How Do You Take Your Morning Hotel?
Ask four colleagues how they take their morning coffee and you are likely to receive four varying responses; loads of sugar, black, splash of cream or packet of artificial sweetener might be some replies. Such is the case with hospitality lenders – each has specific likes and dislikes when it comes to financing the right hospitality project.
At present, hotel lenders have strong opinions as to what suits their financing programs. Some prefer full-service assets while others favor limited-service. Luxury flags like Ritz Carlton are sought by some as other lenders desire economy operators such as Ramada. Most lenders prefer primary metropolises on the American coasts while still others see opportunity in secondary lending markets while resort locations are perceived to be the riskiest. Further muddying the water is that each bucket of debt has different loan-to-value thresholds, interest rate ranges and debt yield requirements.
Universal desires among lenders include strong historical and in-place cash flow, experienced management, solid borrowers and a superior location compared to competition. One active lender professed a preference for unassuming flags with generous net operating income cushions compared to an institutional known brand with tighter margins.
Appetite from hotel lenders is not expected to peak or valley in the near future as balance sheet lenders pick up the once hot CMBS slack. With treasury bills and LIBOR hovering near historic lows, financing at reasonable pricing remains attainable for well located and cash flowing hospitality assets.
Because revenue is derived from overnight contracts with little contractual future income, both occupancy and rates are intimately linked to economic fluctuations. Therefore, lenders prefer robust in-place cash flow in the event economic fortunes deteriorate quicker than management can adjust expenses and room rates. The good news for established hotels with premium locations, strong cash flow and respected management is that there are active lenders. The caveat? Conversations with hotel lenders of all shapes and sizes indicated widespread use of conservative underwriting.
In the first half of 2011, conduits dominated the debt equation on the heels of a resurgent hospitality market as RevPAR continued to climb. Non-recourse quotes with low fees, 5 percent rates, 80 percent loan-to-value limits and 10 percent debt yields on in-place net operating income were too favorable to ignore by equity investors, loan note purchasers and owners able to refinance. However, recent volatility in the CMBS market saw spreads substantially widen and conduits take a breather. Despite CMBS debt becoming more expensive, demand from borrowers remains. In a sign of what the future may hold, the Renaissance Raleigh North Hills Hotel recently secured a 10 year, $47.5 million conduit loan from RBS Commercial Real Estate that amortizes over 30 years with a rate below 6 percent. With conduit volume weak for now, where do hotel investors seek financing in the capital markets?
Life insurance companies are active on a select basis with laser point focus on trailing 12 month financials and lending up to 60 percent loan-to-value. Despite record low treasury rates, floors have been instituted around 5.25 percent and 3.75 percent for ten and five year loans, respectively. As with other real estate product types, life insurance companies will break through rate floors and increase proceeds for coveted opportunities. Commercial banks may go up to 65 percent loan-to-value with partial recourse including projects with redevelopment components.
Hotel deals with any combination of negligible cash flow, necessary capital improvements or questionable locations remain challenging to lend against. However, debt funds and bridge lenders are poised and well capitalized to execute on projects with a compelling story. Interest rates range from 6 percent – 12 percent depending on several variables with an emphasis placed on the hotel’s equity sponsor.
Construction loans are nearly exclusive to the top five largest metropolitan areas and are difficult to execute. Borrowers seeking subordinate financing can obtain proceeds up to 75 percent loan-to-value with debt yields approaching 7.5 percent. Though mezzanine lenders remain engaged, borrowers should expect pricing to be commensurate with risk.
By Greg Dietz - Senior Analyst
September 28, 2011
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