The Financing Challenge
Clearly, the tide has turned in lodging financial markets, and after many years at a disadvantage, lenders are back on top. They control the flow of debt money and, as a result, the pace of new hotel development and acquisitions. Money — and plenty of it — is still available, but the terms and rates have changed, as well as who can gain access to it. These are some of the conclusions drawn from this year's survey of the hotel lending community conducted by Hotel Brokers International in conjunction with Lodging Hospitality.
“Despite an increasingly challenging credit environment, hotel performance metrics remain positive,” noted survey respondent Cameron Larkin of Larkin Hospitality Finance. “As a result, hospitality lending volume should pick up during the second half of the year as broader economic indicators disprove current recessionary panic. In the interim, hotel projects continue to be financed at historically favorable terms.”
2007 was another stellar year for hotel transactions. According to Hotel Brokers International's TransActions Data Service, 736 single-asset property sales were brokered last year. The number of deals was higher than recorded in 2006, as was the average price. The average sold hotel had 196 rooms, and the average sales price per key was $117,000, up from $110,000 in 2006 and up from the decade low of $52,000 in 2000.
While the sales covered all industry segments, upscale hotels showed the most activity (193 sales), followed by upper upscale (161), economy (140) and midscale without food & beverage (127).
The overall cap rate for the sales was 9.21 percent, flat compared to 9.19 percent in the prior year. The economy property cap rate was 10.97 percent, up from 10.06 percent in 2006. Cap rate for mid-market hotels was 9.19 percent.
Lenders in the survey were busy last year, too. Nearly half said they underwrote more loans in 2007 than in the previous year. Many of them were big deals. A sample of the loans extended last year included 33 valued at $774 million, 65 at $110 million and 91 at $1 billion.
This year may be a different story for transactions, according to K.J. Singh of Fairway Lending. “Hotel financing has been tight for the past two quarters,” he said. “I expect less activity in hotel sales and for valuations to either be flat or go down.”
Participants in this year's survey represented a wide cross-section of lenders who deal in most segments of the industry. One-fourth of respondents are mortgage bankers, and a nearly equal number are representatives of national and regional banks. About one in five are SBA providers. Others in the mix included credit companies, life insurance companies and mortgage bankers.
Nearly all of the lenders say they finance new-construction projects as well as acquisitions of turnaround or under-performing properties. Nearly everyone surveyed provides funding for refinancings, renovations and acquisitions. As one respondent commented, “I see a moderate increase in refinancings and permanent loans, but a decline in new-construction lending.”
Limited-service and extended-stay properties are most popular with these lenders; all of them provide funding in these segments. Most finance upscale and mid-market hotels, and 96 percent are lenders for full-service properties. About three-fourths of lenders in the group fund economy hotels and resort properties.
In a change from surveys in recent years, 27 percent of respondents said they provide funding for timeshare development. In the 2006 survey, fewer than 10 percent of those surveyed said they would consider vacation ownership.
Property location isn't much of an issue with these lenders. All of them say they fund properties in suburban and airport locations, while 92 percent of respondents consider urban and highway hotels. And, as noted previously, resorts and timeshare projects have favor with many of these financial sources.
Here's a review of loan terms, pricing and requirements these lenders apply to the deals they fund:
Loan terms range from two to 25 years, with 10 years the most common term.
Amortization rates are typically in the 25- to 30-year range.
Loan-to-value ratios range between 75 and 90 percent. Some lenders and borrowers report that LTV ratio requirements have tightened, even for stabilized properties.
Debt coverage ratios are typically 1.0 to 1.4.
Most lenders offer both fixed- and variable-rate loans.
The calculations for both management fees and reserves for replacement range from three to four percent.
A majority (68 percent) of respondents use trailing 12 months to compute debt coverage ratios. Forty-four percent use a property's previous year's profit-and-loss statement, while 40 percent use rolling-12 months and future-stabilized-year projections.
A majority of lenders include anticipated renovation expenditures, reasonable proformas and future-stabilized year figures in their underwriting.
Most of the respondents extend non-recourse financing for stabilized properties.
A majority of lenders originate loans that are assumable and/or prepayable.
Sixty percent of those surveyed say they write new construction loans that evolve into permanent financing.
Regarding loan packages, a majority of lenders require appraisals and Phase 1 environmental and engineering reports. Some also require feasibility studies.
Not surprisingly, a majority of respondents believe hotel lending will continue to moderate this year. “Careful and prudent underwriting” is what one lender says borrowers can expect. As another said, “There is a general move toward quality brands in quality locations with very strong sponsorship.”
“It will be a difficult year,” said one less-than-optimistic lender. “With the continued dysfunction in the global credit markets, lenders will be much less aggressive on loan to value and spread.”
Another lender was even less positive: “From an underwriting perspective, it will be a greatly tightening market, particularly in conventional products, with widening spreads, lower LTV ratios and compression in cap rates. On the good side, SBA 504 lending should continue strongly.”
While the overall economy is filled with danger signs, the fundamentals of the lodging industry should remain strong and provide assurance to those lenders still in the hospitality market. As Jay Patel of High Trust Bank commented, “Hotels will remain resilient to the economy.”
According to the latest projections from Smith Travel Research, most industry operating benchmarks, except occupancy, will continue to rise this year. Although down slightly from 2007, occupancy should fall by just a half-percentage point to a still-healthy 62.7 percent.
Demand will rise by 1.4 percent but will be offset by a 2.2-percent increase in supply. STR predicts average rate will rise by more than five percent, which is well above the industry's 20-year average of 3.4-percent annual increases. After topping $100 for the first time in '07, ADRs will hit nearly $110 this year.
Still, the industry faces some challenges. New construction is heating up, although it is ultimately dependent on the availability of capital. According to Lodging Econometrics, at the end of the first quarter, more than 5,800 hotel projects and 779,307 guestrooms were in the development pipeline, a new record. During the quarter, 125,442 newly announced rooms entered the pipeline, an all-time high that shows the continued viability of new hotel construction.
“Financing for new construction will be tough,” said James Munson, president of Munson Associates. “Supply has overcome demand in many markets so it will be project-by-project underwriting.”
The midscale without food and beverage segment remains the darling of developers, with more than 50,000 rooms in the pipeline. Certain markets are hot, too. Las Vegas has 18,000 rooms under development; New York City has 8,000 in the works; Chicago and Washington, DC each have 6,000.
There's still opportunity for development of large, full-service hotels. According to LE data, seven hotels with more than 1,000 rooms each enterted the pipeline in the first quarter. Of those seven, three are casino hotels, while another is a 3,500-room Marriott in Las Vegas.
The condo-hotel boom is over. According to STR figures, nearly 5,000 condo-hotel units opened in both 2006 and 2007. However, in '07 developers abandoned nearly 100 projects with a total of 11,500 projected units. As one survey respondent noted, “It will be difficult to fund any hotels that require condominium units to justify the development.”
To put them into perspective, the economy and the hotel business are facing challenges this year, but it's not the time to panic. Deals will still get done, and new development will continue — although developers of new projects not yet funded may have some difficulties and face longer time lines to completion.
“We will continue to fund hotels that make sense,” said Tom Hollinshead of Zion Small Business Finance, “those that are are properly priced and when the borrowers are experienced hoteliers.”
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