Debt availability is on a lot of hotel owners’ minds, so I sat down with Phil Ribolow of Deutsche Bank to talk about it.
As a director in Credit Risk Management, Ribolow reviews virtually every hotel loan that Deutsche Bank considers in the Americas and Asia. His views are his own and not those of Deutsche Bank.
How do you think about refinancing in today’s market?
As we all know, interest rates are up significantly, and certain markets are still feeling the dislocation from COVID. In order to get a deal done, the borrower needs to show commitment to the property. As lenders, we view ourselves as being in partnership with our borrowers, and we want to achieve the best outcome for all parties concerned.
For borrowers to refinance or modify most loans, they're going to need to inject additional equity into the property. And that money will likely come from either the borrower’s equity, a mezzanine lender, an outside third party or a rescue capital source that we can connect them with.
The capital stack needs to be reset. It needs to be rationalized based on today’s reality. We need to get back to a 60% to 65% loan-to-value ratio and with some new equity infusion, and there would be a loan pay down that gets to the right loan-to-value ratio. We have borrowers purchase an interest rate cap to guard against any future moves. And lastly, we’ll need to establish loan reserves that get everyone through seasonality issues, an upcoming [property improvement plan] or something along those lines. But nobody wants to force any kind of property into default, which is why we’ve come up with putting borrowers together with other equity resources.
That sounds like the era of “extend and pretend” is finally over. But what if a borrower wanted to source new debt?
For the right deal, it can be done. There is good investor demand for hotel paper. Deutsche Bank did the LaQuinta / Corepoint deal that was sold without a hitch earlier this year.
The market is showing good demand for buying hotel loans. Is that because hotels are strong fundamentally or is it that hotels just look better relative to where everybody else is sitting? I can't really say for sure, but let's enjoy the good times while the good times are here.
Hotel debt, relative to debt on other asset classes, is more attractive. Does that attractiveness extend to new construction lending as well?
Today, construction lending really doesn't pencil for the equity. The reason for that is the increase in construction costs due to supply chain issues, and also the huge jump up in interest rates means it's really difficult to see how any borrower could generate attractive enough equity returns to get that deal done.
What about deal activity this year?
When the Fed either stabilizes interest rates or, even better, starts lowering interest rates, then we go back into deal mode. Once there is price discovery, it will be easier for everyone to have conviction. We are hopeful and looking forward to early 2024 as the time when you get back to a rate level where we think the markets going to transact again.
Anyone with a lot of conviction and deep capital sources who makes a bet on upper-upscale, urban hotels will probably do very, very well. But the problem today is how do you get financing for that and how do you have the guts to make that move? But somebody will, and they will make out very, very well, and we'll all look back and say, "Oh, why didn't I do that?"