Like all commercial property sectors, the lodging capital markets have been reeling from the rapid-fire series of interest rate hikes. The Federal Reserve has raised interest rates five times this year, increasing the target rate from 0.25% at the beginning of the year to 3.25% currently. The last time the federal funds rate was this high was in 2008.
Given the stubbornly high inflation, more rate hikes are expected and lender underwriting has become even more conservative, affecting both the cost and availability of capital. Spreads have also widened from 250 to 300 basis points over the Secured Overnight Financing Rate (SOFR), a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, reflecting the higher risk levels lenders are underwriting for the lodging sector.
Loan coupons on hotels with floating rate debt have increased from 3% to 3.5% at the beginning of the year to 7.5% to 8% in October. Lenders are also underwriting lower loan-to-value ratios, or LTVs, now in the 50% to 60% range depending on the business plan and related risk level. This highly volatile capital markets environment has widened the bid-ask spread, resulting in reduced prices and lower transaction volume. Third quarter hotel transaction volume declined by 30% compared to $15.5 billion in total hotel transaction volume in the first quarter.
Given the financing challenges, motivated sellers are getting creative and offering seller financing at terms meaningfully below market levels to help buyers bridge the debt financing gap, achieve higher loan-to-value ratios, preserve asset price and enhance the certainty of closing. Sellers who are either under pressure to sell assets due to end-of-fund life or debt maturity issues, or those having higher and better use of the capital from sale proceeds are the ones who are stepping up with seller financing options.
Here are a few significant transactions that have included seller financing.
Kimpton Muse, New York
Barings sold the 200-room Kimpton Muse New York in October for $49.5 million or $247,000 per key. Barings' parent, Mass Mutual Life Insurance, provided a first mortgage of $37.98 million to the buyer, Chartres Lodging Group. This represents a 77% LTV, significantly better than what hotel lenders are currently quoting for newly originated loans. Per CoStar’s loan data, LTVs for new originations have ranged from 25% on the lower end to a max of 66% over the past two months.
Sheraton Boston
In February, lodging real estate investment trust Host Hotels & Resorts sold the 1,220-room Sheraton Boston to a joint venture between Hawkins Way Capital and Varde Partners for $233 million or $191,000 per key. To close the deal, Host provided a $163 million bridge loan carrying a 4.5% interest rate. The loan matured on Aug. 1 but included two six-month extensions, each at higher rates. Host’s bridge loan represented a 70% LTV on the purchase price.
Sheraton New York Times Square
Host also sold the 1,780-room Sheraton New York Times Square to MCR and Island Capital in April for $373 million or $210,000 per key. The REIT provided a $250 million bridge loan in conjunction with the sale that carries a 5% interest rate through its initial maturity in October, and can also be extended by an additional 18 months at higher rates. The $250 million bridge loan has a 67% LTV on the sale price.
The Federal Reserve is expected to continue raising the Fed funds rate as it combats 40-year high inflation levels. Current median projections anticipate a target rate of 4% at the end of 2022 and 5% in 2023, according to data from the Federal Open Market Committee meetings. This will likely result in hotel loan coupons in the 9%-10% range next year based on current spreads.
At these high levels of market debt costs, combined with fewer active lenders, expect seller financing to be increasingly popular for hotel sales in coming quarters. It is a strategy that offers sellers the opportunity to achieve optimal loan-to-value ratios, higher asset pricing and greater certainty of closing.