Hotel industry threats cast pall over underwriting standards

Photo credit: Getty Images/wutwhanfoto

Hotel underwriting hasn’t changed significantly since 2014. Depending on the capital source, cash flow continues to be reasonably normalized and standard adjustments are made. Strong debt yields are applied, along with loan-to-value ratios and other typical underwriting metrics. Despite this, 2018 may prove to be the year when some of the threats facing the hotel industry seep into underwriting standards.

New Competitive Supply

New supply and Airbnb host supply will soon result in an imbalance with roomnight demand. This will hurt occupancy first and pricing power second. From a financing standpoint, owners should show lenders strong data proving why their hotels will not be as hard hit as the national averages will be. Statistics should show that recent new supply has been absorbed successfully or that a specific location is less impacted by macro cycles. STR reports and Airbnb data will help but are not enough. Lenders soon will reduce cash flow and loan amounts arbitrarily to reflect this threat unless owners are prepared with the right data.

Rising Interest Rates

Rising short-term and long-term interest rates are likely in 2018. Hotel owners will benefit by watching rates closely and locking in long-term fixed-rate financing when rates drop. Even during a macro trend environment of rising rates, there will be intermittent rate drops, and this is when borrowers must execute on prenegotiated rate-lock agreements. Selecting lenders that permit rate locks and having documents ready for signature will prove to be beneficial.

Underwritable Cash Flow

For cyclical reasons, lenders are likely to tighten the screws further when it comes to analyzing historical cash flow in 2018. Owners must avoid this by telling a story that explains historical cash flow trends and why they are sustainable. Lenders go on automatic pilot when it comes to underwriting models, usually based on rating agency requirements. But strongly supported explanations regarding the sustainability of recent cash flow increases can offset inflexible mindsets. Owners should understand how micro trends are impacting their hotels so they can market transactions using strategies and stories that prove the continuity of revenue. Qualitative analysis matters.

Structuring for PIPs

Property-improvement plan costs are a problem. At all-time highs, these costs are hurting not only new development projects, but also the structuring of reserves for PIPs that are required during loan terms. Owners must address this before obtaining financing. They should extend franchise agreements or identify costs up front so that outrageous PIP reserve structures are not built into their loan agreements. With the proper due diligence, often undertaken in connection with franchisors, reasonable costs and structures that benefit borrowers and lenders can be determined.

Lender Competition

Lenders are in a tough spot. Amazon is killing retail and multifamily properties are typically financed by agencies. This leaves only office, industrial and hospitality assets as the three big “food groups” for many commercial real estate lenders. Owners must understand that this gives them leverage if they shop the market for lenders. Owners should contact banks, commercial-mortgage-backed-securities lenders, insurance companies and specialty lenders on every transaction they market. Lenders will compete for business when a deal is being marketed across varied capital sources. Focusing on one capital category is not a good strategy.

2018 Game Plan

2018 may end up being too soon for the capital market cycle to turn, and if that’s the case, none of the above suggestions will do owners any harm, since they are all prudent steps. But if 2018 is the year when the cycle turns, these steps will ensure that owners obtain the smartest financing available for their needs.

Zak Selbert is founder of Vista Capital Company.