With high interest rates taking their toll on the hotel industry, hoteliers have to take unique avenues to source their loans. Hotel Business caught up with Ben Johnston, COO, Kapitus; Afshin Kateb, CFO/head of hospitality, Palladius Capital Management, and Michael Sonnabend, managing member/co-CEO, PMZ Realty Capital, to offer their insights on how the lending environment is dealing with high interest rates and other topics.
—Adam Perkowsky
How have high interest rates affected the current lending environment?
Johnston: Rising interest rates have created challenges for banks that have experienced deposit outflows as customers seek higher returns on their money outside of the banking system. This has forced many banks to raise deposit rates, lowering profit margins. Deposit outflows have also forced banks to sell assets that they had intended to hold to maturity at a loss in order to generate the cash required to cover deposit withdrawals. These losses have reduced the equity value of the banks, weakening their ability to withstand future losses, and curtailing their ability to lend. Banks have barely grown their exposure to small businesses over the past four years despite strong economic growth and significant inflation, meaning that small businesses have much lower access to bank capital relative to their revenue than they did before the pandemic. While fear in the banking system has subsided, risks to the banking system have not gone away. The Federal Reserve continues to present the possibility of additional rate hikes if inflation remains above its 2% target rate. Additional rate increases would continue to weaken bank deposit bases, profitability and the capital position of many U.S. banks.
Kateb: Since March 2022, the Fed has had 11 rate hikes that have significantly increased the costs of commercial real estate borrowing. These rate hikes, coupled with regional banks’ problems, heightened regulatory scrutiny, and tightening lending standards across all regional and large banking institutions, have generated a “liquidity crisis storm.” With the usual players—banking institutions—on the sidelines, this void is now primarily filled by private credit funds, which have a higher cost of capital and thus a higher lending cost. Quality of assets, performance trajectory and creditworthiness of the sponsor are key metrics for separating the haves and have-nots in this environment. In short, banks are on a strict- to no-lending diet and private credit is on a regimented, highly selective diet. Thus, quality is now paramount and projects lacking quality will struggle in refinancing efforts.
Afshin Kateb Palladius Capital Management
Sonnabend: Higher interest rates have negatively impacted the market for hotel loans. This is reflected in several areas. Both valuations and debt-service coverage ratios (DSCR) have decreased due to the increases in cost of capital.
How has business been this year?
Johnston: The hotel industry has improved despite higher interest rates because of a shift in consumer spending trends which have favored travel and experiences over the consumption of material goods. Recent crackdowns on Airbnb and other short-term rental sites, especially in major U.S. cities, has also provided a lift to an industry still struggling to recover post-pandemic.
Kateb: We have been very active lending on a range of asset classes, including hospitality. Most recently, we closed two ground-up construction deals in secondary markets and a mezzanine position in a stabilizing asset in a major market. Our pipeline is active with a number of quality cash-flowing assets that have been turned down by their long-term relationship lenders due to their mandated excessively heightened lending standards and limited capacity due to liquidity concerns. We remain a solution provider and anticipate having a robust pipeline in 2023 and 2024 as maturities expire and lending options remain scarce.
Sonnabend: This has been a very interesting year. We have been as busy as ever discussing potential deals with clients, but there is a lack of transacting when borrowers have to stay within current lending parameters.
What are the types of loans hoteliers are gravitating toward?
Johnston: Hoteliers are most likely to pursue term loans and mortgages secured by their hotel’s real estate. This generally provides the lowest-cost financing available given the relative security of the collateral.
Kateb: Most hoteliers view the current conditions as temporary. Accordingly, they are looking for bridge financing on existing assets. That will enable them to navigate the current rapid waters for the next 12-18 months. Our debt has strict lending guidelines, but we tend to be more flexible than banking institutions in the current environment.
There are a number of assets that are in the middle of their ramp up period and need the right facility to assist them with their momentum. We offer the borrowers creative options with less restrictive covenants that enable them to continue their journey to stabilization. Once economic conditions normalize, traditional banking institutions will be open for business and borrowers will be able to refinance into competitively priced debt options.
On the construction front, the landscape is more challenging. Due to banking system disruptions, lodging construction lending has dried up. A large number of construction projects are now officially on ice. However, liquidity is still available to platinum quality, financially strong developers. As a result of repatriation of depository dollars from larger banks to community banks, some developers are receiving very favorable rates, but they come with full recourse strings attached.
Michael Sonnabend PMZ Realty Capital
Sonnabend: There is a focus on shorter-term loans. The most popular product has been 3–to-5-year terms with both fixed and floating rates.
What is your forecast for the near term?
Johnston: Despite higher interest rates, the U.S. unemployment rate remains at historic lows. Strong employment generally means that consumers have sufficient capital to fuel discretionary spending on travel and entertainment. Hotels should continue to benefit from a strong employment rate as long as inflation continues to be brought under control.
Kateb: From a demand standpoint, transient growth has slowed down, but business and group demand are making good strides in most top markets. The drop in leisure demand is expected to continue and impact RevPAR growth. Additionally, labor shortages and the combined increases in the cost of labor, operating expenses and insurance have put further pressure on results. However, the U.S. economy’s continued resilience remains a positive fundamental indicator. Until the Fed achieves normalized economic conditions, the heightened standards in debt markets are expected to continue. This means that the ability to sell an asset continues to moderate, placing the borrower in a quandary: divest at a lower than ideal price or temporarily refinance at much higher rate with potential cash-in infusion.
Sonnabend: During the near term, I see a continued appetite among capital sources to invest in the hospitality sector. It’s important to know the specific characteristics of financeable deals.
