How can hotel owners achieve higher leverage and get transactions done in today’s market?
It looks like 2024 is going to be a year for the history books. Sure, it’s an election year, but we’re also anticipating the Federal Reserve’s interest-rate changes. While lower interest rates may seem like good news, cuts could be triggered by a significant downturn in economic activity and lead to job losses. This conundrum could prove to be fatal for our economic recovery.
Although it has been a challenging time to close hotel and commercial real estate transactions in the current high-interest-rate environment, we witnessed a let-off in long-term rates in the last three months of 2023. If we continue to experience this reprieve in five- and 10-year treasuries, the market will see an uptick in transaction volumes. The increased activity will be the result of both pent-up demand for real estate owners looking to transact, and the large swath of maturing loans.
More than $161 billion in hotel loans and $1 trillion-plus in commercial real estate loans will soon come due in 2024, with most of this ‘wall of maturities’ coming to a head this year. All of these loans will need to be replaced. A large percentage of maturing loans will end up in work outs and likely require an equity infusion because they can no longer support the higher interest rate. For perspective, according to Moody’s Analytics, 20% of all outstanding hotel loans are coming due in 2024. This is in addition to the overhang of loans still being worked out from the second half of 2023. Bottom line, we will see a large demand for hotel loans in the capital markets this year. When you combine the looming maturities data with the current regional bank lending landscape – mainly driven by regulatory pressures – the solution for most borrowers will be CMBS financing.
Experts suggest CMBS will play a pivotal role in 2024. Owners with maturing loans through regional and community banks may be notified their financing won’t be renewed, and they must find a new home for their loans. We likely will see more and more distressed sellers lining up to sell their assets, which creates opportunities for buyers with capital. Here are three strategies – and a few bonus ideas – buyers can look to while pursuing these attractive deals.
1. KEEP THE SELLER IN THE TRANSACTION
One strategy for taking advantage of acquisition opportunities is to keep the seller in the transaction. A distressed seller is likely willing to part ways at a slight discount, allowing buyers to value assets at a slightly higher price. By keeping the seller in the transaction for a small equity share in exchange for higher value on the purchase price, the buyer can finance the purchase at slightly higher leverage. For example, the buyer would purchase an asset for $15 million and keep the seller in the transaction for $3 million in exchange for a 20% limited partnership in the deal. Now, the transaction qualifies for a 70% loan from a CMBS lender. The buyer essentially acquires the asset for $1.5 million of equity because the seller is contributing $3 million of equity in the transaction. This scenario creates a win-win-win opportunity for the buyer, seller, and lender. The buyer can purchase the asset with a lower down payment, the seller garners slightly above market price for their asset, and the CMBS lender books a new $10.5 million loan. This structure also allows the seller to remain closer to the asset longer.
2. CONSIDER MEZZANINE DEBT AND PREFERRED EQUITY INVESTMENT
Other mechanisms owners can use to achieve higher leverage for both refinance and acquisition transactions are mezzanine loans or a preferred equity investment. There are numerous family offices and private equity firms dedicated to investing in higher leverage pieces on hotel properties. The majority of these preferred equity partners are seeking to invest at SOFR + 900 basis points. At the time of writing, SOFR is 5.25% for a 14.25% interest rate.
3. LOOK AT C-PACE FINANCING
C-PACE financing is another financing strategy that’s gaining momentum due to its viability under the current market conditions. Because of the higher interest rates on senior loans, the super-senior piece for a C-PACE loan now is typically lower than the interest rate on the senior loan. By using C-PACE, a borrower can bring down the overall weighted average interest on the capital. Unfortunately, it can be challenging to find a senior lender that will consent to C-PACE in the transaction because C-PACE is the super-senior loan that primes the senior lender’s mortgage because it gets paid off from the property taxes from the asset. By definition, the C-PACE financing’s interest rate should be cheaper than the senior lender’s interest rate, which for the first time is in line because senior loan interest rates have risen.
OTHER FINANCING OPTIONS
Hotel construction financing remains in demand in this market. Due to the inherent risk in this type of financing, however, there is a smaller universe of lenders offering this product. A few debt funds and some loan syndication programs are actively lending on financing construction for hotels at 65% loan to cost. For less-institutional borrowers, higher leverage is available through SBA loans.
Bridge loans continue to be a staple for borrowers in today’s environment. Current pricing ranges from SOFR + 350 basis points to SOFR + 500 basis points. Bridge financing is a good fit for hotel assets in transition, changing flags, or on the path to stabilization.
As we look forward into 2024, knowing which strategies are most viable for each transaction will be critical. Consulting a seasoned advisor who has all the necessary tools in their toolbox will be the best strategy for getting transactions done and done on time.
