Hotel Financing Q&A: Should I use debt instead of equity to fund my growth plan?



Whether you are looking to acquire a cash-flowing or distressed property, or are creating value through renovation or conversion, equity is always the most expensive and elusive type of capital. For a property in a primary market with standard market risk the cost of capital for preferred equity for 80.1% to 90% of value is typically 15%, and for JV equity or common equity at 90.1% of value and above, is typically 18% or more. For debt on the same property, however, the cost of capital typically decreases to 4.5% for 65% of value and 12% for 65.1% to 80% of value. Metrics for properties in secondary and tertiary markets will vary, and in a bullish economy with rising rates, numbers can increase based on the current supply-demand dynamics for capital.

By leveraging the accrued equity in your portfolios to put on senior debt instead of using equity, you can more effectively procure the capital you need at a typically much lower cost, alleviate many of the pain points of using equity, minimize your future risk and improve your overall position for growth.

For example, one of our clients used his imputed equity in two of his assets to help buy a third Hilton-branded property without any down payment. By cross-collateralizing the hotel with another asset with significant built-up equity, the borrower avoided shelling out valuable cash from his own balance sheet and effectively reduced the opportunity cost of the capital.

In another transaction, we are working with a client to refinance his 10-hotel portfolio, where three of the properties were acquired within the last year. We are leveraging a non-recourse loan to deliver higher proceeds than the entire cost basis of all of his properties in the lifetime of the deals. This solution surpasses any equity arrangement that any equity partner would be willing to offer.

Executing a debt transaction is also easier than securing equity. While sourcing pure equity, transaction times can be long and dealing with multiple partners (and their individual personalities and often conflicting goals) can be onerous. Deals may take months, or partners may bail unexpectedly, leaving your growth engine at a standstill. In addition, you typically have to share the profits with your equity partners beyond a certain threshold, adding to equity’s expense. In contrast, debt ensures you retain 100% control of your property and its cash flow, and when done through a qualified intermediary brings certainty of execution. Don’t fall for someone that just promises low rates. The real proof is in the transaction execution and closing. Ask any potential intermediary to show you an actual closing statement disclosing the rate he or she achieved for a recent, similar deal.

In many cases, debt is the only means to access capital without any tax consequences. Non-recourse debt through CMBS and other non-traditional lenders allows borrowers to monetize the accrued value by taking cash out. Unlike conventional and SBA loans, there is no ceiling on how much you can take out, and the funds are typically tax-free. Always consult your tax advisor.

Another benefit of debt is it gives you ample capex capital to cover all of your Property Improvement Plans (PIPs). This ensures your franchise continues for the foreseeable future, and allows you to future-proof your portfolio against ever-changing franchise requirements.

Can I still leverage debt if my hotel isn’t yet stabilized or has had weaker performance?

Absolutely. You can typically stretch on debt terms even if some of your assets are not fully-seasoned. Shorter-term, interest-only bridge loans can buy you time to execute your business plan before refinancing or selling your property. An experienced intermediary can negotiate on rate, term proceeds and reserve requirements to creatively structure your deal to cure any issues.

With a debt transaction, you can also buttress less strong properties by pooling or cross-collateralizing them with high-performing properties and financing as a combined portfolio. A qualified intermediary can further protect your interests by negotiating individual release provisions. This ensures there is a price attached to each individual asset, in case you want to sell them individually.

Is putting on debt a better alternative to just selling my property?

In addition to more certainty of execution and potential tax benefits, debt allows you to take advantage of the increase in theoretical value in your portfolio without the friction of broker fees, the need to find a buyer willing and able to transact, or nasty negotiations.

More importantly, by maintaining ownership and using debt to access capital, you will retain ongoing cash flow. You can continue to reap the rewards of your hard work, building value while also protecting your legacy and preparing for future cash flow needs.

We are approaching the end of a protracted economic recovery and entering into a sustained rising rate environment. At this stage of the cycle, leveraging the expertise of a qualified intermediary to lock in long-term debt with long-term interest rate savings is the most prudent way to be a good financial steward for your portfolio, your company, your partners, your investors and most importantly your family.

Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Club Blue Founding Member, Aries Conlon Capital. As a leader in hospitality financing, Shah specializes in structuring and placing high-leverage, non-recourse bridge and permanent debt with cash out for full- and limited-service hotels nationwide. Since joining the firm’s predecessor Aries Capital in 2015, Shah has structured and closed hundreds of millions in financing for all property types. Shah has held previous positions at Northern Trust and has an MBA from The University of Chicago’s Booth School of Business.

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