Article by: Jane Larkin Managing Director of Larkin
In the early part of 2011, hotel lending had not returned in earnest even with the improvement in hotel fundamentals. Today, more lenders are actively engaged in hospitality lending, but debt is still not readily available to a broad range of borrowers. This is an issue in all areas of commercial finance. As Kiplinger’s states, “Although banks are willing to make more loans overall, many entrepreneurs—the largest creators of new jobs—still find it tough to secure funds needed to start and expand small businesses.”
What continues to make financing hotels particularly difficult is the large number of loans banks are still in the process of working out, but as these are resolved money will slowly become more available across markets and segments. An indication that the sector is moving in the right direction is the 52 basis point drop in CMBS delinquencies reported by Trepp in April. The hotel segment was the only one to see a decline, as all other major property types jumped, pushing overall CMBS delinquencies to a new record high.
Hotel finance: What to expect for the remainder of 2011
With the ability to secure financing for a hotel still a challenge, borrowers should expect the following as they bring their projects to the capital markets in the second half of the year:
• Increasing debt availability—The availability of lending is expanding to a broader range of borrowers. Although the easiest projects to secure financing for continue to be top-tier, name brand, stable property types anchored by experienced owners and operators, more properties in the mid-to-lower tier and in secondary and tertiary markets have access to debt today. SBA and USDA loans have been the driving force in funding hotels outside of the top markets and upper chain-scale categories. While we have seen some government guaranteed lenders pull back from hospitality after aggressively filling their pipelines with hotel projects, we expect most to remain very active. Conventional lending also will continue to grow as lenders clear their balance sheets. Keys to this happening are a return to a robust secondary market, the workout of non-performing loans and the pay down of principle by strong borrowers.
• Focus on refinance and acquisition remains—More than 80% of commercial real-estate loan closings this year have been for the refinance or acquisition of a property, and most industry analysts don’t expect debt for development to return in earnest for another two to three years. As I discussed in my May column, “It’s not time to build hotels,” with occupancy forecast by STR to be approximately 60% for both 2011 and 2012, the market is not at the point where it is overwhelming supply. In addition, the hotel sector is still in the process of absorbing the 480,000 rooms that came online between 2007 and 2010. The many mature loans sitting on bank balance sheets are also a factor. Lenders remain focused on deploying capital on the large number of refinance and acquisition projects available. The second half of 2011 will continue to be a good time to refinance to unlock cash for property improvements or bring down debt service costs, as well as acquire new assets for 20-30% below replacement cost.
• Continuation of tighter underwriting—The best terms continue to go to the projects with strong brands, sponsors and management teams; in urban locations; with cash being brought to the table. The desire by lenders to see strong financial performance across a borrower’s portfolio will remain, and strict underwriting standards will stay in place for the rest of 2011 with some banks tightening lending criteria even further after quickly loading up on hotel loans in the first half of the year.
• Increased CMBS activity—After virtually no CMBS originations the past two years, the market is returning in 2011. Industry experts expect about US$50 billion in issuances, which is higher than the US$45 billion forecasted in February, with about 10% of these loans for hotels. Many lenders are using a selective lending model when considering a property for this type of loan after getting stuck with assets in the last downtown. The loans being done typically have low leverage (45-70%), in-place cash flow, strong debt service coverage and high debt yields. Most properties are full-service in gateway cities.
• Growth in non-recourse and fixed rates—Non-recourse lending and fixed rate financing are growing in tandem with the re-emergence of CMBS loans. We don’t expect non-recourse debt to return in earnest until hotel performance improves further and property values increase and stabilize. There is some availability of fixed rates on non-CMBS products for pristine projects in strong locations with low loan-to-values.
At mid-year, hotel lending continues to be well below peak levels. But each month I am contacted by lenders that had stopped lending on hotels to let me know they are again open for business to the hospitality sector. That bodes well for owners and operators, especially those interested in refinancing or acquiring a property. As we move into the second half of 2011, we continue to expect more hotel financing to become available to a broader range of borrowers.
Jane Larkin is managing director of Larkin Hospitality Finance, a national hotel investment-banking firm focused exclusively on meeting the debt and equity financing needs of hotel owners and developers. She can be reached at firstname.lastname@example.org or (469) 916-8518.