For hotel developers, debt for projects is never a sure thing and lenders in the space are keyed in on market fundamentals.
Angelo Stambules, principal at Davis Hotel Capital, said the market has responded to the industry’s slow revenue-per-available-room growth by demanding sharper, more precise underwriting.
“You really have to have your project buttoned up,” Stambules said. “Understand and anticipate certain questions, and be prepared to answer [them].”
One question Stambules said hoteliers should be ready to field is: “What is the impact of supply on a market?” Rushi Shah, principal at Aries Capital, said that lenders are also looking into the sustainability of cash flow, and it doesn’t stop there: Rating agencies also want this information.
“The demand growth is there,” Shah said. “There’s no catalyst that’s changing the demand growth from 3 percent to 7 percent, but there is something going on in the supply side that’s changing that supply from a 3-percent growth to an 8-percent growth. And that’s what’s got people worried.”
Peter Nichols, national director of the hospitality group at Marcus & Millichap, said that while hospitality’s supply issue cannot be ignored, other factors should be considered. He said that New York receiving 15,000 new rooms without significant demand growth is a problem, but secondary and tertiary markets still have room to grow, and new supply in those locations is a boon.
“Are we overbuilt if the market’s running 86-percent occupancy? I would say no, I think you’d still have some runway in front of you,” Nichols said. “But at the same time, if you’re in that smaller market where you still have an increase in demand that’s outpacing the supply, then I think that fundamentally is the place that you’re looking to put those dollars to work.”
See below for a 10-part video of the roundtable as it happened:
Build Your Way Out
With supply as much a concern as it is for the industry, lending for new construction has logically slowed. Anand Jobanputra, SVP at Wells Fargo Hospitality Finance, said that while lending for new builds hasn’t dried up, the bank is doing noticeably less of it.
“We try to do what we call more standing loans: there’s cash flows in place, strong debt yields, as opposed to construction,” he said. “Given where we are in the cycle, construction is going to take you 18, 24 months to get off the ground, and then you’re going to need a year to ramp. So we think that’s going to be pretty late in the cycle, or we’re going to be in different environments [before it picks up again].”
Shah characterized new construction as “the red-headed stepchild of the lending business,” and said it is “only getting redder.” While deals are still taking place in the construction space, Shah said lenders are focused on smarter deals that will make real impact as opposed to simply going big.
“We are doing between $10-million and $20-million deals, but they are very sponsor specific, very market specific and there is more equity going into those deals," Shah said. "Sponsor equity, hard equity, not just some imputed land value equity.”
Even in the face of mounting supply concerns, Matthew Hick, director, underwriting at Access Point Financial, said his company is willing to get to work on a project that is proven to make sense.
“Each hotel is a street-corner business where it’s focused on [its own] market. So if there are no new hotels and it’s a good market, it’s a good brand and it’s not represented, then we love to finance something like that,” Hick said.
Just Start Over
While funding for building may not be available, the opportunity to reposition existing assets has never been more real. Nichols quoted a former colleague in saying that some markets are “under-demolished,” meaning the age of existing assets may be too advanced in order to properly push rate when compared to the competition. It’s a problem that is often solved through renovations, or in some cases, knocking everything down and starting over.
Chris Burdette, managing director of North American development, Best Western Hotels & Resorts, said many of his group’s member hotels are experiencing that exact problem. Many of the company’s owners set up shop early in secondary and tertiary markets across the country, and are now losing out to newcomers who have swept in with fresh products and high rates.
“Our hotel has captured the market from a TripAdvisor score standpoint, but from an [average daily rate] standpoint there’s kind of a ceiling because of the age of the asset,” Burdette said. “So what we’re advising them to do is scrap it. Create an asset that is now leveraged with the competition.”
Carrying The Torch
If major banks are curtailing their lending for new construction, as Jobanputra pointed out, are smaller banks stepping up to fill the void?
According to Burdette, regulations in place due to the Dodd-Frank Wall Street Reform and Consumer Protection Act mean that small community banks have been limited in how they can take action during this period.
In response, Michael Sonnabend, managing member of PMZ Realty Capital, said that his company will often help local properties refinance and recapitalize at local banks in instances where the banks are tapped out. This often takes place in secondary and tertiary markets, where a hotel’s best chance for success lies in a local bank. Even then, the issue grows complicated due to consolidation taking place in the banking industry.
“But part of it also is that a lot of the smaller banks were gobbled up by the bigger banks,” Sonnabend said. “We have clients who had a deal with a bank and now they’re on their third bank on that deal, and they never did anything other than have the banks be purchased, or fail, or a combination of both.”
Optimism For Now
When asked about the current geopolitical landscape through-out the U.S. and beyond, the table noted a general optimism felt primarily as a result of a pro-business administration and a strengthening dollar. Policies such as President Trump’s proposed border wall and previous travel bans, however, were viewed as potential drags on the positivity. Shah said he sees optimism everywhere, but it’s possible for optimism to top out.
“My prognosis is that come fourth quarter of 2017, the markets are going to run out of steam. The optimism is not going to translate,” he said.
However, Shah did say that there are multiple positives to the current administration. Currently, hotel lending is considered specialty lending, which means some community banks have to have 100 percent of the capital allocated for hotels.
“The capital requirement has gone up five-fold,” Shah said. “If that gets curtailed back, yes, we’re going to see some of the smaller lenders [return to] the market. But that might have some impact on some other sides of the equation.”
Stambules said that these larger geopolitical issues matter, but they work in the background of deals as they are trying to get done. But at the end of the day, someone has to take action.
“Investor interest, lender interest, all the psychology of the bigger-picture questions and economy are there in how the deal is reviewed and what kind of interest you get from investors in the deal,” Stambules said. “But the deal itself has to stand on its own.”
Foreign Buy
In closing out the discussion, the table threw around the concept of EB-5 financing as a viable financing vehicle. Jobanputra said that it is still taking place, but it is mostly reserved for gateway cities.
“A Chinese investor doesn’t know a bank in Georgia, but they know Chicago,” he said.
According to Sonnabend, EB-5 is limited in practice be-cause of timing issues related to getting money for development when it is needed.
“We did a construction loan on a branded boutique AC by Marriott where the developer said, ‘I’m putting my money in EB-5,’” Sonnabend said. “I said, ‘That’s great, we’re not your guy.’”
Nichols added that it’s a delicate situation limited by timing issues. However, there are workarounds—but nobody has tried them all yet.
“If you can pair with a short-term lender and get the debt piece to say, ‘Yes, you can swap out EB-5 for your initial capital,’ then it makes sense,” Nichols said.