No matter your plan for that dream project you’re looking to create, you’re not going to get anything done without a loan. These days, lenders are getting a little bit stingier with their loans for reasons explained below. But to get the money you need for that next project, there are things you can do to ensure the odds are in your favor. Here’s what the experts say you should do to make yourself look good to those lending institutions:
Determine the Fundamentals
First up is figuring out the type of loan you are hoping to achieve. There are two major types: a construction loan and a loan to buy an existing property. While there are nuances to securing either type, generally speaking, it becomes an issue of ensuring the bank you can pay it back.
Mike Hines, chairman of HP Hotels, a Birmingham, Ala.-based management company, said would-be hotel owners and builders must put a certain percent of the overall loan total down to secure a loan. It’s called loan-to-value ratio, a number currently running about 30 percent. Historically, that number has swayed some up and down, but it fluctuates depending on hotel ownership development experience.
“There is no substitute for a great track record demonstrating expertise in the space and having internal and other resources,” said Adam Valente, president of Continental Hospitality Group, a real estate and development company that invests in select-service and extended-stay hotels ranging from $15 million to $75 million.
“It’s also essential to have a balance sheet of one or multiple individuals to cover the debt through either a personal guarantee or a joint guarantee,” Hines said.
Tip: Be aware that in most cases all investors are responsible for the full amount of the loan regardless of percentage ownership in the project, but this is something that can be negotiated with the bank.
“Borrowers must be organized and make the flow of information easy, timely and accurate,” Valente said. “Yes, this is seemingly simple, but it’s a misplaced idea a lot in the marketplace.”
Be sure all information is accurate, and what Valente calls “consumable;” the right amount of information creating the right story for the lender to see and understand quickly. “If you give much or too little, you’re forcing the lender to create that story on their own. Lenders want a high return on their time, that goes off the radar for many developers. Return on lender time metric should be very high.”
Valente said it’s about grabbing their attention, ensuring they know you have conviction and can support that conviction with data and analysis. “It’s underwriting that makes the lender’s job easier, and about making the lender look good in their recommendation to give you that loan,” he said.
Tip: Double check all information you plan to provide is timely and consumable. Plus, don’t provide too much information, only what the lender is looking for in the initial screen, a couple of pages of underwriting support.
Have Command of the Details
Remember, it’s a lot easier for lenders to say no to a loan than yes, a side effect of a growing sense of internal conservatism, Valente said.
To get money, passion for a project isn’t enough. You must get the lender equally excited. That means knowing in sufficient detail what drives a market, how this investment and opportunity is positioned to outperform or satisfy demand where none currently satisfied. It’s the premise for the investment, so it must be compelling.
“Paint a picture and support the story. You must continually show the lender this project is merited and makes very good business sense to pursue,” Valente said.
Our experts also say don’t obfuscate negative factors. Be up front regarding risks and challenges, and communicate them in a way that is transparent and thoughtful. There are risks to every loan, and they will be found by an underwriter. So, prove they are intelligent risks.
Tip: Be honest and credible with your expertise and your internal resources. You have been there and done it, show it.
You don’t have to simply accept the terms you are given by the underwriter. For example, Hines said you can negotiate the debt service coverage ratio. Typically, banks will want to make sure there will be more than enough cash flow to cover the payments and they’ll want to see $1.30 in cash flow for every dollar of the loan payment.
Hines said to negotiate in the first year a one to one ratio. “Hotels must generate profitability of 110 percent to 150 percent of a loan,” Hines said. He elaborated that those willing to work with the bank can hammer out a deal to see that debt service ratio rise in subsequent years when the hotel stabilizes.
One way to achieve more favorable terms is to put in more equity up front. The amortization schedule is also up for negotiation.
One example Hines points to is getting a 10-year loan, but negotiating a 30-year amortization with a lower monthly payment and balloon note at the end. This generates more cash flow and allows you to take higher profits up front, rather than years from now. This also makes it much easier to hit that debt service ratio. The catch: you better sell or refinance the property before the balloon notes comes due.
Also, negotiate interest rate. And look to get a nonrecourse loan over a personal guarantee. Hines said when you buy a hotel, you get a 100-percent personal guarantee in year one, but as hotel makes more profit, the bank will release you of guarantees, also called burn-offs. Eventually it’ll become a nonrecourse loan. “If I get a 25-percent burn-off when I hit 1.25 service ratio, I am not responsible for 25 percent of the debt,” Hines said.
Tip: Do due diligence on loan terms to make sure everything discussed with the lender makes it into the final agreement.
Remember: Cycle Matters
We’re at the part of the hotel cycle where lenders are becoming increasingly skittish about lending in the hotel segment. “A few years ago, borrowers were beating lenders away and negotiating low spreads, that is not the case now,” Valente said. “Lenders have limited hospitality capacity in capital allocations [much of which has been distributed], plus many think the hotel sector has peaked in performance.”
Valente said the most easily achievable loans right now are refinancing of construction loans: They are more stabilized in lending markets because they are more liquid.