How to Secure the Most Favorable Hotel Financing Terms

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How to Secure the Most Favorable Hotel Financing Terms


Even within the context of a lengthy economic expansion, the hospitality sector is demonstrating its strength and stability. According to CBRE, year-over-year national hotel occupancy reached a new record of 68.1 percent—and the hotel demand rate continues to grow. This is a positive sign for investors. While some in the finance industry feel that, given the length of this recovery, the hotel market has topped off and is about to change, in truth, there are no signs that the market is in decline.

In fact, now is one of the best times in recent history to refinance existing hotels based on the continuation of historically low interest rates.

That said, lenders today remain careful and selective in their hotel underwriting, making it more important than ever for borrowers to reach out to many different financing sources, and to present lenders with clear, well-documented financing packages and business plans in order to receive competitive loan options.

Hotels are different than any other commercial asset type because lenders must recognize the value in both the real estate and the ongoing operation. Based on this complexity, it is critical that today’s borrowers understand all their available sources for hotel financing in the current market for each type of transaction.

Below is a look at those transactions and sources.

Acquisitions

CMBS lenders provide the highest leverage for existing stabilized loans and are therefore one of the best sources for higher-leverage hotel acquisition financing.

While most hotel lenders prefer to stay between 55 percent and 60 percent loan-to-value in the current market, we have successfully achieved up to 65 percent-70 percent for borrowers, subject to a 10 percent-12 percent debt yield constraint. That financing level can then be topped off with an additional layer of mezzanine debt, bringing the total debt stack up to approximately 75 percent to 80 percent loan-to-value.

It’s also important to carefully navigate recourse versus non-recourse loan terms. Borrowers who opt for a recourse loan can receive a much more flexible loan with fewer controls, less reserves, and a lower rate. Non-recourse loans, such as CMBS loans, by their nature, must be self-contained and designed to include requirements that allow the loan to stand on its own.

Some buyers of hotels may intend to commence renovations or other upgrades following their hotel acquisition. If these are projected to substantially increase the value and cash flow of the property, the buyer should consider a renovation loan. These types of loans are discussed below.

Renovation/redevelopment

Renovation or redevelopment of an existing hotel is a very cost-efficient option for hotel owners because it can be less expensive than building a new hotel from the ground up. These types of renovation/redevelopment loans can generally be obtained from banks or debt funds. Bank loans will generally be recourse, but can provide a lower rate, while debt funds will be non-recourse but will be more expensive.

Even with these sources, financial and strategic presentations to the lenders with full analysis of the proposed renovation or redevelopment are required to achieve a favorable response from a lender.

Refinancing

Refinancing may be necessary if the hotel’s current financing is due and/or if the owner is seeking equity through a larger loan. This can give the owner an opportunity to capitalize on the hotel’s increased value and obtain cash to reinvest into new opportunities or complete renovations on the subject hotel that will increase value.

These loans can be obtained from banks, CMBS lenders, debt funds or life insurance companies and can be from 50 percent to 70 percent of value, with rates between five and eight percent, depending on the transaction.

In analyzing the request, lenders will look carefully at the supply and demand for hotels in the area and may even adjust the hotel’s current operating history downward if they think the hotel will be facing increased competition and reduced demand.

Ground-up development

For ground-up hotel development, a bank or debt fund is the best source of financing. These lenders tend to cap their lending at 50 percent-65 percent loan-to-cost, depending on whether the borrower chooses a recourse or non-recourse option.

Mezzanine funds are typically used to add another layer of leverage to the capital stack. These lenders are eager to place capital and may price their loans between 10 percent and 14 percent fixed return. They are a good option for the borrower and can reduce the need to raise more equity.

Other ways to fill the funding gap in new construction of hotels involve the utilization of PACE, EB-5 or Opportunity Zone fund financing. All of these funding types can supplement the construction financing provided by the senior lender. The challenge is coordinating all these multiple financing sources in order to make a project work.

For example, George Smith Partners recently arranged a $32.4 million financing for the development of a high-end resort in a secondary market. The capital stack for this hotel financing included a senior construction loan from a debt fund, a PACE financing, local municipal grants, sales tax rebates, and even stock pledges from the borrower to get to the required leverage. PACE financing is a state-organized bond funding secured with the property-tax obligations to fund the construction of energy-efficient equipment in a new hotel. This financing was the first PACE funding in the country on a to-be-built hotel.

Equity

Finding equity for the acquisition, renovation or development of hotel opportunities can require some rigor; however, the right capital advisor can identify these sources.

Institutional investors are most interested in investing in larger hotels in infill suburban or downtown locations, while high-net-worth individuals are the best bet for smaller hotel equity.

Historically, one of the best sources of hotel equity has been EB-5 funds. Because these funds require job generation both during construction and ongoing operations, hotels easily qualify for EB-5 equity. That said, the most prolific EB-5 capital came from Chinese immigrant investors. But with the increased waiting times for approval from the U.S. government and restraints on capital transfers from the Chinese government, that capital has all but disappeared. EB-5 money from Europe and India may be available now.

Another emerging source of hotel equity is Opportunity Zone (OZ) funds. While OZs, by definition, are for less affluent areas, which often would not support a hotel property, some developers may find opportunities to creatively introduce hotel redevelopments or developments in specific OZs where demand can be demonstrated.

Equity can also be provided in creative ways. My team recently closed the financing for a luxury historically registered hotel and spa resort being redeveloped in Napa, Cal. For this project, we arranged for a $27 million acquisition and redevelopment loan from a private lending group. With a strategy to sell some of the excess land, and by giving the lender a small participation depending on the speed of the land sales, we arranged for the lender to provide more than 85 percent of the initial capital.

On the horizon

While hotel financing will continue to remain complex to secure, with the help of the right capital advisor, good structures can be arranged. Lenders will continue to underwrite cautiously to minimize risk, and that is not expected to change in the future. For a developer, buyer, or owner seeking hotel financing, there are still plenty of lenders willing to make those loans.

Valuations are high and cap rates are low for high-end downtown hotels, and we expect those trends to continue. The smartest borrowers understand that finance terms and options can vary widely. By working with an advisor who can present opportunities to a large network of finance sources, borrowers can find very competitive terms for their financing needs.

Steve Bram is principal and co-founder of George Smith Partners, a national commercial real estate capital advisory firm. Prior to his 35-year tenure at GSP, he worked in hotel operations. He can be reached at [email protected].



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