With the Federal Reserve recently lowering its federal fund rate and laying a plan for further cuts through 2025, hotel owners are exploring ways to lower their debt costs.
Many expect the lower cost of debt will spur hotel deals in 2025, but it should also lead to many owners facing debt maturities, property improvement plans and other challenges to refinance, perhaps forestalling a sale or helping to afford renovations.
While a 50-basis-point drop to interest rates isn’t enough to make anyone pull the trigger now, it’s enough to make them pick up the phone.
“Certainly, our phones have been ringing more,” said Peter Berk, president of real estate investment banking firm PMZ Realty Capital.
People want to know what’s going on with rates and how fixed-rate loans and floating-rate loans are priced, he said. There are a lot of conversations and education happening right now.
“People who sat on the sidelines are now going to move to action,” Berk said.
Careful movement
The No. 1 thing Michael Lipson and his team at Access Point Financial are hearing from hotel owners is concern about debt maturities this year and next. Some were granted short extensions this year or last year, but it’s going to be time for people to move on.
That said, Access Point's chairman and chief executive doesn’t expect to see a lot of movement until the first quarter of 2025. First, hotel owners are going to want to see what the Fed’s actions will mean for the economy. The other factor is the presidential election this year.
“I think realistically that it won't be until the first quarter of next year that you will begin to see signs of the economy improving or leveling off,” he said. “Maybe a further rate cut, or anticipation or another further rate cut. And then, of course, what did the election mean to you? Was it a positive thing? Was it a negative depending on your politics? Clearly, you see the conversation pick up, but it's still conversation.”
It's going to take people some time to get used to where the new rates are, Berk said. It may also take another rate cut or two to spur activity. Some owners are sitting at a rate of 4.5%, but they secured that in 2021, so the maturity is coming due in 2026. They’re going to sit with their lower interest rate as long as they can, and when it’s time to move on, they’ll roll off to the lower rates.
“Deals are five years or so,” he said. “We’re about to go into 2025, so a lot of those lower rates were done in 2021 and 2022, so as those rates roll off, people will get used to the new normal.”
The options available
More stabilized assets that are performing reasonably well with debt yields of 10 and more allow property owners to look at fixed-rate financing, Lipson said. The owner of a well-performing, good-flagged hotel with a debt yield in the 12 range will find fixed-rate debt an attractive alternative at today’s rates. For a hotel still in recovery mode or in need of a property improvement plan, the owner is going to look at traditional bridge financing, which has floating rates.
Those are the two basic groups, but there are other options, he said. There’s also mezzanine and preferred equity.
“There’s interest in mezzanine or preferred, for example, on properties — people that want fixed-rate but they can’t get to their debt yield, so can they find an attractive mezzanine or preferred equity component and properly stack their debt structure?”
At the time of the interview, Berk said PMZ Realty Capital has seen a lot of borrowers that want fixed-rate debt instead of floating-rate because it’s currently cheaper. Floating-rate debt is generally either prime or SOFR, which hasn’t gone down much. The prime rate went from 8.5% to 8%, and SOFR went from 520 basis points to 490.
U.S. treasuries, however, are based on the forward-looking curve and have decreased more. The five-year treasury dropped from 440 to 350 because it anticipated the Fed’s rate cut.
PMZ Realty Capital has been offering five-year and 10-year fixed-rate loans at about 6.5% since about six months ago when the rates were between 7.5% and 8%, Berk said.
“We see a lot of people who are doing floating-rate loans, which in the best case are in the high sevens and usually more likely the high eights switching to more of a fixed-rate product,” he said.
It took the Fed two years to finish its run of increasing rates, and it’s going to take it probably 18 months to lower the rates, Berk said. It’s going to be a slow process, but the fixed-rate loans that are forward-looking are going to be more attractive than the floating-rate loans.
“We get a lot of people who either have loans with private lenders or banks looking to secure a fixed-rate product,” he said.
Factors to consider
It’s expensive to refinance, said Anne Lloyd-Jones, director of consulting and valuation services at HVS. Hotel owners need to evaluate where they are now with their interest rate and what they could get now and see how those savings stack up to the cost of refinancing. They should also do an analysis of what it would be if they waited six months for rates to drop another 50 or 75 basis points and how much they could save then relative to the cost of holding onto that higher rate for another six months.
“It's a relevant perspective for commercial mortgages,” she said.
The type of mortgage an owner has dictates how flexible it is, Lloyd-Jones said. A commercial mortgage-backed securities loan has yield maintenance provisions even if they refinance to 2 points lower.
“It would be a great deal in that regard, but there's yield maintenance provisions where you have to make a payment to the lender to ensure that they achieve the return on investment that they were expecting,” she said.
Owners considering refinancing need to have realistic expectations of how their properties are performing and what’s available in the marketplace today, Lipson said.
“Too many sponsors like to take one out of Column A and then another one out of Column B,” he said.
If a hotel owner has a project that’s not performing well but knows another owner got a fixed-rate loan at 7%, they may try to get the same deal, he said. The problem is, the other owner’s property has a 14-debt yield while the first owner’s is a 7-debt yield.
Owners have to understand where their properties fit in this and where they are in relation to their next renovation and lending relationships, Lipson said.
“That’s where a lot of that conversation is starting to go on right now,” he said.
Another thing to consider is that lenders don’t want their loans to get churned, Lipson said. If owners are getting floating-rate debt, the lenders are going to make sure the borrower doesn’t refinance out in 12, 18 or 24 months. They will look at a prepayment penalty or lock them in for an extended period of time.
“Conduit deals tend to have maintenance and fees attached to the fixed-rate, so that's the natural back-and-forth depending where interest rates are going,” he said. “We'll see that, but I think it still could be somewhat negotiated.”