Lenders use variety of factors to determine borrowing power for hotel loans

When hoteliers need loans, lenders look at many different metrics in order to calculate borrowing power. From NCF to NOI, RevPAR and beyond, Mac Dobson, senior vice president of originations at Aries/Conlon Capital, breaks down all the acronyms and terms hoteliers need to know.

First, Dobson said hoteliers need to know their numbers upfront so that they or their intermediaries can ensure the accuracy and structure around them and improve results.

“Get organized,” he said, adding that hoteliers should gather at least three years’ worth of profit-and-loss statements in Excel as well as a trailing 12-month statement.

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With those in hand, the following are what lenders look to and hoteliers should know about:

Net Cash Flow or Net Operating Income

This is net profit before paying for any debt, such as interest and principal, or any non-cash expenses, such as depreciation or amortization, and is used to determine a hotel’s value and loan amount. As NCF increases, so too does the loan amount.

“This is your bottom line,” Dobson said. “If net income is $200,000 and interest is $150,000 and depreciation is $50,000, then net cash flow will be $400,000.”

After arriving at NOI before reserves, the lender will underwrite a furniture, fixtures and equipment reserve of 4 percent of revenue and a management fee of 3 percent, even if the hotel is self-managed.

“That’s a buffer to make sure there’s a little bit of breathing room,” Dobson said.

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He offered an example of a 90-room Hampton Inn in a second- or third-tier market that has $3 million in revenue. For midscale hotels, he said net cash flow should be around 35 percent of total revenue, making the NCF for the Hampton Inn about $1.05 million.

However, he said two properties with the same NCF might not qualify for the same loan amount because market conditions, flag, property condition, location, operating efficiencies, franchise term and costs to build, buy or renovate all can factor.

“Market is very important. A Hampton Inn in Columbus, Ohio, is going to be looked upon in terms of loan structure more favorably than a Candlewood Suites in Cincinnati,” he said. “Columbus is viewed as a booming market and lenders, right or wrong, perceive Hampton as a slightly better flag than a Candlewood.”

Revenue per Available Room Index

The RevPAR Index is the property’s average daily rate times percent occupancy. It offers a good gauge as to how a property is performing in its competitive set.

“Lenders will look to it right away,” Dobson said, adding that the target to shoot for is a RevPAR Index of 100 percent.

He said that if hoteliers find their RevPAR Index is lower than 100 percent, they should confirm the comp set is valid. It’s not always a deal breaker, but it does warrant an explanation before a deal can be presented to an investor’s credit committee.

Capitalization Rate

The cap rate identifies the hotel’s value or the percent return an investor would receive if the property were purchased with cash, Dobson said. The maximum loan-to-value allowed by a lender is applied to the calculated value to determine the loan amount. As cap rates go down, the loan amount increases.

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Dobson said it’s important to work with someone who has market knowledge to address variances because cap rates in markets with few trades can differ.

Looking at the example of the 90-room Hampton in the second- or third-tier market, the hotel might have an 8-percent cap rate based on the market’s past sales data. Thus, the value of the hotel for financing would be about $13.125 million.

Debt Yield and Loan-to-Value Requirements

This is the expected rate of return on a lender’s investment from the start, Dobson said. Debt yield equals NOI divided by the loan amount. As debt yield requirements decrease, the loan amount increases.

Dobson said that when income is less predictable, lenders will raise the required debt yield level, which will reduce the loan amount. This can happen in markets where cash flow is less stable or for flags that are lower on the STR chain scale.

In primary markets, debt yield will be about 9 percent for higher-end hotels. In secondary and tertiary markets, debt yield will be 10 percent to 12 percent for select-service hotels. The loan amount is then still subject to the lender’s LTV cap, which is 70 percent for select service. Dobson said that debt yield and LTV are the main drivers for leverage. As credit markets pull back on hotel lending, debt yield will rise while LTVs fall.

For the 90-room Hampton Inn in the second or third tier market, whose NCF is $1.05 million and the estimated value is $13.125 million, a debt yield of 12 percent will garner a maximum loan value of $8.75 million.

Total Cost Basis

Dobson said this metric is often overlooked but important to the credit committees and bond market rating agencies. Total cost basis is the total dollars invested for construction or capital improvements since the hotel was built or acquired. It is especially important for a cash-out refinance because the new loan will be higher than the current loan. The longer a hotelier owns a property, the less important total cost basis becomes, however.

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“If you bought a hotel for $2 million and you put $1 million in and now it’s worth $7 million, you’ve more than doubled the value,” Dobson said. “Your cost basis is likely to come into play there. You want to be able to explain your cost basis. You want to keep detailed records when spending money. If you have records to show, then the less of an issue this will be.”