by Rushi Shah
There is a common myth that all unflagged hotels are unfinanceable. Not true. While a lack of a brand adds another dimension to the underwriting process, unflagged hotels that can support debt levels of $5 million or higher may qualify for bridge and even non-recourse, long-term loans. However, because you can’t rely on a brand’s marketing muscle, your perceived ability to execute your business plan is paramount to lenders. Enlisting an experienced management company can improve your deal’s optics, as well as leveraging the experience and relationships of skilled intermediary or investment bankers.
Is construction financing available for unflagged hotels?
In this stage of the economic recovery cycle, financing a ground-up hotel construction without a nationally-recognized brand can be challenging. However, if your property is in a market with high barriers to entry, captive and sustainable demand drivers, and where a brand and its reservation system wouldn’t add a tremendous amount of value, it may qualify for a construction loan.
Construction financing for independent hotels is usually at lower-leverage than what is allowed for a nationally-branded hotel. Typical leverage for an independent hotel ranges from 50 percent to 65 percent vs. 60 percent to 70 percent for a flagged hotel. This is because lenders don’t underwrite the loan based on what you actually spend (or expect to spend) to manage and market your property, but rather based on a calculated amount they would need the debt to support if they had to foreclose, assume operations and add a flag.
Construction lenders are also hyper-focused on projected cash flow at exit. They don’t give much credit for food and beverage, as it is considered too speculative. They will focus on room revenues and still require a STR report. If your hotel is in a converted building that is 50 years or older, you may be able to leverage Historic Tax Credits as additional equity.
What if I need short-term financing while I ramp up my independent hotel?
The universe of bridge lenders shrinks when financing an unflagged hotel. Those who are willing to lend to an independent asset, typically won’t write a check for less than $10 million and demand an airtight exit strategy. They need to believe that you will successfully execute your business plan and that your asset’s revenues will increase as projected. For independent hotels in secondary MSA’s, lenders expect a debt yield at exit of 13 percent to 15 percent, as opposed to 10 percent to 12 percent in primary markets.
Bridge lenders also underwrite to ensure the independent property can support enough debt to cover marketing, management and franchise fees to add a flag if the borrower were to default. This is called “MMF” and is usually set at 14 percent of Trailing 12 months of Room Revenue. This percentage is applied as a standard, even if your current operating expenses fall well below this requirement. You don’t have to pay this amount to operate your business, but the lender will still underwrite for it.
If I’m buying or refinancing a stabilized independent hotel, can I qualify for a non-recourse, long-term loan?
The availability of permanent financing for unflagged hotels is very asset-dependent, and greatly-improved with the expertise and relationships of an experienced intermediary or investment banker. A non-recourse, cash out refinance is possible, but lenders scrutinize the cost basis of the sponsor and the sponsor’s ability to run the asset long-term. If this is your first hotel and you are going independent, securing financing will be an uphill battle. Lenders prefer the predictability of seasoned owners over rookies.
Permanent lenders focus on the independent hotel’s bottom line and underwrite for the same 14 percent for MMF as bridge and construction lenders. Market and demand drivers are critical, and the leverage or the debt yield you can finance the asset at is directly correlated to the population of the hotel’s market. A boutique hotel in downtown New York will get more lender attention and better terms, than an unflagged hotel in the middle of Arkansas.
There is no denying that a strong hotel flag smooths your path to securing construction, bridge and permanent financing. However, larger boutique or independent properties that are in bigger markets and have owners and/or management companies who demonstrate that they will be able to execute, can be financed – especially with the extra support of an experienced intermediary or investment banker who has previously navigated similar waters with lenders.
