Tue. May 28th, 2024
hotel lending

A possible slowdown in the economy will have an effect on the whole hotel business. However, according to several experts, the hotel lending market is likely to suffer the most.

“There are signs of a soft landing [in the economy], but if the economy goes into recession, it will hurt hotel performance,” said Michael Sonnabend, managing member and co-founder of PMZ Realty Capital. “The second big risk is that interest rate protection on deals closed in 2021 and 2022 will end.” This could be expensive because short-term interest rates have been rising for 18 months.

Problems with coverage hotel lending 

The main problem is that benchmark rates have gone up so fast while hotel income has not. This is what Loren Balsam, chief investment officer at Hotel Asset Value Enhancement (hotelAve), said. Coverage is a problem for a lot of places right now. “The majority of loans for private hotels are floating-rate because many investors purchased interest-rate caps, which kept them safe during the period when benchmark rates increased so quickly.” As those caps burned off, they were safe for one, two, or three years. “According to Balsam, the cost to replace such caps has significantly increased. “To protect against changes in the benchmark rate now costs a lot of money.” 

He also said that credit market rates have become very wide since many lenders have left the market. “I imagine the spreads as a pendulum.” The spreads go up when lenders enter the market,” he said. “Spreads get wider when the number of lenders who are willing to quote drops. The standard rates have risen quickly, and the spreads have also grown. This is not normal. The rate change appears to have hit the markets twice.

Peachtree Group Credit SVP and head of hotel originations, Jared Schlosser, said there wasn’t as much cash as in previous years. “I believe that there are just less lenders willing to lend money to individuals who need it. Ten months ago, there were 32% more lenders on the market than there are now. It depends on what you’re trying to get when you narrow that down to the hotel market.” 

Schlosser said that these days, fewer people are able and willing to give loans for building things, and hotel lenders are often much less willing to lend money. Because of this, private capital can come in and lend money to hotels. “We have been very busy this year,” he said. “We have seized a significant portion of the market from investors, those who need to pay maturities, and those who wish to construct hotels.” 

Don Braun, president of Hall Structured Finance, said that the biggest problem is that banks and other institutional lenders are making it harder for the hotel industry and other real estate sectors to get cash. “Simply said, the increase in borrowing rates and other expenses has made deals more difficult to close.” People must be prepared to provide additional equity when they wish to refinance their present assets.

It’s not all bad news for the hospitality lending market right now. In fact, some people have said that it’s “relatively strong right now.” 

Kevin Davis, Americas CEO of JLL Hotels & Hospitality, said, “To be honest, the hospitality lending market is much stronger today than it was a year ago. That may come as a surprise, but there are a number of reasons for that.”

“First, throughout the previous year, the foundations of operating a hospitality business have remained and even strengthened.” Lenders are reacting to this by making loans in this area.” 

“Other asset classes, like multifamily and industrial, were on a tear [in 2021 and 2022], so a lot of debt capital was going to those areas,” Davis explained. “However, those are very rate-sensitive sectors.” Those areas suffered when the Fed started to tighten monetary policy in March 2023.. It’s had a negative effect on the capital markets in terms of values and hospitality, but at the end of the day, we can change the rates every night. In times of inflation, we could respond by raising our ADRs. As a result, our NOIs have stayed pretty stable. Lenders are increasingly interested in the space. A lot of money has moved from other types of assets to hotels. 

Risks in the Market hotel lending

Following the COVID pandemic, Davis noted a surge in “pro forma underwriting,” essentially insuring hotels against a potential “ramp-up” scenario. “Lenders usually base their loans on how well a business is already doing,” he said. COVID significantly negatively affected the performance of most hotels. “You had to lend money against income that wasn’t there if you wanted to be a lender in hospitality in 2021, 2022, and early 2023.” A lot of the time, the income came in as a sector grew. But sometimes, assets didn’t grow as planned. Upon granting a loan for specific assets through “pro forma underwriting,” the cash flow failed to meet the projected levels in the business plan. Also, over the past 20 months, the cost of debt has gone up by more than 500 basis points. 

According to Davis, there are times when the asset can’t cover the debt service because it hasn’t grown as planned. 

Castle said that those delayed PIPs pose another risk to the lending market right now. “Hotel owners made it through COVID but put off their PIPs, and they’ve put a lot of money into these deals to stay alive,” he said. “They are now using the money they could have invested in the asset to cover its costs for the next two or three years.”

“A lot of people in the industry will borrow money but not have any more, and they’ll just hand the lender the keys.” Your borrower will have a big PIP due if they don’t have enough money to get through COVID. They’ve been holding an asset for a long time. These individuals will find it challenging to sell their asset. They will either sell it if it’s worth something or give the keys back to the lender. 

Schlosser went on to say that the only risk for new loans is that interest rates are higher. “If you have a debt yield of nine to thirteen percent and can only size it to ten percent, you have a loan that will never pay for itself,” he said. 

“Making sure that we are putting loans on strongly positioned assets owned by borrowers who can weather the short-term risks that may occur,” Sonnabend said, was the old-fashioned way to lower the economic risks in the industry. “The most important thing for people who use capital to understand is that they need to be honest about what they expect.” Rates of interest and standards for getting a loan are not the same in 2020 as they were in 2010. 

Braun believes that the 2024 hotel loan market will be similar to the 2023 market in a number of ways. “Banks and other institutional lenders will pull back even more than they have been doing all year, making it more important and more likely for private lenders and other alternative sources of financing to step in and fill the gap,” he said. 

Braun believes that private lenders will play a more significant role in bridging the cash gap that banks and other institutional sources are leaving behind. He said, “There is a real opportunity to provide hotel construction financing in 2024. We believe this is an attractive time for developers to look at the prospect of delivering a new hotel in two to three years, when it is likely that we will see a dramatic reduction in new supply coming online, and the interest rate environment may be somewhat lower.” “We also think there will be more chances to work together with C-PACE lenders in some situations to offer combined loans that can be much cheaper than loans from a single source.” 

How to Get Money: Tips 

Davis said that the debt markets are whole and ready for business. It’s easy to get money. “I’d say the prices are about 5 percent higher than they were 20 months ago,” he said. “Borrowers may not like the prices, but there is definitely liquidity for hotel debt.” 

There is some liquidity for ground-up building, but Davis said it is one of the harder types of assets to finance right now. Most of the time, a borrower needs to have a lot of knowledge about development. To get a building deal done, they need to have a strong balance sheet and look for leverage that isn’t too high. 

According to Davis, the lack of sufficient investment in many assets over the past few years has created a real need for PIPs. The brands also demand that owners invest in PIPs. ” In general, it’s not a PIP loan. He went on, “It just turns into a loan against the property.” “We’ve seen borrowers get more money than they already owed to pay for a PIP.” The comparison of the loan to the asset’s value after renovation, along with the loan’s current cash flow and an estimate of its future cash flow, will determine this.

Schlosser’s best advice for hotel owners is to check ahead of time to see when payments and PIPs are due. “I can’t tell you how many times people with hard maturity wait until the last minute,” he said. “The way things are now, you don’t know what your lender will do if your loan is due.” It makes sense for people to want to know if interest rates will go down. However, it may be better to pay the extra money to refinance in 18 months than to get into a jam. 

Braun said that Hall Structured Finance is looking for experienced hotel developers who have shown they can stick with a project. Also, being able to find and bring in new cash will be important for getting new financing in this market. 

The financial markets are very tough right now, Balsam said, and most owners know that. “They know that their debt will come due in 12, 24, or 36 months, and that refinancing will be hard for them.” “I think those owners are spending a lot of time with their operators, focusing on operating margins, trying to cut costs so they can keep their margins,” he said. 

If you look at revPAR growth, 2023 was a pretty good year. But I don’t think 2024 will be as strong, Balsam said. “I think that’s what we want to happen, but owners will have to keep their costs down.” We will pay close attention to running costs and optimizing worker utilization to maintain the property’s health.

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