by RUSHI SHAH
The ongoing effects of the pandemic continue to permeate through our industry. While news of a widespread vaccine is hopeful, we must first deal with a second surge of positive cases. Facing this uncertainty, commercial real estate owners – and especially hoteliers – are trying to understand and navigate the new norm. They want to know what it means for them individually and how to best adapt their business. In doing so, an obvious place to start is to look at the state of the capital markets and the markets’ view of leverage, in-place and potential cashflow, cost basis for assets, risk-adjusted return, underwriting metrics, and other indicators.
Hotel lending is back, whereby CMBS lenders are issuing term sheets and closing deals for hotels with in-place debt yield (net operating income, or NOI, as a percentage of loan amount) of 12 percent or more for the trailing 12 months. Lenders, mainly CMBS, are still focused on a stabilized loan-to-value of 65 percent. Within the current conditions, in-place cash flow is a natural corrector of leverage and therefore a metric that appraisers and lenders are using to effectively value assets and size proceeds for loans, respectively. This is because the trailing 12-month period should reflect the degree to which the pandemic shutdowns affected the hotel and contributed to the cash-flow hit. Assets with cash flow that showed more resiliency during the past few months will have less of a COVID-19 discount applied to their value, while assets such as a full-service hotel in an urban market that saw more significant cash-flow degradation during that same time period will merit a larger adjustment. This discount can range from 7 percent to 20 percent of 2019 values. When seeking financing, it is important for owners to ensure that the analysis of how “COVID-proof” their property has been is accurate. Going through a professional with pre-existing relationships in the marketplace can definitely help maximize the asset’s calculated value and subsequent loan proceeds.
There continues to be ample short-term capital from debt funds, with the majority of lenders looking to fund hotels at 6-to-9-percent interest rates on a non-recourse basis. Most lenders funding these deals tend to prefer select-service hotels in markets that are business-friendly and have largely remained immune to the industry shutdowns. These lenders also are ultra-focused on their ability to be refinanced out of these loans by either a CMBS or another permanent loan when the market stabilizes.
For capital markets participants, cost basis is an important decision driver. Lenders and equity providers want to make sure that the developer has skin remaining in the game after a refinance. For developers who are looking to build new hotels, there is capital available. For these projects, lenders will use dollars-per-square-foot and cost-per-key metrics as a barometer to measure the success rate of a particular asset. Developers should pay close attention to their construction costs and land costs to determine the real feasibility of the projects.
Market participants also are focusing on risk-adjusted returns. This means lenders are comparing a hotel asset at an 8 Cap Rate to a multifamily asset at a 7 Cap Rate and trying to determine if the additional 1 percent of return is worth the risk that overnight renting of real estate carries.
It is important for any lender to fully vet projections provided by the sponsor and challenge the assumptions to be able to successful underwrite and exit the loan. As we anticipate a vaccine and start to emerge from the pandemic, most lenders are underwriting potential hotel cash flow with 50-percent occupancy and $80 to $150 of ADR for assets in major markets that enjoy drive-to demand and do not rely on group travel. This is a good gauge to determine if a hotel will be able to support a given loan amount or not.
Now more than ever, every deal should be evaluated based on a case-by-case basis. In an everchanging market like we are in now, it is even more important to connect with a professional who is active in the market and who can help put together the best financing solutions for your properties.
Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Allied Member Mag Mile 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.