MADRID — Hotel investors throughout Europe are becoming more comfortable with folding mezzanine debt into their financing strategy.
In fact, given the difficult financing environment, mezzanine debt could be the part of the deal that gets a project over the finish line. That's a big change from years ago, when investors and brokers perceived mezzanine debt as more of a "villain" of the capital stack.
“What is mezzanine debt today probably was the senior debt of yesterday. Mezzanine debt is not always the problem. It can be the solution,” said Neil Kirk, chief operating officer of London & Regional Hotels, on a panel at the recent Atlantic Ocean Hotel Investors’ Summit.
Panelists agreed that anyone seeking debt will be lucky to receive 50% loan-to-value, where before they would likely get 60%, as lenders buckle down against risk.
Joan Bertran, a Miami-based executive vice president of commercial real estate and hotels and head of corporate advisory at Banco Sabadell, said some lenders are adapting and becoming more creative, or perhaps less risk-averse.
“Players that only used to be on the mezzanine side, now they take the whole thing, so they are competing with the traditional banks. Often, they will sell on the senior tranche and keep the more profitable returns,” he said.
There has been an increase in foreclosure notices, largely on hotel deals that might have been in some form of trouble before the recent interest-rate spike, panelists said.
That, of course, presents a window for others.
Kai Tan, partner, portfolio management at Lifestyle Hospitality Capital Group, said there are significant hotel investment opportunities and ways to go about financing a deal.
“Office and hotel are not the same thing, but they are related in some ways. You can either fill that sack with debt, or provide equity, and if that plays out in Europe, there might be some opportunities to buy,” he said. “There are unstablilized assets, speculative developments, things that [traditional] banks cannot be involved. At some price, someone will lend to you.”
Christophe Beauvilain, managing partner of Pygmalion Capital Advisers, said the interest rate environment could change quickly.
“Lending opportunities might be fewer now and are purely opportunistic but, I think, time-limited,” he said.
Creative financing, including mezzanine debt, is needed to get projects through the hard times, Kirk said.
“There are many ways to [complete] a deal, and mezzanine is not the only one. Mezzanine is now being used to get through people’s lack of liquidity on this side of the interest-rate hike,” he said.
Courting Care
Some hotel developers have sat on three years of mezzanine debt during the COVID-19 pandemic when construction halted, Beauvilain said.
He added Pygmalion Capital Advisers was “quick in terms of underwriting. If things go wrong, we’re probably more comfortable with mezzanine than a traditional lender. If forced, we become very active in the asset,” he said.
But there are still plenty of unknowns in the hotel investment environment, Tan said. Between 2000 and 2024, the number of traditional banks has reduced by 36%, but new sources of capital are waiting to act.
“What scares me is how many nontraditional lenders there are out there … with the amount of money we’re seeing rush into the space, removing covenants, with exit penalties, and especially for good assets and in hotels. Where is the money coming from, and how will it play out?” Tan said.
Bertran said it's unlikely many people can fund this type of capital at LIBOR rates plus double-digit percentages. LIBOR stands for London Interbank Offered Rate, a benchmark interest rate used in global financial markets.
“Spanish hoteliers are not used to nontraditional debt. They say I will not pay 12%, I have never paid 12%,” said Helena Murano, owner of business advisory Arcano Partners.
Kirk said the play is a calculation of capital against risk.
“Underwriting is risk versus debt, and people are just moving up and down the risk profile and the capital stack,” he said.
Often the difference will be how one underwrites at any time of pressure, Kirk added.
“Most would rather take a cash-flow position, but it is always about what return you seek,” he said. “Some lenders go in and are not averse to perhaps having to own the asset. Operating a hotel is not easy and not for everyone. Some have a more traditional view, others a more Machiavellian notion.”
Germany, Europe’s largest economy, has felt particular pressure from the weight of mezzanine debt, Bertran said.
Dealing with debt always merits caution, panelists said.
“Debt is so expensive, we try not to layer it on. We’d rather create value organically. I do not want to go back to the days when we can get more just because we can. That breeds bad behavior,” Bertran said.
Bertran added the exit strategy needs to be front and center.
“Mezzanine is more messy, but it is not intrinsically bad. We have experiences good and bad,” he said.