NATIONAL REPORT—It appears hotels continue to be in the favored-status zone when it comes to lender financing. Industry prosperity, an elongated lodging cycle, and continuing, although slowing, RevPAR growth all support potential hotel deals (although always project and market dependent).
Hotel Business recently reached out to take the pulse on how financing is trending now and caught up with several leading executives who are immersed in the art—and nuts and bolts—of funding.
They include Michael (Mike) Armstrong, principal, HREC Investment Advisors; Elliot Eichner and David Sonnenblick, co-founders and principals, Sonnenblick-Eichner Co.; and Michael Sonnabend, founder/managing member, PMZ Realty Capital LLC.
How is the lending landscape for hotels looking from your perspective? Armstrong: In a word: healthy. In many ways, this is a borrower’s market. Loan terms remain favorable despite the Fed’s recent and planned rate hikes. There are lots of lenders who will make hotel loans and plenty of capital (both debt and equity) for hotel owners looking to do deals. The hotel-financing market is active with a variety of lenders offering loans for all situations: non-recourse, fixed-rates, floating-rates, permanent, bridge and mezzanine. Interest rates are creeping up but rates are still well below where they were at the peak of the last cycle. Eichner: The lending landscape for hospitality financing is very attractive right now. There is a tremendous amount of liquidity across the sector for all types of hospitality including full-, select- and limited-service product. Moreover, we are seeing capital being provided from every major provider of capital. These capital sources include life insurance companies, commercial banks, Wall Street investment banks, private debt funds and equity funds. Capital is being provided for all types of structures, including acquisition loans, permanent loans, renovation loans, mezzanine, construction loans and joint-venture equity transactions. Sonnabend: The lending market is solid. Although underwriting standards are tightening, there are a variety of lenders/investors active in all levels of the capital stack. It may take more creativity, but attractive financing at reasonable leverage levels is attainable.
In general, what kind of lending terms can owners/developers expect? Armstrong: Borrowers should expect to have 30-35% equity in the deal, but it depends on the type of loan the borrower needs and his/her specific situation. Non-recourse permanent financing (CMBS) currently tops off at 70% LTV with coupon rates in the 4.5-5% range for a 10-year term. Rates could be lower for lower leveraged deals. Non-recourse bridge loans are typically floating with coupons in the 5-6.5% range for 65-70% leverage. Construction lenders will require 40% equity, which could be partially funded with mezzanine, preferred equity or EB-5. Sonnabend: In general, first-mortgage lenders are becoming more conservative on leverage levels, but there are a variety of sources ready, willing and able to fill those gaps. The blended cost of capital is still very attractive based on historical levels. Sonnenblick: Terms are going to be a function of the type of property, location, operating history, brand affiliation and management. With this being said, we are generally seeing permanent loans for quality transactions at full leverage, 65-70% LTV, being sized to about a 10% debt yield, with credit spreads generally in the 200-225 bps over the 10-year swap rate, equating to an interest rate today of 4.5% or less. As the leverage point decreases, pricing will improve. We are currently arranging a $50-million financing for a Marriott property at about a 12% debt yield that is achieving pricing at sub 200 bps over the 10-year swap rate. We are also working on a financing in excess of $100 million for a branded hotel for which the pricing is less than 150 bps over the swap rate. Leverage on that hotel is expected to be less than 50%.
Obviously, deals are getting done. What’s getting the money? Armstrong: Premium-branded hotels with strong sponsors in solid markets attract more lender interest and better terms than hotels missing one or more of those ingredients. Additionally lenders prefer hotels with a two-to-three-year stable operating history. However, there are lenders for just about any situation but borrowers should expect to pay slightly higher rates and/or may have to accept lower leverage. Eichner: Hotels that have strong sponsorship, cash flow (although we have recently closed several loans that were in ramp-up), and are well located attract capital. Sonnabend: The most highly sought-after deals are those in markets that have significant barriers to entry, multiple demand generators and strong sponsorship.
Are certain lodging segments, e.g. select-service projects vs. full-service, or markets (primary, secondary, tertiary) a better bet for financing right now? Why? Armstrong: Hotel lenders are using conservative underwriting standards and, as a result, they tend to prefer hotels with stable cash flow with strong sponsors in solid markets. Specifically, hotels with premium brands in markets with stable demand generators are good candidates for financing today. In general, the size of the market and the service level of the hotel do not have much impact on its ability to get financed because lenders look closely at the strength and track record of the borrower. Some lenders gravitate to full-service hotels and/or major markets, while others prefer limited- or select-service and are agnostic to market size so long as they can identify strong demand generators in the market Eichner: Location in a primary market is beneficial. However, well-positioned hotels in secondary and tertiary markets can also be financed, although the pricing for assets in these markets may be a bit wider than in primary markets. Generally, the reason for this is that lenders feel primary markets will weather downturns in the economy and real estate cycles better than secondary and tertiary markets. We are seeing capital available for all types of hotels, including the select- and limited-service assets. Sonnabend: There is a lot of interest in projects in secondary markets. Both select-service and full-service assets in non-gateway cities are attractive to the lending community. Those markets didn’t typically experience the rapid run up, and valuations relative to replacement cost are more attractive.
Are there opportunities for financing now that were non-existent last year? Armstrong: CMBS financing is stronger this year than last year due to the risk retention rules that caused uncertainty last year. The uncertainty around implementation of risk retention rules in 2016 is behind us and CMBS financing is healthy and readily available. Several lenders are offering float-to-fixed loans for transitional hotels. Essentially, it’s a bridge loan that can be rolled into a permanent loan once the hotel stabilizes and the lender will typically waive the exit fee when it converts. Additionally, several private equity funds and debt funds formed new loan platforms this year to take advantage of borrower demand for favorable bridge loans for their value-add and transitional hotels. Eichner: Not really. The markets have been consistent as to types of financing that are available today versus last year. Credit spreads have widened a bit since last year but there is no shortage of liquidity. Sonnabend: There has been a significant increase in the availability of attractively priced floating-rate debt in the middle-market space. Historically, floating-rate debt for deals under $25 million had been priced significantly higher than larger deals, but that differential has tightened considerably.
What is getting a lot of play: fixed rate, floating rate, mezz, other types of debt? Any CMBS financing? And for what? Refis? PIPs? Acquisitions? Armstrong: Financing is available for all of the above. Sonnabend: We have seen a lot of acquisition financing of all types. Floating rate and CMBS with and without subordinate debt have been very popular among our clients. There also has been a lot of refinancing that has included a significant portion of the proceeds for brand-mandated PIPs and refreshes. Sonnenblick: We are seeing the CMBS market being very aggressive in this space. Loans from CMBS lenders for hospitality are in the 65-70% range. Life insurance companies also are providing long-term, fixed-rate loans for hospitality, but their leverage point typically will not exceed 65% and, in many cases, is less. Floating-rate debt also is available for acquisitions and repositioning of existing hotels, and mezzanine lenders will provide financing for hotels up to 80-85% of value.
How difficult is it to secure new-construction financing? Armstrong: Hotel-construction financing is available for developers with strong track records but developers should expect to have 40%-plus equity in the project. Some portion of the equity can be funded by mezzanine financing or preferred equity. EB-5 is still available to fill in the gaps for construction deals. Sonnabend: New-construction financing is becoming increasingly difficult to secure. The deals that have been successful in obtaining this type of financing have strong sponsorship and branding. Sonnenblick: Construction financing is typically the most challenging type of hotel financing to arrange. Lenders for new-hotel construction are limited. Generally speaking, if construction financing were to be available for a new hotel project, we are seeing commercial banks lending in the 50-55% loan-to-cost range, with the possibility of debt funds and other strategic lenders providing capital up to 65% of cost.
What challenges are faced in terms of financing independent projects? Armstrong: Independent hotels and soft-brand hotels are subject to the same underwriting standards as branded hotels and are more likely to get financed if they are located in major urban markets and year-round resort markets. Sonnabend: Lenders are concerned that independent projects face a tougher time during down markets than those with strong franchise affiliation. Sponsors need to show that there are significant other demand segments to obtain financing for non-flagged projects. Sonnenblick: Quality independent branded hotels are well received in the marketplace. We have been successful in placing loans for independent properties with a good track record, sponsorship and management. It is important for boutique/independent hotels to have seasoned sponsorship and an experienced management team to provide comfort to capital providers that the borrower is comprised of experienced professionals with the expertise and track record to assure the success of the asset given that there is no brand affiliation.
What are the top three things you’re looking for when approached for financing? Armstrong: For placing permanent loans, we look for experienced borrowers/operators with substantial equity and hotels with stable performance and minimal PIPs. For bridge loans for transitional hotels with bigger PIPs, we look for similar criteria. We look for: 1) cash flow; 2) sponsors with satisfactory equity; and 3) markets with diverse demand generators. Eichner: We look for location/market; sponsorship; historical performance of the property. Sonnabend: We look for experience sponsorship, strong business plan and/or operating history and, perhaps most important, realistic expectations. HB