Different Ways to Restructure a Hotel Loan

After four years of negative and negligible growth, the U.S. economy is finally showing signs of recovery. Despite this, global events including financial challenges throughout Europe and political turmoil in the Middle East may contribute to tipping our economy back into a recession.

After the hospitality industy’s slow, but steady recovery the past few years, the global events mentioned above could curtail travel and once again put hotel properties in jeopardy of foreclosure and bankruptcy. For these properties, a workout may be the best possible solution. Workouts are an attempt by the borrower/hotel owner and lender to salvage a potentially valuable hotel property and avoid the delays, expense and reputational damage generated in foreclosure or bankruptcy proceedings.

In the hotel industry, a property’s reputation is critical, and the decision to pursue a workout or an alternative solution shouldn’t be delayed. Below are brief descriptions of some of the actions hotel owners and lenders can take:

One route is the lender takes no action, which causes the least disturbance to the property. This choice indicates either the lender’s supreme confidence in the borrower, or the absence of a viable alternative, and leaves the solution of the hotel’s problems to the ability of the borrower and the patience of the lender.

Another alternative is selling the property, assuming a price can be obtained that is at least close to the unpaid debt balance, and provides the lender with a fast and relatively risk-free resolution while protecting the borrower’s reputation and credit history. In the event the price received is less than the principal and accrued interest, the lender must recognize its loss at the time of the sale, while the owner is forced to take the negative tax consequences of the sale.

Hotel owners in this situation could also work with the lender to extend the term of the loan. This will reduce the amount of debt service paid toward amortization, which may result in the lender receiving the return of its entire loan and more interest due to the longer payout period, while reducing but lengthening the payment provisions for the hotel owner. However, the lender must remain with the property for an extended period of time and, if the workout is not successful, the lender may have to make future concessions. In exchange for lower debt service initially, the hotel owner will be forced to pay significantly more interest over the term of the loan, but will stay in possession of the property.

Another possibility is the lender could reduce the interest rate on the property. However a lender may be hesitant to subsidize the hotel after it became successful, as it would hurt its bottom line if interest rates increase and the property is tied to a low-interest loan. One option for a borrower interested in this option is to propose a shortened maturity date for the mortgage to protect their position. Alternatively, the owner could suggest a moratorium in which loan payments will accrue, but are not made until after the property’s performance improves. If a lender agrees to this option, the borrower should be prepared to make significantly higher payments after the moratorium ends and the property’s problems are resolved.

The lender could also restructure the debt service so that it is not in excess of the net operating income, which can be accomplished by dividing the loan into an “A” piece, with the debt service paid currently, and a “B” piece, which accrues and is paid from sale or refinancing proceeds or an improved economy. If the property becomes successful, this alternative would produce a good return for the lender since it would receive the bulk of the profit. The lender could reduce the principal amount of the indebtedness, which provides the borrower with a lower monthly payment and a smaller amount that has to be repaid on maturity, thereby making it easier for the borrower to sell the property. However, the lender loses any right to a portion of its loan, even if the property increases substantially in value.

A final alternative would be for the borrower to repay the existing mortgage loan with a large discount by borrowing the maximum amount available from another lender based on the then current loan-to-value ratio and use the net proceeds to satisfy the existing debt.

Stuart M. Saft, chair of Dewey & LeBoeuf's Global Real Estate Department, is one of the leading lawyers in the development, financing, leasing, conversion to condominium and cooperative ownership, construction, exchange, syndication, sale/leaseback, timeshare, restructuring, acquisition and sale of residential, commercial and hospitality property throughout the U.S.

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