by Rushi Shah
Hotel ownership has evolved over the years. Thanks to the growth of brands and franchising opportunities, an owner that may have owned only one independent hotel in the past can now tap into resources that make it possible to have an entire portfolio of Marriott and Hilton properties. The same can be said for accessing hotel financing. In the 1990s, a typical hotel wouldn’t qualify for a CMBS loan, and balance sheet loan options didn’t exist for hospitality assets. Today, capital opportunities have expanded and hotel owners can leverage a plethora of financing mechanisms.
While both of the above elements have contributed to this progression, there is another underlying reason for the evolution. An industry originally comprised of first-generation immigrants has grown to include their Gen X and millennial children, nieces, and nephews. This influx of new blood and ideas has created a sea of change in hotel owners that has affected their appetite to use more sophisticated financial tools, how they operate their business, and who they trust to guide them in key decision making. Let’s take a closer look.
Broader Circle of Influence
The impact of the new generation is obvious as they take on a bigger role in running or growing their families’ businesses. But even in situations where the children are not actively involved, they still have influence. Members of this new generation are typically well educated and bring finance, business, and law degrees from top institutions to the table. They have grown up with technology and know how to use it to access information and compare resources. As a result, they are able to bring a fresh, global, and often more objective perspective to the decision-making process, even indirectly.
Deeper Understanding of the Risk of Recourse
Historically, hotel assets were financed using an SBA or some form of government guaranteed or community bank financing with full personal guaranties, or recourse. Hotel owners chose these types of loans because they were comfortable and familiar. Owners were also operating under the misconception that they would lose their property if they went with a non-recourse loan. Today, non-recourse financing has become more mainstream, and hotel owners are more likely to understand that non-recourse loans will actually help insulate against losing a property by providing leverage to negotiate more effectively with lenders and servicers during adverse market cycles.
This enlightenment is partly due to many owners feeling the realities of suffering through a down cycle with full recourse on their loans. It also is because the new generation is helping instill confidence in how non-recourse financing works, and the benefits of using “other people’s money.” For example, we had a client who hesitated to put on a non-recourse loan on his large hotel property. After consulting with his younger family members, they convinced him to choose a non-recourse loan. This was indeed a wise decision. When his loan was close to maturity, he found out the brand wasn’t going to renew. Because his loan was non-recourse, he had better leverage and was able to negotiate with the servicer at the time of maturity for a principal reduction.
A hotel owner in the past may have also compared the term of a full recourse bank or government-backed loan with a non-recourse Wall Street execution and, if the rates were significantly different, automatically gravitated to the bank or government-backed loan. Fast forward to today and we see a knowledge shift. Now, armed with a broader perspective that draws from experience and the new generation, owners are better able to accurately price the risk of recourse. They understand that there should be at least a 2-percent premium on non-recourse capital compared to loans with personal guaranties attached. In other words, with all else being equal, if a 10-year CMBS loan is available at 5 percent, hotel owners should not even consider a bank loan above 3 percent.
Plus, when there is no burden of personal guaranties, a lender can’t touch the hotel owner’s savings, retirement, house, car, or other personal assets. This makes it easier for owners to build healthy cash coffers for their retirement and families and is a smart strategy for planning for the future. For example, we had a client who had amassed a significant amount of assets and was looking to transition the business to his offspring and retire. While he was willing to hand over the reins to the next generation of capable people in his family, he didn’t want to carry the credit risk. By refinancing to a long-term non-recourse loan, he was able to continue to own the hotel assets and trust his next of kin to handle the operations, without the burden of the personal risk. As an added benefit, he was able to take some cash off the table to diversify away from hotel ownership and monetize the equity he had built up over the years without tax consequences.
Increased Operational Sophistication
Generational change also is evident in how hotels are run day to day. The newer generation has recognized the benefits of more sophisticated operational infrastructure and the need for better internal controls and accounting to grow and scale. Using a separate management company to run the hotel is one example of a growing trend. As a byproduct of elevating their asset operations, hotel owners have opened the door to more sophisticated financing options such as institutional non-recourse financing through CMBS conduit, balance sheet and life company lenders, as well as hedge funds, private equity shops, mezzanine lenders, and REITS.
Increased Critical Mass
Working together, both generations have made taking advantage of the buying power, resources, and information provided by industry organizations such as AAHOA, local lodging associations, brand gatherings, and other hospitality events a common practice. Together, they have created a critical mass with considerable influence within the industry and over government legislation, politics, and the economy.
Strategic Use of Outside Expertise
Trust must be earned in any industry. People work with people they know and who they’ve worked with in the past. While relationships are still king, no matter the generation, we are seeing an increasing willingness in hotel owners to partner with qualified professionals who can bring the critical experience and expertise they may lack to the table. This is often driven by having next-generation advisors who can help vet the quality, serve as sounding boards and provide a more big-picture, less-emotional perspective. The willingness to effectively leverage qualified outside resources can significantly improve success and create a competitive edge for hotel owners. We see this proven every day when it comes to hotel financing. Knowledge translates into more options and better results.
Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Club Blue 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.
