and best use of the site and that no alternative use would produce a higher return. H&W also analyzed the highest and best use of the site as if vacant and concluded that development of a luxury resort hotel would be the highest and best use, subject to applicable zoning, land use, and environmental constraints in Monroe County.
B. Valuation Approaches Employed
H&W employed three approaches to value, consistent with standard appraisal practice for income-producing resort hotel properties:
1. Income Capitalization Approach: This approach was designated as the primary valuation methodology and was given the greatest weight in the final reconciliation. H&W employed a ten-year discounted cash flow ("DCF") model as the primary analytical tool within the income approach, supported by a direct capitalization crosscheck.
2. Sales Comparison Approach: This approach served as a supporting methodology and was given secondary weight in the reconciliation. H&W identified a set of comparable resort hotel sales and applied adjustments for differences in location, physical characteristics, operating performance, and market conditions.
3. Cost Approach: This approach was included in the appraisal report for completeness but was given the least weight in the final reconciliation. H&W noted that the cost approach is inherently less reliable for an 17-year-old income-producing resort property due to the complexity of estimating accrued depreciation and the subjectivity involved in quantifying functional and external obsolescence.
C. Reconciliation of Approaches
H&W's reconciliation of the three approaches to value yielded the following:
H&W reconciled to $192,000,000, giving primary weight to the Income Capitalization Approach, which is the methodology most commonly relied upon by investors, lenders, and appraisers in the valuation of income-producing hotel properties. The Sales Comparison Approach served as a reasonableness check and provided secondary support for the value conclusion. The Cost Approach provided a lower bound but was acknowledged to be less reliable given the age of the improvements and the difficulty of accurately estimating depreciation for a complex, multi-use resort property.
The relative clustering of the three value indications within a range of $188,000,000 to $195,000,000 (a spread of approximately 3.7%) suggests internal consistency within H&W's analysis. However, as discussed in detail in Sections IV, V, and VI below, we have identified several specific assumptions and methodological choices within each approach that warrant scrutiny and may form the basis for a formal appraisal challenge.
IV. Detailed Analysis of the Income Capitalization Approach
A. Overview of H&W's Income Approach
The Income Capitalization Approach was the primary valuation methodology employed by H&W, and it was the dominant driver of the final reconciled value. Given the significance of this approach to the overall value conclusion, it merits the most detailed scrutiny.
H&W employed a discounted cash flow ("DCF") analysis with a ten-year holding period as the primary analytical tool within the income approach. Under the DCF model, H&W projected the Property's annual net operating income over a ten-year period, applied a terminal capitalization rate to the projected year-eleven NOI to estimate a reversion (sale) value at the end of the holding period, and discounted all projected cash flows and the reversion value to present value using a market-derived discount rate. H&W also performed a direct capitalization analysis as a crosscheck on the DCF conclusion.
The key inputs and assumptions employed by H&W in the income approach, and their comparison to VHG's actual trailing performance and forward projections, are summarized below:
• Stabilized NOI Estimated by H&W: Approximately $17,200,000. This figure is approximately $1,200,000 (or 6.5%) below VHG's trailing T-12 NOI of approximately $18,400,000. The reduction is attributable to H&W's lower occupancy assumption, modestly higher operating expense ratio, and the application of a 4.0% FF&E reserve (compared to VHG's 3.5% assumption).
• H&W's Stabilized RevPAR Projection: Approximately $263. This is approximately $14.36 (or 5.2%) lower than the Property's actual trailing T-12 RevPAR of $277.36. The lower RevPAR projection results primarily from H&W's lower occupancy assumption of 68.0%, as the ADR assumption of approximately $387 is essentially flat with the trailing ADR of $389.
• H&W's Stabilized Occupancy: 68.0%. This is 330 basis points below the Property's actual trailing T-12 occupancy of 71.3% and significantly below VHG's forward projection of 73–75% stabilized occupancy.
• H&W's Stabilized ADR: Approximately $387. This is marginally below the actual trailing ADR of $389, representing an essentially flat assumption that, combined with the lower occupancy projection, drives a materially lower RevPAR.
B. Key Assumptions — Where H&W Diverges from VHG Projections
The following discussion identifies the five principal areas in which H&W's assumptions diverge materially from VHG's actual performance and internal projections. Each of these areas represents a potential basis for challenging the appraisal.
1. Occupancy
H&W used a stabilized occupancy assumption of 68.0%, compared to VHG's actual trailing T-12 occupancy of 71.3% and VHG's forward projection of 73–75% stabilized occupancy. The 330-basis-point differential between H&W's assumed occupancy and the trailing actual occupancy is the single most impactful assumption in the income approach, as it directly reduces projected rooms revenue and, by extension, food and beverage revenue and other ancillary revenue streams that are partially driven by occupancy levels.
H&W justified the lower occupancy assumption by citing three factors: (i) Monroe County seasonality, noting the significant peak-to-trough variance between the winter/spring high season and the summer/fall low season, which H&W argued creates structural occupancy ceilings for Keys resort properties; (ii) limited airlift, noting that Key Largo is served primarily by surface transportation via U.S. Route 1 (Overseas Highway) and that the nearest commercial airport (Miami International Airport) is approximately 70 miles to the north, which H&W argued constrains demand during shoulder and off-peak periods; and (iii) competition from newly expanded resorts in the Upper Keys, including the recently completed expansion of the Isla Serena Resort and the announced renovation of the Bay Harbor Beach Club, both located in the Islamorada-Key Largo corridor.
While these competitive and market factors are not without merit, H&W's 68.0% occupancy assumption fails to adequately credit the Property's demonstrated post-renovation stabilized performance. The Property achieved 71.3% occupancy during the T-12 period ending September 30, 2022 — a period that reflects the first full year of operations following the completion of the $47,000,000 renovation in August 2021. This performance was achieved despite the fact that the Property was still in the early stages of post-renovation ramp-up and market repositioning. The trailing occupancy figure is an empirical data point that should carry significant weight in the appraisal analysis, particularly given that it was generated during a period that included both peak and off-peak seasons. This is a primary area for challenge.
2. ADR Growth
H&W projected modest ADR growth of 1.5–2.0% annually over the DCF projection period, whereas VHG's internal model projected ADR growth of 3.0–4.0% annually. H&W argued that the renovation premium — the incremental ADR lift attributable to the newly renovated physical product — had already been largely captured in the T-12 period and that future ADR growth would revert to long-term inflationary trends.
This assumption is potentially challengeable on several grounds. First, the comprehensive renovation was completed only approximately 14 months before the end of the T-12 period (August 2021 to September 2022), and the Property was still in the process of establishing its post-renovation rate positioning in the market during much of that period. It is common in the hospitality industry for rate premiums associated with a major renovation to take 24–36 months to be fully realized, as the renovated product gains broader market awareness, repeat guests experience the improved product, and group and corporate rate negotiations reflect the upgraded quality tier. Second, VHG's management team has indicated that the Property has been selectively yielding occupancy in favor of rate during the post-renovation period — a deliberate revenue management strategy that is expected to produce continued ADR gains as market awareness of the renovated product deepens. Third, the broader luxury resort segment in South Florida has experienced ADR growth well in excess of 2.0% in recent periods, driven by strong leisure demand and constrained supply.
3. Operating Expenses
H&W assumed a total operating expense ratio (inclusive of all departmental expenses, undistributed operating expenses, management fees, and fixed charges, but exclusive of FF&E reserve and debt service) consuming approximately 72.5% of total revenue. By contrast, VHG's actual T-12 operating performance implies an expense ratio of approximately 70.7%, derived from total revenue of approximately $62,800,000 and NOI of approximately $18,400,000 (representing an NOI margin of approximately 29.3%, and thus an implied expense ratio of approximately 70.7%).
The 180-basis-point differential in the expense ratio, applied to H&W's projected revenue base, produces a material reduction in projected NOI. H&W cited industry benchmarks for independent (non-branded) resort hotel operations and management overhead, arguing that independent hotels typically incur higher costs for sales and marketing (due to the absence of a national brand's reservation system, loyalty program, and global distribution network), technology infrastructure, and general and administrative expenses compared to properties operating under major brand franchises. H&W also noted that VHG's self-management model, while eliminating external management fees, introduces general overhead allocations and management expenses that H&W characterized as comparable to a market-rate management fee of approximately 3.0–3.5% of total revenue.
While there is some validity to the observation that independent hotels may face higher per-unit sales and marketing costs, H&W's generic benchmarking approach may not adequately reflect the specific operating efficiencies achieved by VHG at this particular property. VHG's management team has implemented several cost-reduction initiatives in connection with the renovation, including the installation of energy-efficient building systems, the consolidation of vendor contracts, and the deployment of a proprietary revenue management platform. These property-specific efficiencies are reflected in the trailing operating performance and should not be disregarded in favor of industry averages.
4. FF&E Reserve
H&W deducted a furniture, fixtures, and equipment ("FF&E") reserve of 4.0% of total revenue ($62,800,000 × 4.0% = approximately $2,512,000 annually) from the projected income stream. VHG's internal model had used a lower FF&E reserve assumption of 3.5% of total revenue.
A 4.0% FF&E reserve is generally considered standard in the hospitality appraisal industry and is consistent with the treatment recommended by the Appraisal Institute and the Uniform System of Accounts for the Lodging Industry. As such, this assumption is less readily challengeable than the other assumptions discussed in this section. However, we note that for a recently renovated property with a brand-new FF&E package installed as part of the $47,000,000 renovation completed only approximately 17 months before the appraisal date, a lower FF&E reserve in the early years of the projection period may be defensible. The FF&E installed in August 2021 is effectively new, and the annual replacement cycle for major FF&E components (soft goods, case goods, bathroom fixtures, etc.) typically runs on a 5–7 year cycle. A phased FF&E reserve that starts at 2.5–3.0% in years one through three and ramps to 4.0% in later years could be argued to better reflect the property's actual near-term capital expenditure requirements.
5. Capital Expenditure Deductions
Beyond the annual FF&E reserve, H&W included additional deferred maintenance and capital expenditure deductions in the DCF model. These deductions were based on specific maintenance items identified during the appraiser's physical inspection of the Property on January 6, 2023. According to the appraisal report, H&W identified the following conditions requiring near-term capital attention: (i) deterioration of certain marina pilings and dock structures requiring partial replacement, estimated at approximately $2,200,000; (ii) concrete spalling and waterproofing issues in the parking structure, estimated at approximately $1,800,000; and (iii) replacement of the rooftop HVAC condensing units on the east wing, estimated at approximately $950,000.
These capital expenditure deductions, totaling approximately $4,950,000, were applied as deductions from the property's cash flow during the first three years of the DCF projection. While deferred maintenance deductions are appropriate where identified, the magnitude of these deductions in the context of a property that underwent a comprehensive $47,000,000 renovation only approximately 17 months prior to the appraisal date warrants scrutiny. Specifically, we should investigate whether the marina and parking structure items were within the scope of the 2021 renovation. If these components were excluded from the renovation scope, the deductions may be appropriate. However, if the renovation scope included marina and parking structure work (and we have requested the renovation scope-of-work documentation from VHG to confirm), the deductions may represent double-counting or overstatement of the property's near-term capital needs.
C. Capitalization Rate
The capitalization rate is a critical determinant of value in the income approach, and the differential between H&W's capitalization rate assumptions and VHG's implied cap rate accounts for a significant portion of the $43,000,000 valuation gap.
H&W applied the following capitalization rates:
• Terminal Capitalization Rate (DCF Model): 8.25%, applied to the projected year-eleven NOI to estimate the reversion (sale) value at the end of the ten-year holding period. The terminal cap rate is then adjusted by deducting estimated selling costs (typically 2.0–3.0%) to arrive at the net reversion value.
• Going-In Capitalization Rate (Direct Capitalization Crosscheck): Approximately 9.0%, applied directly to H&W's stabilized NOI estimate of approximately $17,200,000 to produce a value indication of approximately $191,100,000 (rounded to $190,000,000 in the direct capitalization crosscheck).
VHG's internal valuation implied a going-in capitalization rate of approximately 7.83%, derived from the trailing NOI of $18,400,000 divided by VHG's projected value of $235,000,000 ($18,400,000 ÷ $235,000,000 = 7.83%).
The differential between H&W's going-in cap rate of approximately 9.0% and VHG's implied cap rate of 7.83% is approximately 117 basis points. This spread alone accounts for a substantial portion of the valuation gap, as even a modest compression in the applied cap rate would produce a materially higher value conclusion. By way of illustration, if H&W's stabilized NOI of $17,200,000 were capitalized at VHG's implied rate of 7.83%, the resulting value indication would be approximately $219,700,000 — a figure $27,700,000 higher than H&W's income approach conclusion of $190,000,000.
H&W justified the higher capitalization rate by referencing the following factors:
(i) Independent (non-branded) status: H&W argued that the Property's operation under an independent trade name, without affiliation with a nationally recognized hotel brand (such as Ritz-Carlton, Four Seasons, Waldorf Astoria, or similar luxury flags), carries a risk premium of 50–75 basis points relative to comparable branded luxury properties. H&W cited several academic and industry publications suggesting that branded luxury hotels benefit from lower risk perceptions among investors, stronger distribution channels, and more predictable operating performance, all of which tend to compress capitalization rates.
(ii) Hurricane and windstorm risk: H&W noted that Monroe County, and the Florida Keys generally, are located in a high-risk hurricane and windstorm zone (FEMA Flood Zone AE, with portions of the Property in Zone VE). H&W argued that this geographic exposure to catastrophic weather events introduces an additional risk factor that is reflected in higher capitalization rates for Keys properties relative to mainland South Florida resort properties.
(iii) Interest rate environment: H&W referenced the prevailing interest rate environment as of January 2023, noting that the Federal Reserve's tightening cycle had resulted in the federal funds rate target range of 4.25%–4.50% as of the appraisal date, with market expectations for additional rate increases. H&W argued that rising interest rates exert upward pressure on capitalization rates across all property types, including hospitality assets.
(iv) Limited comparable transactions: H&W acknowledged that the volume of comparable luxury resort hotel transactions in the Florida Keys submarket is inherently limited due to the small number of institutional-quality resort properties in the Keys. H&W indicated that this limited transaction evidence introduces greater uncertainty into the cap rate analysis and supports a more conservative approach.
D. Discount Rate
H&W applied a discount rate of 10.50% to the annual projected cash flows and reversion value in the ten-year DCF model. VHG's internal analysis had assumed a discount rate of approximately 9.0%.
The 150-basis-point differential between H&W's discount rate and VHG's assumed discount rate further depresses the present value of projected cash flows and contributes to the overall valuation gap. H&W cited comparable investor survey data, including the Marlowe Crane CPAs LLP Real Estate Investor Survey and the CBRE North American Cap Rate Survey, as well as the risk premium associated with single-asset, unbranded resort properties. H&W noted that the discount rate reflects the total return required by a typical investor in a property of this type, considering the property's risk profile, the illiquidity of real estate investments, and the opportunity cost of capital in the current interest rate environment.
We note that the investor survey data referenced by H&W typically reflects broad ranges (e.g., 8.0%–12.0% for luxury resort properties), and the specific positioning within the range requires subjective judgment by the appraiser. VHG may be able to argue that the Property's strong trailing performance, recent renovation, prime oceanfront location, and robust amenity package warrant positioning at the lower end of the survey range rather than the upper-middle portion selected by H&W.
E. Potential Areas for Challenge — Income Approach
Based on the foregoing analysis, we have identified the following primary areas in which the H&W income approach may be subject to challenge:
1. Occupancy Underestimation. The Property achieved 71.3% occupancy during the T-12 period ending September 30, 2022, which reflects the first full year of post-renovation stabilized performance. H&W's stabilized occupancy assumption of 68.0% is 330 basis points below the demonstrated trailing figure and appears conservative. The property's actual operating data constitutes direct, property-specific evidence that should carry substantial weight in the appraisal, particularly where it reflects a full twelve-month period encompassing all seasonal cycles. H&W's reliance on general market concerns regarding Monroe County seasonality, limited airlift, and competitive supply to override the property's own demonstrated performance may not withstand scrutiny. The $47,000,000 renovation was specifically designed to expand the Property's competitive positioning and attract new demand segments, including corporate group and incentive travel, that are less seasonally concentrated than the leisure segment. These demand dynamics should be reflected in the occupancy assumption.
2. ADR Growth Suppression. H&W's projection of 1.5–2.0% annual ADR growth does not adequately account for the continued ramp-up of the newly renovated product. The comprehensive renovation was completed only approximately 14 months before the end of the T-12 period, and historical patterns in the luxury resort segment indicate that rate premiums associated with major renovations typically require 24–36 months to be fully realized. The Property's revenue management team has been strategically yielding volume in favor of rate, and forward booking data (which may not have been available to H&W at the time of the appraisal) indicates continued rate acceleration. Furthermore, the broader luxury resort market in South Florida has experienced ADR growth in excess of the rates projected by H&W, and the Florida Keys' unique supply constraints (resulting from stringent Monroe County land use regulations that severely limit new hotel development) support above-average rate growth for existing properties.
3. Cap Rate Premium for Independent Status. While it is generally accepted in the hospitality valuation literature that independent hotels trade at a modest cap rate premium relative to comparable branded properties, the magnitude of the premium applied by H&W (50–75 basis points) may be excessive in this instance. The Coral Palms Grand Resort & Spa has established strong brand recognition in the luxury Florida Keys market over its 17-year operating history. The Property benefits from a loyal repeat customer base (VHG has indicated that the repeat guest rate exceeds 35%), a 42-slip marina and 18,000-square-foot spa that create significant barriers to entry and demand generators that are independent of brand affiliation, and a direct booking platform that produces a higher proportion of direct reservations (lower cost of acquisition) compared to many branded properties. Moreover, the independent operating model eliminates franchise fees (typically 4–5% of rooms revenue for luxury brands) and management fees (typically 2–3% of total revenue plus incentive fees), resulting in higher cash flow margins. The net effect of brand-fee savings may partially or wholly offset the perceived risk premium associated with independent status.
4. Expense Ratio. H&W's assumed total operating expense ratio of 72.5% is 180 basis points above the Property's demonstrated expense ratio of 70.7%. While H&W argued that the higher ratio reflects industry benchmarks for independent resort operations, the application of generic benchmarks to override property-specific actual performance data is methodologically questionable. The Property's trailing operating expenses reflect the specific cost structure, management efficiencies, and operational characteristics of this particular asset, and these demonstrated results should be given significant weight in the appraisal.
5. Deferred Capital Expenditure Deductions. The comprehensive $47,000,000 renovation was completed approximately 17 months before the effective date of the appraisal. This renovation was one of the most significant capital investments in the Florida Keys hotel market in recent years and addressed virtually all of the Property's physical plant. The inclusion of approximately $4,950,000 in additional deferred maintenance and capital expenditure deductions requires detailed scrutiny to determine whether these items were within or outside the scope of the 2021 renovation. If the identified maintenance items (marina pilings, parking structure, HVAC units) were not addressed in the renovation, the deductions may be appropriate; however, the renovation scope should be carefully examined before conceding this point.
V. Detailed Analysis of the Sales Comparison Approach
A. Comparable Sales Identified by H&W
The Sales Comparison Approach was employed by H&W as a supporting methodology, providing a secondary value indication to corroborate the primary Income Capitalization Approach conclusion. H&W identified approximately five to seven comparable resort hotel sales transactions that occurred in Florida and the Caribbean over the 24-month period preceding the effective date of the appraisal.
The comparable properties identified by H&W ranged from approximately 200 to 500 rooms and included a mix of branded and independent luxury and upper upscale resort properties. The specific comparable sales were not disclosed in detail in the executive summary of the appraisal report that C&H received; however, based on our preliminary review of the adjustments described in the report, the comparable set appears to include transactions involving properties in the following submarkets: Key West, Fort Lauderdale Beach, Palm Beach, Naples/Marco Island, and one or more Caribbean island locations.
H&W applied adjustments to the comparable sales to account for differences in the following categories: (i) location, including Keys premium or discount relative to mainland Florida and Caribbean locations; (ii) room count and scale; (iii) resort amenities, including quality and breadth of meeting space, spa, marina, and recreational facilities; (iv) condition and renovation status, including recent capital investment; (v) oceanfront access and waterfront positioning; and (vi) date of sale, with time adjustments to reflect market conditions as of the effective date of the appraisal.
After application of all adjustments, H&W's adjusted comparable sale prices ranged from approximately $475,000 to $620,000 per room. Based on the adjusted range and the appraiser's judgment regarding the relative comparability of each transaction, H&W concluded a value of approximately $570,000 per room for the Coral Palms Grand Resort & Spa. Applied to the Property's 342 rooms, this per-room value produces an indicated value of approximately $194,940,000, which H&W reconciled downward to $195,000,000 for the Sales Comparison Approach conclusion.
B. Potential Areas for Challenge — Sales Comparison Approach
1. Comparable Selection. A critical area for review is the composition of H&W's comparable sales set. We need to examine whether H&W included the most relevant comparable transactions, particularly recent premium resort trades in the Florida Keys and broader South Florida luxury market. Several noteworthy luxury resort transactions have occurred in the South Florida market over the 24-month period preceding the appraisal that may not have been included or may have been insufficiently weighted in H&W's analysis. For example, there have been reports of luxury resort transactions in the Key West, Miami Beach, and Palm Beach submarkets at per-room values in the range of $600,000 to $800,000 or more. If H&W omitted or underweighted these transactions in favor of more geographically diverse but less directly comparable Caribbean or Gulf Coast sales, the comparable set may skew downward. Claybourne should be instructed to conduct an independent comparable sales search to identify any material omissions.
2. Per-Room Value. H&W concluded a per-room value of approximately $570,000 for the Property. VHG's internal valuation of $235,000,000 implies a significantly higher per-room value of approximately $687,134 ($235,000,000 ÷ 342 rooms = $687,134 per room). The differential between the two per-room values is approximately $117,000, or approximately 17%. This differential is substantial and should be analyzed in the context of the Property's recently completed $47,000,000 renovation, which translates to approximately $137,000 per room in capital investment. A property that has received approximately $137,000 per room in renovation capital within the past 17 months should, all else being equal, command a premium per-room value relative to comparable properties that have not undergone recent renovation. The extent to which H&W credited this renovation investment in the per-room value analysis warrants careful examination.
3. Adjustment Methodology. A detailed review of H&W's adjustment grid is necessary to assess whether the adjustments applied for the recently renovated condition of the Coral Palms Grand Resort & Spa are adequate. Standard appraisal practice involves applying upward adjustments to comparable sales that were in inferior condition relative to the subject property at the time of sale. The magnitude of these condition adjustments should reflect the cost and scope of the renovation and the impact of the renovation on the Property's competitive positioning, quality tier, and revenue-generating capacity. If H&W applied only modest condition adjustments (e.g., 5–10%) to comparable sales involving properties that were not recently renovated, while the $47,000,000 renovation represents approximately 24.5% of the appraised value, the adjustments may be insufficient.
4. Marina and Ancillary Value. The Property includes several significant non-room revenue-generating components that contribute materially to overall value: the 42-slip marina, approximately 28,500 square feet of meeting and event space, and the approximately 18,000-square-foot full-service spa. These ancillary facilities are significant value drivers that differentiate the Coral Palms from many of the comparable properties identified by H&W. In the per-room analysis employed in the Sales Comparison Approach, the value of these non-room components is implicitly embedded in the per-room value conclusion. However, if the comparable sales included properties with significantly less robust amenity packages (e.g., properties without a marina or with smaller meeting/spa facilities), the per-room comparison may not adequately capture the incremental value contributed by the Coral Palms' superior amenity offering. An alternative approach — extracting the value of the non-room components and analyzing the rooms separately — may be warranted to ensure that the comparison is conducted on a like-for-like basis.
VI. Analysis of the Cost Approach
A. H&W Cost Approach Summary
H&W included a Cost Approach analysis in the appraisal report, which produced a value indication of approximately $188,000,000. The components of the cost approach are summarized as follows:
• Replacement Cost New of Improvements: Approximately $350,000,000. This figure represents H&W's estimate of the current cost to construct a functionally equivalent resort property with similar utility, using modern construction methods and materials, as of the effective date of the appraisal. The estimate was developed using a combination of cost-estimating publications (including marshall Valuation Service and RS Means) and comparable construction cost data for luxury resort properties in the Florida Keys.
• Less Accrued Depreciation: Approximately ($185,000,000). This deduction represents H&W's estimate of the total depreciation accrued to the improvements from all causes, including physical deterioration (both curable and incurable), functional obsolescence, and external (economic) obsolescence. The depreciation deduction of $185,000,000 represents approximately 52.9% of the estimated replacement cost new.
• Plus Land Value: Approximately $23,000,000. H&W estimated the value of the 22.4-acre oceanfront site using the sales comparison approach for vacant land, analyzing comparable sales of waterfront land parcels in Monroe County and the broader Florida Keys.
• Cost Approach Conclusion: Approximately $188,000,000.
B. Observations. The Cost Approach was appropriately given the least weight in the reconciliation, which is consistent with standard appraisal practice for income-producing resort hotel properties. The cost approach is most reliable for new or nearly new improvements and is inherently less reliable for older properties, where the estimation of accrued depreciation involves significant subjectivity and where the market value of a property may bear little relationship to its replacement cost.
Nevertheless, two aspects of the cost approach warrant further review:
Land Value. H&W's estimated land value of $23,000,000 for 22.4 acres of oceanfront land in Key Largo warrants scrutiny and may be conservative. The Florida Keys are subject to some of the most restrictive land use and development regulations in the United States, including the Monroe County Comprehensive Plan, the Area of Critical State Concern designation, the Rate of Growth Ordinance (ROGO), and stringent environmental regulations governing development in areas of environmental sensitivity. These regulatory constraints severely limit the supply of developable oceanfront parcels in the Keys, creating a scarcity premium that should be reflected in the land value estimate. The $23,000,000 land value translates to approximately $1,027,000 per acre ($23,000,000 ÷ 22.4 acres), or approximately $23.59 per square foot of land area. Given the property's location on a 22.4-acre oceanfront parcel in Key Largo with direct ocean access, a private beach, and a 42-slip marina basin, a land value in excess of $23,000,000 may be supportable.
Depreciation Deduction. The total depreciation deduction of approximately $185,000,000, representing approximately 52.9% of the estimated replacement cost new, appears aggressive in light of the comprehensive $47,000,000 renovation completed in August 2021. While the original improvements date to 2006 (approximately 17 years of age as of the appraisal date), the 2021 renovation addressed virtually all guest-facing improvements and a significant portion of the building systems. A property that has received $47,000,000 (approximately 13.4% of the estimated replacement cost new) in renovation capital within the past 17 months should exhibit a depreciation profile that reflects the newly renovated condition of a substantial portion of the improvements. The depreciation estimate should be decomposed into its component parts (physical deterioration, functional obsolescence, and external obsolescence) to assess whether each component is reasonable.
VII. Impact on the Proposed Refinancing
A. Loan Sizing Impact
The following table summarizes the impact of the H&W appraised value on the proposed loan sizing, compared to the sizing at VHG's internally projected value:
As the table illustrates, the H&W appraised value of $192,000,000 causes the proposed $160,000,000 loan to exceed the 68.0% maximum LTV by a margin of 15.33 percentage points (83.33% versus 68.0%). This is not a marginal exceedance that can be addressed through a minor waiver, as was the case with the 9-basis-point exceedance under VHG's projected value. Rather, it is a material breach of the Commitment Letter sizing constraint that will fundamentally alter the economics of the transaction.
B. Financial Impact on VHG
The financial impact on VHG of the reduced appraised value is significant and far-reaching.
At the Commitment Letter's 68.0% maximum LTV, the maximum loan amount supportable by the $192,000,000 appraised value would be $130,560,000. The sufficiency of this reduced loan amount must be evaluated against VHG's total capital requirements for the transaction:
• Existing Tidewater mortgage payoff: $118,500,000 (outstanding principal balance)
• Prepayment premium (1.0% of outstanding balance): $1,185,000
• Estimated closing costs (legal, title, escrow, recording, lender fees): $3,250,000
• Upfront reserves (tax, insurance, FF&E, capital expenditure): $4,800,000
• Total Required Payoff and Transaction Costs: $127,735,000
Loan proceeds of $130,560,000 would exceed the total required payoff and transaction costs of $127,735,000 by only approximately $2,825,000. This residual amount effectively eliminates the approximately $32,265,000 net cash-out distribution to VHG that was a primary economic driver and strategic objective of the refinancing. The loss of the cash-out proceeds will impact VHG's capital allocation plans, which, based on prior discussions with VHG's management team, contemplated deploying the proceeds toward renovation of VHG's other hotel properties and reduction of corporate-level revolving credit facility borrowings.
VHG must anticipate that PAC will respond to the appraisal in one of the following ways:
(i) Reduced loan amount at existing terms: PAC may reduce the loan amount to approximately $130,560,000 (the 68.0% LTV maximum) while maintaining the originally quoted rate and structural terms. This outcome eliminates the cash-out but preserves the refinancing of the existing Tidewater mortgage.
(ii) Increased loan amount at worse terms: PAC may offer a loan amount above $130,560,000 but below $160,000,000, subject to materially worse pricing and structural terms. Such terms could include an increase in the fixed interest rate (potentially 50–100 basis points or more), the imposition of additional collateral requirements (cross-collateralization with other VHG assets), increased recourse obligations (partial or full recourse replacing the limited "bad boy" carve-out structure), more aggressive amortization (commencement of amortization from day one rather than an interest-only period), and enhanced cash management provisions (hard lockbox and cash trap or cash sweep structures).
(iii) Declination to fund: PAC may decline to fund the loan entirely if PAC determines that the risk profile of the transaction at the reduced appraised value exceeds its underwriting parameters, regardless of repricing adjustments.
If PAC is willing to stretch the LTV to approximately 72–73% (as some institutional lenders are willing to do with appropriate credit enhancements), the loan amount could reach approximately $138,240,000 to $140,160,000 ($192,000,000 × 72% = $138,240,000; $192,000,000 × 73% = $140,160,000). However, any LTV above 68.0% would require material credit enhancements, and the resulting loan would still fall $19,840,000 to $21,760,000 short of the originally proposed $160,000,000, significantly reducing the cash-out to VHG.
C. Existing Loan Considerations
The timing dimension of the refinancing adds additional pressure to the current situation. The existing Tidewater National Bank first mortgage loan matures on June 1, 2024, which is approximately 16 months from the date of this memorandum. The current floating interest rate on the Tidewater loan is SOFR plus 2.25% per annum, as converted from LIBOR pursuant to a benchmark transition fallback amendment dated March 15, 2022.
If the PAC refinancing does not proceed — or proceeds at a materially reduced loan amount that does not satisfy VHG's capital needs — VHG will need to pursue one of the following alternatives before the June 1, 2024 maturity date:
(i) Extension with Tidewater: VHG could seek to negotiate a maturity extension with Tidewater National Bank, N.A. The feasibility and terms of any extension would depend on Tidewater's credit appetite, VHG's relationship with Tidewater, and the bank's assessment of the Property's value and operating performance. Extension terms may include an extension fee, a rate adjustment, and the posting of additional reserves or collateral. There is no guarantee that Tidewater would agree to an extension, and the extension negotiation itself would consume time and management attention.
(ii) Alternative refinancing: VHG could pursue a refinancing with an alternative lender. However, any alternative lender will likely require its own appraisal, and there is a risk that a new appraisal would produce a value conclusion similar to H&W's. Furthermore, the timeline for sourcing, underwriting, and closing an alternative refinancing would be compressed, particularly if the PAC transaction is not formally terminated until several months from now.
(iii) Payoff from internal resources or capital markets: VHG could arrange to repay the Tidewater loan at maturity using a combination of internal cash reserves, corporate revolver borrowings, or proceeds from a capital markets transaction (e.g., a secondary equity offering or corporate bond issuance). The cost and feasibility of this alternative would depend on VHG's balance sheet capacity and market conditions at the time.
An additional timing consideration relates to the prepayment premium on the Tidewater loan. The existing loan documents provide for a prepayment premium of 1.0% of the outstanding principal balance ($118,500,000 × 1.0% = $1,185,000) if the loan is prepaid before March 1, 2023. After March 1, 2023, no prepayment premium applies. If the PAC refinancing can be restructured and closed after March 1, 2023, VHG would save $1,185,000 in prepayment costs. The timing of any refinancing closing, whether with PAC or an alternative lender, relative to this date is therefore a relevant economic consideration.
D. Deposit Exposure
VHG has committed the following deposits in connection with the PAC refinancing transaction:
• Good Faith Deposit: $1,600,000, deposited on December 12, 2022, with Meridian Title & Escrow, Inc. (the "Escrow Agent")
• Rate Lock Deposit: $800,000, deposited on January 5, 2023, with Meridian Title & Escrow, Inc.
• Total Deposits at Risk: $2,400,000
The refundability of these deposits in the event VHG elects to terminate the transaction (or PAC materially reprices the loan such that VHG declines to proceed) depends on the interpretation of the Commitment Letter provisions and the terms of the side letter agreement regarding conditions under which the Borrower may terminate and recover deposits. Section 8.4 of the Commitment Letter addresses the treatment of deposits upon termination, and the side letter dated December 9, 2022 (executed concurrently with the Commitment Letter) contains additional provisions governing the borrower's termination rights and deposit recovery. A separate analysis of these provisions is recommended and should be prepared as part of the parallel workstream described in Section VIII.D below.
The key question is whether PAC's repricing of the loan — if it results in terms materially different from those set forth in the Commitment Letter — constitutes a "material modification" of the Commitment Letter terms, which may trigger VHG's right to terminate and recover the deposits. The definition of "material modification" and the enumeration of borrower termination events will need to be carefully analyzed in the context of the specific Commitment Letter language and applicable New York law (the Commitment Letter is governed by New York law pursuant to Section 12.1).
VIII. Recommended Strategy for Challenging the Appraisal
Based on our review of the H&W appraisal, we recommend that VHG pursue a multi-pronged strategy to challenge the appraisal and protect its position in the refinancing transaction. The following elements constitute our recommended approach:
A. Formal Appraisal Challenge to PAC
We recommend that C&H prepare, on behalf of VHG, a detailed formal letter to PAC identifying specific deficiencies and areas of concern in the H&W appraisal. The letter should be addressed to PAC's outside counsel, Whitford Baines & Driscoll LLP ("WBD"), attention Philip Tarrant Corporation, Esq., with copies to the PAC deal team (Ma