The lingering travel reduction due to the ongoing pandemic has increased the financial stress on the majority of hotel owners. Lenders have taken a more adversarial position (their interests are definitely not aligned with the borrowers'), and there is a need for capital to satisfy the requirements of current debt payments and longer-term restructuring.
As the probability of government assistance through the proposed Helping Open Properties Endeavor (or HOPE) Act diminishes, hotel owners would be smart to begin focusing on the capital markets to provide outside funding needed to carry their assets through the pandemic. The initial deferral of payments for three to six months has expired, and lenders are looking for borrowers to show commitment to the assets as part of a restructure. Seasoned lenders want to work with borrowers who have access to sufficient capital to solve the cash-flow problem during the term of the loan, and rescue capital can provide that needed liquidity from a third-party source.
What is Rescue Capital?
Rescue capital typically is preferred equity provided by a third-party equity investor. It helps carry the hotel through the downturn and returns cash flow to sufficient levels to refinance the capital stack. The investor/lender expects to be repaid from a capital event in an agreed-upon time frame. It has many characteristics of a loan but is structured as equity to meet the existing lenders' requirements. Due to the debt-like characteristics, the capital needs to be returned by a certain date, even though it is considered equity. The investor requires a specific minimum return (IRR), which is typically in the mid-teens but does NOT share in the upside as the asset gains value. In addition, professional preferred equity providers are not seeking a "loan to own" situation.
There are both positive and negative aspects to utilizing preferred equity capital, but it is often the best way to maintain ownership of the asset, allows owners to focus on strategic issues for the property and generate third-party funds to replace or supplement ownership funding.
We have recently closed several rescue capital deals and have investors actively seeking to put out more capital. This financing allowed our clients to raise the required capital to guide their hotels through the pandemic while retaining full ownership and management of the asset. It also allowed them to effectively renegotiate workouts with their existing lenders since they had fresh capital available for the deal. This is typically a requirement to get the best execution on the existing capital stack.
Factors to Consider
The most important consideration in any financing is to make sure that the loan's characteristics fit with the business plan for the asset. Rescue capital is no different. While not right for every circumstance, it is most appropriate to help with short-term cash-flow issues when the long-term value of the asset is significant.
Michael Sonnabend is managing member and co-founder of PMZ Realty Capital.