Is non-recourse financing truly necessary?



By Rushi Shah

We talk to hotel owners every day who want the long-term interest rate savings and ability to take unlimited cash out that CMBS financing offers, but still settle for a recourse loan through their local bank when refinancing or securing a purchase loan. They may worry that the CMBS process will be too complex, too expensive or more often just don’t think they will need the risk-management benefits of non-recourse financing.

This may be the case for you. If you are confident in your abilities and have a successful hotel proving your expertise, you may be comfortable putting both your personal assets and property on the line as recourse to guarantee the debt, instead of choosing a non-recourse loan where (except in cases of borrower fraud) only the property is at risk to satisfy the loan. Non-recourse becomes critical, however, when things happen outside of your control.

Insulate your property from unforeseen risk
Take the Great Recession in 2008 for example: performance suffered and many hotel owners lost their properties because the assets couldn’t generate enough income to cover their loans. Owners subsequently found themselves in a position where their properties were worth less than their loan amount. Banks not only foreclosed on their borrowers and liquidated the assets, they also sued the borrowers for their personal guarantees. Good borrowers with previously strong track records were forced into personal bankruptcy.

In hindsight, if the loans had been non-recourse, only these owners’ properties would have been in jeopardy. As a result, they would have had the option to give up the property without any additional personal liability and without permanently tarnishing their credit. With today’s volatile markets and uncertain domestic and global landscape, wise owners will learn from the past and arm themselves with the risk-protection that non-recourse financing offers.

Based on all available data, the hospitality asset class is usually the first to go and the last to come back after recessions and recoveries. Investing in hotels can be like playing with fire. Case in point: In the latter half of 2016, hotel valuations and prices declined by 8.5 percent while the other four food groups – office, retail, multifamily and industrial – rose. Regardless of how the effects of the new administration continue to play out in the markets, the micro-dynamics that affect the hotel industry are likely to remain the same. Owners will face brand proliferation by the franchise companies and additional supply entering their markets, with new competitors putting older properties at a disadvantage. Modular buildings and other more efficient building practices, as well as technology replacing some travel, are also likely to have an impact.

Don’t limit future growth
Non-recourse financing not only safeguards your personal wealth, it also eliminates unnecessary contingent liabilities on your personal balance sheet that might prohibit your ability to add to or refinance your overall portfolio. Furthermore, CMBS loans allow you to layer mezzanine debt to increase leverage, as well as free up any trapped equity in your property by taking cash out for other investments.

Choose wisely
Not all CMBS shops are the same. Do your homework, or better yet, fortify your search with an experienced intermediary who specializes in non-recourse financing. With the recent credit tightening in the CMBS markets, it is now even more important to know which lenders are active in your market, what properties they’ve financed in the past, and whether they are willing to negotiate on proceeds, terms, interest rate or pre-payment penalties.

Leverage your resources
Relationships make a difference, as many lenders are willing to make concessions if they have or worked with the borrower, or his or her mortgage banker on a previous deal. Your intermediary can usually negotiate a better financing package for you by putting together more creative structures, negotiating mitigating factors to hedge inherent risks, reserving extra dollars instead of requiring an expensive lockbox or cash management, paying a higher rate in exchange for more proceeds, cross-collateralizing the loan with another property, bringing in a new equity source, or leveraging tax credits and other government incentives.

The only thing predictable about the future is unpredictability. Use non-recourse financing to position you and your property well now and to avoid unnecessary hardships later. There are enough risks our clients take in their business, using prudent financing is the least our clients and owners can do to hedge the risks that can be mitigated naturally without additional costs.         ■

Rushi Shah is CEO at Conlon Capital, a commercial mortgage banking firm formed by a merger with Aries Capital, which specializes in CMBS and other non-recourse lending solutions. Over the past 26 years, the Conlon and Aries Capital teams have collectively funded over $8B for hotel, multifamily and other commercial real estate properties. Shah held previous positions at Northern Trust and is a member of AAHOA’s Founding & Allied Member Committee. Shah holds an MBA from The University of Chicago’s Booth School of Business.


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