What is the best type of financing to purchase a value-add or cash-flowing hotel?

0

by RUSHI SHAH

You already expend significant energy identifying how, when, and where you want to grow your portfolio. What are the hotel’s demand drivers? How strong is the flag? Who are my competitors? Or, is there enough room to build value? If you are a buyer looking to maximize your investments and grow your business, then the same careful forethought you put into choosing the property should also be applied when choosing how to finance it.

Why do banks push SBA loans?

You may find that your local bank consistently steers you down the SBA 7(a) route. The borrower benefit is clear, an SBA 7(a) loan allows lower down payments including the ability for the seller to carry-back a small piece of the purchase price and count it toward the buyer’s equity. However, the primary reason a bank recommends this type of financing is because there are inherent monetary incentives for the bank. For these transactions, the government agency guarantees up to 75 percent of exposure and the lenders securitize 75 percent of the loan at a double-digit premium, typically in the 10 to 12 percent range. For example, in a $5 million deal, the SBA guarantees $3.75 million of it, paying the bank up to $450,000 to purchase the $3.75 million piece. As a result, the bank’s risk return is outsized and bottom line, the bank makes more money.

Local and regional banks may also tee up a SBA 504 loan to finance a hotel purchase. Unfortunately, the SBA 504 process can be clunky because two organizations need to approve the debt, the bank and the local Certified Development Company (CDC). CDCs are certified and regulated by the SBA, and work with SBA and participating lenders (typically banks) to provide financing to small businesses. Of course, the more parties involved, the longer the timeline and the higher the risk of failing to execute. Layer this with the fact that increased hotel financing volume has led the SBA to scrutinize hotel assets more than other property types, and borrowers can find themselves frustrated and searching for better options. Most SBA loans, whether a 7(a) or 504 loan, have hefty origination fees as well.

If I don’t want an SBA loan, what are my alternatives to fund my purchase?

Depending on the quality of the asset’s location, brand and cash flow, non-bank debt funds can be a strategic option for financing your hotel purchase. Lenders are willing to finance from 70 percent to 90 percent of acquisition cost. Rates and origination fees are usually commensurate with the leverage, since the higher the leverage, the higher the lender’s risk. Rates are also affected by the transition the property requires and how quickly you need to close. Expedited closings truncate the lender’s due diligence timeline. Having less time to do its homework elevates the lender’s risk and results in higher rates for borrowers.

My property hasn’t reached maximum cash flow yet, what are my financing options?

If you are purchasing a value-add property, a short-term, interest-only bridge loan through a debt fund can provide the funds to purchase the property, execute any Property Improvement Plan (PIP) and buy you time to stabilize your property before refinancing to permanent debt through a conduit or conventional loan. Bridge lenders will typically finance up to 70 percent of loan-to-cost for the acquisition of properties still in transition.

Bridge lenders focus less on the property’s current health, and more on how successful they think you will be at improving the asset. Their main concern is their exit strategy when the loan matures. The questions they will evaluate include, what is your business plan? Will you be able to execute it? Will you achieve the forecasted projections? And most importantly, will the property be able to be refinanced to permanent financing through a conduit or conventional loan at the end?

A bridge loan can be a very strategic tool for fueling ongoing growth, as it affords you time to build value before monetizing your hard work as cash out for further investments. For example, we have a client who is buying an asset at auction. He won the bid and will be able to finance 85 percent of cost at 10 percent. However, based on projections, after successfully executing his business plan, the financing will represent only 65 percent of the projected value at exit. As a result, the borrower is able to buy a $6.6 million property now, which will be worth $9 million later. When he refinances to permanent debt, he can take the imputed equity out as cash, invest it in more properties and continue the cycle.

Furthermore, unlike SBA loans which require personal guaranties and a lengthy approval process, a non-recourse bridge loan doesn’t clutter up your personal balance sheet. Having the capacity to take on additional SBA or other recourse financing, gives you the freedom to act more opportunistically in your business decisions.

The property I’m buying is already stabilized. Am I eligible for long-term debt?

If you are buying a stabilized asset, you can take advantage of a non-recourse, permanent loan through the conduit market right from the start. Conduit lenders offer up to 10-year terms with 25- to 30-year amortization and will finance up to 75 percent of the total cost of acquisition at closing. In select markets, credit unions and life companies can get aggressive on acquisition financing, increasing leverage from 70 to 75 percent. The financing will cover the purchase price, any immediate PIP requirements and closing costs. Borrowers often find acquisition loans easier and more favorably priced than refinances, as lenders and credit committees like that purchase loan borrowers are bringing cash into the deal, instead of pulling cash out.

When in the purchase process should I start looking for financing?

For purchases, closing the necessary financing on time is paramount. Miss a financing date, and you could miss out on the property. Involving an experienced intermediary early on will deliver a higher level of certainty of execution. After you have a Letter of Intent (LOI) signed or are ready to sign, it is a good time to get your intermediary involved to lead the financing.

For maximum results, look at the big picture instead of approaching each loan as an individual transaction. Focus on a larger relationship with your intermediary or investment banker so that he or she puts you in front of his list when you are looking for financing. Remember execution and closing is key to any successful deal. Jump into an SBA loan only after comparing it with other, potentially more lucrative, options. Strategize and explore with your intermediary to plan how you will use each acquisition or refinance as a stepping stone to reach the next milestone on your road to even greater prosperity. ■

Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Club Blue 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.

PHOTO CREDIT: FOTOGESTOEBER/SHUTTERSTOCK.COM

Share.

Leave A Reply