You’re well into planning a new hotel. You’ve picked the market, you’ve seized on a segment, a seasoned management team is ready to work with you, and you’ve locked down a trophy flag.
A lender will talk to you if you come to the bank armed with all this, even if it’s your first venture into hotel development. It’s common sense: Lenders offering conventional loans want to avoid risk and make money. So fortifying yourself with expertise, insight and the best possible location for the project presents an appealing picture.
Oh, yes. The other factor in this complex equation is a development plan backed by 30 to 35 percent equity. Gone are those pre-recession days when lenders were willing to bet the house, offering low-interest loans of up to 80 percent. These days, a lender wants skin in the game.
For you, the borrower, the trick is to think like a lender. So if you think you have to go out and finance that hotel and only have 10 percent equity, you better find more investors –and your project has to make sense. Proposing a limited-service hotel that will cost $400,000 a key to develop, say, doesn’t make sense because it’ll never generate the necessary ROI. You need to make sure your deal will work for a lender before you present it. You have to show you’ve got the brand, the market and the equity.
Just because equity and due diligence requirements are stiffer than they were in those boom days before the Great Recession doesn’t mean it’s a bad time to build a new hotel, however. It also doesn’t mean lenders are unwilling to work with you. Even though hotel investment got a bad rap after the recession, when all forms of real estate dropped in value but hotels in particular, lenders are beginning to see that their investments in commercial and office real estate may have peaked, so hotels are looking more attractive.
That’s especially true since 2010, when RevPAR began to grow again after dropping by 17 percent the year before. At the same time, supply has remained flat and rate has increased. The combination puts the hotel industry in an enviable position as an investment vehicle.
When an industry is hot – OK, hotels aren’t quite at that point and most of the action is in renovation and conversion – lenders have a tendency to bend the rules. The housing market’s coming back and everybody’s been lending on apartments. That’s going to be your next bubble. At the same time, such signs mean the money supply is loosening up. It just has to hit hotels, still not a go-to industry.
Because part of the problem is perception, when you present your project to a lender, do so with pride and make sure you have all your bases covered.
Lenders, particularly banks, still look at hotels as non-favored assets. It shouldn’t be that way, with the hotel industry so healthy right now and RevPAR growth, expected to be 6 percent this year, consistent for the past several years. But lenders still overlook hotels because they can get returns on real estate like multifamily, commercial and office. Those are perceived as less risky because of the herd mentality in the lender community.
Banks are reactive rather than proactive. They’re going to do what everybody else is doing so when everything goes bad, they can say everybody was doing it.
That means you should look for lenders willing to take a chance – like you. Most are focused on existing assets because such hotels have a history of performance, making them less risky to underwrite than betting on the future. There’s construction risk and ramp-up risk, so lenders aren’t being forced into such investment these days because they’re getting enough out of other assets. Still, lenders with vision are out there.
Banks that have been lending to existing assets are starting to realize multifamily is getting saturated and owner-occupied is getting oversupplied, so they’re going to start looking at new-construction hotel deals.
In fact, as the economy sputters back to life, some new assets are getting built. Such developments are usually transacted at larger institutions or in smaller markets with government guarantee-type loans, but relationship-based deals are inching back.
All this makes it a great time to build a new hotel, especially since your cost of development is still relatively low (not to mention the cost of money). That also holds true for lenders, because now’s the time for them to invest in hotels and be ahead of the curve. Lenders can virtually choose their markets and name their terms, making today and tomorrow great opportunities. It’s up to you, the borrower, to show those lenders the way forward.
By: Greg Morris