There’s a lot for hotel lenders to keep their eyes on this year: fluctuating interest rates and growing inflation, market volatility, the war in Ukraine and general economic uncertainty. Perhaps the biggest challenge right now? “The lack of lending opportunities out there,” said Evan Hurd, managing director, RobertDouglas.
“Lenders deploy capital primarily through acquisitions and refinancings. Acquisitions have slowed to a trickle due to a disconnect on value between buyers and sellers, and rising interest rates have resulted in some of the highest costs to borrow in decades—in most cases, if an owner doesn’t need to refinance now, why do it?” Hurd said. “Consequently, opportunities are limited to the short list of deals actually closing, and near-term loan maturities.”
“The most challenging aspect of today’s lending environment is for lenders to determine the proper valuations on deals that aren’t acquisition loans or based on actual historical cash flows,” said Michael Sonnabend, managing member, PMZ Realty Capital. “Borrowers’ greatest challenge is to work with the lower leverage levels most lenders are willing to provide. This requires additional capital to close the gap between a 65-70 percent loan that is readily available and the total capital required.”
That said, experts noted that lenders are finding ways to put money to work. And out of the pandemic, creativity was born. For one, Driftwood Capital launched its lending platform in 2020 to fill a gap in the hotel financing space as a source of “rescue capital,” according to Carlos Rodriguez Jr., Driftwood’s COO, to an industry that desperately needed it.
“It’s been tremendously successful, particularly over the last year as interest rates have risen and traditional lenders have moved to the sidelines,” Rodriguez said. Specifically, Driftwood provides mezzanine and preferred equity financing, risk-adjusted loans in the $5 million to $75 million range, usually in conjunction with senior lenders, to meet borrowers’ desired leverage levels.
Biggest Opportunities
Even with the headwinds 2023 will bring for hotel lending, sources said there won’t be a shortage of opportunities either.
While Michael Weinberg, managing director in Berkadia’s Orlando office, said hotel lenders are keeping their eyes on interest rates and recessionary pressures to average daily rate, the second half of 2023 holds some opportunities.
“[Interest rates] will peak early in the year and then pause or come down as the year progresses,” he said. “We believe the second half of the year will have a lot more transaction volume as groups feel like the volatility is past us and they can now quantify risk better.”
“There are going to be many opportunities in 2023 for hotel lenders due to the large number of loan maturities expected over the next 12-24 months. Hotel owners will either need to refinance or sell as well as many hoteliers having to complete renovations,” Rodriguez said. “Both will generate significant demand for capital—and specifically, capital partners that know how to work in this landscape.”
Hurd said near-term maturities will hold opportunity this year. “Just because we are in a higher interest rate environment, it doesn’t mean that your maturity date changes. A lot of deals will come up for refinancing this year. In many cases, maturing loans are not underwater, the properties are not in distress, but the next loan won’t be so easily structured,” he said. “This is an opportunity for lenders to get into the generally profitable mezzanine and preferred equity spaces to fill in the gaps in financing. Higher rates and higher leverage mean higher returns. Relative to the last dozen years or so, lenders can get relatively attractive out-sized returns.”
Finance Seekers
Experts offered tips for hoteliers who may be seeking financing this year.
“First, bring your expectations to the new normal. Borrowers looking for sub-6 percent financing, in most cases, are just non-starters,” Rodriguez said. “Second, leverage your relationships. While many major institutions remain on pause, regional banks and lending funds can still be an attractive source of financing depending on the asset.”
Weinberg said hoteliers should hire a trusted advisor or intermediary to fully canvass the market. “The days of going to your three to four relationship lenders are past, for a least a period of time, because many of them have pulled out of the market completely,” he said.
Hurd outlined several points those seeking hotel financing this year should be aware of.
- The market has changed: At least for the near term, the reality is that it will be difficult or impossible to match the historically low interest rates seen for the previous decade. “We have to accept that the 2019 view is gone now, too far away in that proverbial rear-view mirror,” Hurd said. “Lenders will be looking at the trailing 12 to 18 months of cash flows, post-COVID performance and the prospects for covering debt service going forward.”
- You will have options: Yes, rates are higher now. The good news is that there is liquidity, unlike 2009 when there was no credit. “Check out your options, as the numbers and types of lending facilities continue to grow. From the local regional bank and life insurance companies to [commercial mortgage-backed securities] lenders, debt funds and specialized adjuncts like [property assessed clean energy] financing and bridge lenders,” Hurd said. “From a borrower’s perspective, if you have low leverage and good cash flow, you should get access to the best financing opportunities because the overall volume of deals is depressed right now.”
- Work with your existing lender: “We are encouraged to see lenders working with borrowers on loan modifications. Even with a higher interest rate and other changes, modified loans might yield a better result than a new loan, and there is a lot of liquidity to fill any capital ‘gaps’ that might exist should a modified loan be less than the existing one,” he said.