What borrowers can expect and do.
by RUSHI SHAH
In 2017, the debt capital markets were the most active since the Great Recession. As we kick off 2018, hotel owners can expect a similar lending climate with plenty of available capital for transitioning and stable properties. Borrowers, especially those with larger loan amounts, will continue to benefit from an influx of foreign capital in the form of new bridge funds and institutional bonds. The new year will be an excellent time to lock in a low long-term or bridge rate.
As deal activity slows, however, the debt markets will catch up and cap rates will eventually rise. 2017 already saw a 45-percent drop in hotel transaction volume as of Q3 2017, according to data provided by Real Capital Analytics. This will make it less lucrative to refinance and pull cash out. Furthermore, if political promises don’t materialize during this administration’s sophomore year, the markets may react negatively, leading to the evaporation of available capital. Other looming risks that could lead to recession or dry up capital (and that many are not talking about) are the rising number of retail bankruptcies, increasing retail vacancies and a high amount of debt on retail centers. These additional risks could trigger contagion in other real estate food groups such as hotels. Hotel overbuilding can also lead to supply concerns in some markets. Given this outlook, hotel owners should move quickly to refinance and hedge their risk with non-recourse debt while it remains available.
As you map out your financing plan, keep in mind key variables that will shape your options. Leveraging the expertise and lender influence of an active, qualified intermediary will help you rise to the top and better navigate both smooth and rough waters ahead.
Continuing Increase in Demand
Domestic travel is up, leading to an increase in hotel demand. RevPAR is expected to remain flat, however, as hotel rates have risen but are not keeping pace with the increase in occupancy. This is largely due to a lack of pricing power at the property level. The hotel industry has seen multi-year RevPAR growth that simply cannot be sustained due to supply and saturating demand. This makes it good timing for owners looking to refinance, as lenders underwrite cash flow on a trailing 12 months, so you won’t leave as much money on the table.
As brands continue to wage the battle for market share, in addition to competitors’ brands, hotels may find themselves competing against their same flag, or a slightly different flavor. While an expanded footprint is good news for brands, this dilution of demand drivers can be bad news for owners seeking financing. To protect cash flow and maximize proceeds, borrowers should refinance now before additional competitors move in. Owners of larger properties with better brands can also leverage short-term, interest-only bridge loans to buy time for renovation and/or conversion to brands further up the chain scale with stronger reservation systems and corporate marketing muscle. Borrowers who wait may have to delay financing for several months, until they can demonstrate to lenders that their cash flows can survive the new competition. Or, they can work with their intermediary to use creative approaches such as cross-collateralizing properties to appease lenders.
Banks and CMBS shops have already adapted to the Dodd Frank risk retention mandates to keep 5 percent of the credit risk for loan securitizations as “skin in the game,” by tightening underwriting standards and focusing on historical performance instead of projections. This diligence is expected to continue in 2018. Advance rates remain lower, debt yields are up and landing financing for new construction will continue to be tough. With changing supply fundamentals and revenue saturation due to the factors discussed above, underwriting will remain conservative, and leverage on hotel assets will continue to go down.
Banks and smaller lenders will continue to find it difficult to shoulder the higher cost of regulation and heavier underwriting load, opening the door for larger CMBS and alternative capital sources not burdened by bank regulations such as bridge funds, life companies and credit unions to pick up the slack. Financing will be readily available for cash-flowing properties with good flags in strong markets.
Expanding Gap between Buy and Sell
The combination of flat RevPAR growth and rising cap rates will start having an impact on property prices. Hotel owners looking to monetize value and recoup investment costs by selling may have difficulty finding buyers willing or able to pay what they ask and will look to refinance instead. By refinancing to a long-term, assumable non-recourse loan, borrowers can take some cash off the table at an opportune time and position themselves for risk-managed growth when investment opportunities arise in the future.
Economic and Political Environment
With steady job growth, controlled inflation and an improving U.S. and global economy, all signs point to higher short-term rates in 2018. If global geopolitical uncertainty and the retail crisis in the U.S. lead to a global recession, however, the Fed would slow the increase in rates, and there would be a “flight to quality” to U.S. treasuries, bringing long-term borrowing rates down again. The availability of capital, however, might simultaneously vanish due to this same “flight to quality.” While active now, with EB-5 changes on the horizon and as the U.S. dollar strengthens, foreign investment may taper. Smart borrowers won’t gamble on an uncertain future, but will put their financing to bed now to capture long-term savings and rest easy for the next 10 years.
If you are a borrower facing 2018 maturity dates or purchasing a new property, secure your best deal now and push to close within the first half of the year. What lies ahead may continue to be unclear, but there is ample opportunity to secure well-priced, non-recourse bridge and long-term permanent debt – including cash out for forward-thinking borrowers working with experienced intermediaries. ■
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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