Looking ahead, bracing for a softer market


Institutional financing can position hoteliers for acquisition opportunities and long-term wealth.


Chances are you are among the thousands of hotel owners facing a maturing commercial mortgage and looking for bridge or permanent debt. Until recently, the outlook was overwhelmingly optimistic. Rates were low, capital plentiful and property values up. Although interest rates have risen, they are still lower than rates just 10 years ago. Clouding the forecast now, however, is the tightening of credit in the capital markets. Secondary market demand for Commercial Mortgage Backed Securities (CMBS) has slowed, forcing lenders to turn away borrowers, or adjust to the volatile market by raising rates, cutting proceeds or adding some recourse at the closing table. Reductions in property values are likely to follow.

When faced with these volatile economic conditions, it is even more important to move quickly to secure financing that will not only protect what you’ve worked hard to build, but also position you for a successful future. Bank loans or SBA loans are usually the only choice for construction financing and borrowers with less experience in the hotel industry. Experienced owners of cash-flowing hotels, however, can take advantage of more sophisticated alternative or institutional financing. Prudent owners will refinance now, locking into the long-term savings today’s rates still afford for as long as possible with no or little recourse, while stockpiling cash for acquisition opportunities that may occur in the next few years.

Recourse vs. non-recourse
Because they rely on customer deposits to fund commercial loans, most banks require borrowers to have a banking relationship and to also agree to personally guarantee the loan. Known as recourse, in addition to the property itself, the borrower’s assets are on the hook to satisfy the loan. Not only does this requirement put your personal wealth in jeopardy, it also curtails your future borrowing power. Some banks may offer non-recourse financing, but only for smaller loan amounts, lower loan-to-values and shorter five- or seven-year terms. As a result, borrowers are forced to leave years of interest rate savings on the table.

In the non-recourse financing world there are two solutions, CMBS and balance sheet lending. With CMBS, individual loans are pooled together and sold in securitized form as a series of bonds. CMBS shops, which provide about 20 percent of the overall commercial financings, can make more loans at more competitive rates and terms than local or regional banks that rely on retail depositors for funds. Balance sheet debt isn’t securitized, rather funded through private funds or large banks’ balance sheets.

With a non-recourse loan, only the property is at risk to pay off the loan when circumstances arise outside the borrower’s control. While non-recourse lenders still care about the quality of the borrower due to their accountability to investors, they are more focused on the property they would need to liquidate in the event of a default, or their “exit strategy.” Lenders will look at several key factors when underwriting a loan: the hotel’s market (including the competition and supply/demand drivers), the hotel flag, the property’s cash flow and the borrower’s ability to execute the property’s business plan.

Non-recourse financing is a smart choice for hotel owners who believe in their projects and have strong management abilities, whether they self-manage or use third-party management companies.

Positioning your property for future success
CMBS loans are available for up to a 10-year term without recourse, allowing owners to secure today’s low rates for longer. Thanks to longer amortization periods, payments are lower and cash flow can be maximized. Unlike a bank loan, CMBS loans are also assumable. If you decide to sell your property before your loan matures, the buyer can assume the CMBS loan and you the seller can avoid pre-payment penalties.

Getting cash out of your hotel may also be easier with a CMBS loan because the lenders are focused on the asset’s ability to support the debt. Unlike banks, Wall Street lenders are not subject to FDIC or other regulatory requirements, which results in less strict underwriting standards and the ability to lend at higher loan-to-value (LTV) ratios. We recently had a client whose hotel had doubled in value since closing his original bank loan. A new CMBS loan allowed him to keep the property and increase his leverage at a very attractive rate and without recourse. He was able to take out over $6 million in cash to use to grow his portfolio from four hotels to six hotels.

Choosing the right lender in a volatile market
Navigating through the maze of lenders without professional help can be overwhelming even in a stable market. When economic conditions are influx, partnering with an experienced financier who has a diverse network of capital sources and the ability to quickly change gears is mission critical.

A good intermediary will know which lenders are active in your market, what properties they’ve financed in the past, and whether they are willing to negotiate on loan amount, terms, interest rate or pre-payment penalties. For example, often only 20 percent of an individual CMBS lender’s overall mortgage pool can be allocated to hotels. Many lenders have already hit these ceilings, making timing and access crucial. Relationships are key, as many lenders are willing to make concessions if they have worked with the mortgage banker representing the borrower.

Presenting an accurate picture of your property is also important. Knowing how to use strengths in one area to mitigate weaknesses in another can make or break a deal. For example, strong cash flow and predictable demand generators may convince a lender to reduce the number of months of historical data they require, or to lend outside their typical markets.

Know your competitive set
Typically lenders want to see that your property is performing at or above the level of your peer group and expect the RevPAR penetration to be high. STR reports should have at least five decent comparable properties, including yours. Within secondary and tertiary markets, it can be difficult to fill this quota with a true competitive set. Often in these markets with limited supply, STR must include hotels that aren’t actually peers, which can skew how your property compares.

Cap rates can also be a wildcard. Since cap rates are calculated based on sales prices that have occurred in the past, they can be dramatically skewed in markets where few recent trades have occurred. We’ve frequently defended a property’s value by providing more current market information and pinpointing anomalies.

Historical cash flow and projections
One of the key underwriting metrics CMBS and other institutional lenders rely on is Debt Yield. This is calculated by dividing your Net Operating Income (after FF&E reserves and a management fee) by the loan amount. The Debt Yield is directly dependent on the market of your hotel and the quality of historical cash flows. The more remote the hotel and/or less stable the historical cash flows, the higher your Debt Yield requirements. When sizing the loan, lenders want predictable revenues, requiring Debt Yield levels that can support the ups and downs of the hotel’s business.

Lenders may increase their thresholds when moving outside of primary markets and for certain flags or decrease them if there are other mitigating factors. For example, we recently secured an $8.9 million CMBS loan on behalf of a client for a new Holiday Inn Express in Texas that had only four months of operating cash flows – eight months shy of the 12 months usually required by lenders. We were able to demonstrate the strength of the market, present reasonable cash flow projections for the hotel, show the quality of the borrower and convince the lender that there was a solid exit strategy. Knowing what motivates the lenders makes it easier to structure a better deal.

Non-recourse loans are usually reserved for loan amounts over $5 million. This is because the lender’s effort and expense is the same no matter what the loan size, making smaller loan amounts more cost prohibitive.

The closing process for CMBS loans is also more complex than other commercial loans, another reason to enlist the help of an experienced advisor to guide you through it and protect
your interests.         ■

Rushi Shah is an executive vice president at commercial mortgage banking firm Aries Capital, LLC, and president of its online non-recourse platform LendingCap Commercial. Since 1991, Aries has arranged/funded over $5 billion in financing in the U.S. and Caribbean. Shah held previous positions at Northern Trust. A member of AAHOA’s Strategic Business Advisory Committee, Shah holds an MBA from The University of Chicago’s Booth School of Business.


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