by Rushi Shah
Sophisticated hotel owners understand the benefits of non-recourse financing – low rates, the flexibility to take cash out and longer fixed-rate terms without the burden of unnecessary personal risk. Because non-recourse lenders primarily focus on the property, many owners believe that who actually owns the asset doesn’t matter. As we approach the end of the economic cycle, the people behind the property matter more than ever.
Sponsorship is defined as any persons with interest in the entity that owns the asset, whereby they also have management and critical decision-making authority. Lenders care about it because the property’s business plan is dependent on the sponsor’s ability to execute it. Both debt and equity investors scrutinize the sponsor’s current status and past track record to ensure they can do what they say they will do and can weather economic downturns. This is especially important as credit cycles tighten, as historical data suggests more sophisticated sponsors are more likely to retain their assets and navigate friction in the market. Sponsorship matters more for the shorter-term bridge loans because they’re structured based on future projected performance, which can only be realized if the sponsor executes the business plan.
Sophisticated sponsors are better able to overcome rough economic conditions due to resources and power. First, since successful sponsors tend to be well capitalized, they can pump in their own cash and buy time. Second, franchisors are usually more willing to make concessions for a well-heeled, experienced sponsor group. Third, successful sponsors have built up goodwill, which allows them to negotiate with vendors and suppliers and attract longer-term client contracts.
Because of the role of the franchisor, sponsorship is critical in hospitality financing. There is a common belief on Wall Street that with a good flag comes a good sponsor. For transitional assets, since the lenders are looking at future cash flow that hasn’t yet been generated, the flag and how it will contribute to occupancy is key. This is because lenders can project the flag’s impact based on the performance of comparable hotels with similar flags in the market. They know that a sponsor’s success correlates to a strong reservation system, popular loyalty programs, marketing, and brand power. Further, lenders know that a sponsor with a good flag already has passed a stringent vetting process.
Can sponsors with a less-than-perfect track record still qualify for debt or equity for their hotels?
If there is an absence of track record in the sponsorship, expert help is needed. An experienced intermediary will have relationships with a wider variety of non-recourse capital sources, including Commercial Mortgage Backed Securities (CMBS), life insurance companies, balance sheet lenders, regional banks, and private funds. Due to market volatility, regulatory pressures, secondary market execution risk, and bad borrower experience, more lenders are holding the loans on the balance sheet longer instead of securitizing and effectively offloading the lion’s share of the risk to the B-piece buyer (investors that buy the highest-risk tranche of the loan). Subsequently, sponsor scrutiny increases. Now, even the B-piece buyers are questioning sponsorship.
An experienced intermediary can also structure around sponsor short-comings. For example, we recently worked with a Midwest flagged hotel whose owner had been foreclosed on for another asset. We were able get the lender comfortable by adding an additional layer of credit enhancement in the form of a debt-service guarantee to the current deal’s structure – a win-win for everyone.