Four steps you can take to plan ahead and maximize progress.
by RUSHI SHAH
Successful chess players always look ahead. They take time and execute each maneuver to enable the next move, even taking short-term risks to gain long-term position. Hotel owners who want to maximize growth can borrow a page from this same playbook. While each individual financing transaction is important on its own, it’s the strategic progression of transactions that has the most impact on your ultimate success. By working with an experienced intermediary to leverage the optimal mix of short- and long-term recourse and non-recourse loans at every phase of your property’s lifecycle, you can continuously unlock borrowing capacity and monetize value to fuel ongoing growth.
Step 1: Build your hotel – Using an SBA (504) Loan or high priced Non-Recourse loan for Construction Financing.
Unless you have 35 percent or more equity to put into building a new property, a full recourse SBA loan will likely be your best option for hotel construction financing. In addition to the property being on the line to satisfy the loan, all borrowers with 20 percent or more interest in the asset must personally guarantee the loan. SBA underwriting scrutinizes the experience, credit background and global cash flow, including reviewing three years of tax return data for both you and your property. The good news is you can finance your project with only 15 to 20 percent down.
The SBA also limits how much SBA financing you can have on your personal balance sheet across all of your properties. For SBA (504) this is capped at $5 million. For a new construction, however, there is some wiggle room. If you have already reached your SBA cap, you can install renewable energy mechanisms to gain additional borrowing capacity. Or, as an alternative, refinance your SBA loan to a non-recourse bridge loan.
Step 2: Remove recourse – Using the debt fund market to refinance to a non-recourse bridge loan.
When your hotel is open, but you still need time to execute your business plan and generate cash flow, it’s time to work with your intermediary to remove the burden of recourse. For hotels with good flags in good markets with loan amounts of $7 million and higher, lenders will typically offer competitively-priced, non-recourse, two- to five-year floating rate bridge loans. Many lenders use their bridge programs to feed their permanent debt pipeline and will waive their typical 1 percent exit fee when it’s time to refinance to long-term debt.
Because factors outside your control can affect your hotel’s performance, it’s wise to reduce your personal risk as soon as possible. For example, we had a client who used an SBA (504) loan to finance the construction of his Courtyard by Marriott in Texas. After we took him out to a non-recourse bridge loan, the oil market plummeted. Because the financing we secured was now non-recourse, his personal wealth wasn’t in jeopardy. The lender worked with the borrower to stabilize the property’s cash flow, and we are now refinancing the short-term loan to permanent debt.
Moving to short-term non-recourse debt may also allow you to exit before your construction loan starts to amortize. If your construction loan is an SBA (504) loan, refinancing to a non-recourse bridge loan after receiving your Certificate of Occupancy and before entering into an SBA B-Note through your local CDC (Certified Development Companies) can save you from paying pre-payment penalties on the long-term SBA B-Note with personal guaranties.
If you decide to buy instead of build, the interim funds can be used to finance activities that will deliver future value, such as re-flagging or renovating your property, or acquiring and improving another hotel. For example, we recently had a client who used a full recourse loan from a community bank to buy an almost shuttered hotel with a temporary franchise. He was able to pay off the existing loan and received millions of dollars to finance the large PIP to bring in the new Marriott brand. The client will refinance to a permanent loan next year and will be able to get cash out.
Step 3: Cash out – Using the conduit market to refinance to long-term permanent debt and free up trapped equity.
Conduit lenders combine loans into pools to be sold to bond investors on the secondary market as Commercial Mortgage Backed Securities (CMBS). Because investors demand a predictable rate of return, conduit lenders must minimize investor risk in order to fill their pipelines with capital to lend. They accomplish this through structured pre-payment penalties, reserve requirements and cash management. In exchange, borrowers gain access to more attractive non-recourse financing, including higher leverage, longer terms, longer amortizations and the ability to take unrestricted cash out. In current market landscape, often times this is the only way to get efficient capital for your stabilized real estate because of large scale availability of CMBS capital and competitive pricing.
Except for “Bad-Boy Carve-outs” that trigger in cases of fraud, CMBS financing focuses on the property and removes unnecessary contingent liabilities from your personal balance sheet. This insulates your personal wealth, while also increasing your borrowing capacity for new SBA or other recourse financing. And if your growth plan dictates you should sell, most CMBS loans are assumable by your buyer.
Even more importantly, conduit loans allow you to monetize the value you’ve created in the property by taking cash out for other investments. There are no constraints on how the money must be used, and unlike in a sale, it is typically tax free (please consult your tax advisor).
Step 4: Repeat – Using your equity to go out and do it all over again.
Once you’ve unlocked your equity in the form of a cash out, you can use the funds to build or buy a new property or diversify into other asset classes, without the need to bring on as many equity partners because you will have sufficient cash to get it done. Plus, your now uncluttered personal balance sheet will be available for a new round of recourse/SBA debt. By taking advantage of the most efficient capital structure available at every stage, you can continue to feed your growth engine, while handicapping your risk. ■
Rushi Shah is CEO of 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 teams have collectively funded more than $8B for hotel, multifamily and other commercial 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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