The hotel industry is looking forward to the recovery—whenever that might be, as the data crunchers work out their forecasts amid new COVID variants and travel restrictions and regulations that have the ability to change overnight. All things considered, it puts hotel lending on shaky ground. The lending landscape certainly doesn’t look how it did a few years ago, but as the world continues to change, the lending world adapts in step. In many respects, a conservative mindset reigns.
“Underwriting is becoming more conservative, with an emphasis on actual hard equity going into the deal. Lenders are cutting last dollar closer to 50 to 55 percent,” said Mat Crosswy, principal and president of Stonehill. “From a global lending landscape, there is little liquidity from your traditional sources—banks, insurance companies, [commercial mortgage-backed securities]. The vast majority of today’s capital is coming from debt funds, which includes a large number of new entrants into the hospitality space providing hotel debt capital.”
In some areas of the industry, however, lending may be getting a little looser, according to Alex Cohen, CEO of Liberty SBF. “Getting into 2021, we started to see lending loosen up between assets that are more leisure focused versus corporate-oriented assets in large downtown [central business districts],” he said “As we wrapped up 2021, that trend has continued.”
Jordan Ray, senior managing director capital markets, and Steven Buchwald, senior managing director capital markets, both with Marcus & Millichap Capital Corp.’s Mission Capital Debt & Equity team, have noted there is more availability of capital from private funds and subordinate debt investors at larger scales.
“There are also more capital sources with their own dedicated funding sources like repo or warehouse lines that are allowing lenders who historically focused on the subordinate tranche to take down whole loans at higher leverage,” Ray said.
The Opportunities
However, the market does hold opportunities. A lack of liquidity across the board for acquisition financing, refinancing or ground-up construction continues, according to Crosswy.
“The most significant void in the market is financing for ground-up construction, with borrowers having to pay a premium for construction financing,” he said. “Debt fund lenders with the ability to lend across the capital stack to deliver tailored solutions will see a significant number of opportunities, particularly with the exodus of traditional lenders from the sector.”
Buchwald said there is interest in traditionally noncore hospitality or alternative hospitality uses, such as social clubs and outdoor hospitality offerings. “Some of these subclasses are proving to outperform traditional hotels because of the stickiness of their membership or, in the case of outdoor uses, the attractiveness to a new class of customers due to lifestyle changes in the pandemic,” he said. “These offerings provide lenders an opportunity for outsized yields for what is actually a lower risk profile.”
Cohen said Liberty SBF, which financed hotel owners through the Paycheck Protection Program, sees a huge opportunity in the government subsidy lending space. Beyond PPP, Cohen said the Small Business Administration has additional programs in effect now that aren’t as widely popularized as PPP. For instance, SBA 504 provides long-term, fixed-rate financing of up to $5 million for major fixed assets. Additionally, below-market interest rates are fixed for the life of the loan. Borrowers put down about 10 percent, and loan terms are for 10, 20 or 25 years.
What Lenders Want
Today, it’s more difficult to pin down exactly what lenders want from hoteliers seeking financing. As Crosswy put it: “It’s everything. Lenders need to know the nuts and bolts of every deal. That includes understanding the sponsor’s experience and business plan, what is driving their market and when will the market drivers return if it isn’t back already, and the financial health of the sponsor and its portfolio.”
Ray and Buchwald outlined three of the biggest things lenders will require:
- Pre-COVID historical cash flow performance and how it is trending now. Most hotel assets performed poorly in 2020. The important story today is how those hotels came into 2021 and got through the year. What has been the sponsor’s business plan and what is it going forward?
- Sponsorship track record and strength. Today, this matters more than it ever did before.
- Segmentation/guest profile. Many lenders want to make sure the hotel is not fully reliant on a profile that can disappear or won’t return soon, such as a class of business traveler or reliance on an airport.
Cohen added that lenders want to see the whole picture for 2021. That means the quicker borrowers can put together figures for full-year 2021 or file their tax return, the better. Another thing lenders want to know about, he said, is whether there are any deferred costs or property improvement plan requirements.
“Flags are coming down hard now on PIP and CapEx requirements,” Cohen said. “Everyone took a hit in 2020. Hotels are heavily used assets … and those deferred costs need to be factored into the decision.”
Crystal Ball
Looking ahead, Ray said he expects more new sources of capital from sponsors getting into the lending business. Meanwhile, he said spreads will widen but net borrowing rates will stay at historical lows.
Crosswy said lender pressure will be a significant driver of hospitality sales in 2022. “Many lenders have been going through multiple rounds of loan restructures and deferments, and we believe these lenders are hitting fatigue within the hospitality industry,” he said. “Ultimately, they’re either going to sell off their exposure or they are going to put pressure on the hotel owner to get them paid off, especially if they’re in some form of covenant default or if they’re facing maturity default.
“As a result, the odds of lenders extending loans will be less likely. We believe this will help drive potential asset sales on the real estate side.”
Skies aren’t so bleak, however, as lenders continue to adapt. “We have been extraordinarily active in the hospitality finance space. It’s times like these where we can step a little outside the box and explain a story or a business plan that belongs in a new paradigm,” Buchwald said.