For those of us seeking loans for hotels, this is not the easiest of times.
Debt is expensive for new construction or acquisitions, which makes it hard for developers, buyers and those who require refinancing. Most debt is priced in the 8% range with a 60% to 70% loan-to-value. The commercial mortgage-backed securities (CMBS) market appears to be gaining momentum for five-year, fixed-rate debt, slightly lower than the 8% range. These higher rates are not going away soon, as the U.S. Federal Reserve seems to be backing off its prior comments about a few rate cuts this year.
Why is this critical? The hotel brands are trying hard to get owners to renovate after years of delaying those projects. Property-improvement plans are due, and both Marriott and Hilton use the FRCM process — which stands for fixed renovation cycle management — to determine when renovations are needed. All brands require PIPs, and hotel construction and renovation costs have increased markedly over the past few years.
Hotel construction will often include a mixed-use component to add spaces that cater to the multiple needs of an urban mixed-use development. These may include residences, wellness hubs, offices and private member clubs. Renovations are beginning to focus on recreational activities, new revenue streams and an updated look.
Industry Fundamentals
Top-line hotel revenue is doing well compared to last year. It was expected that the first quarter would be off to a slower start, and I hope more positive RevPAR growth will continue over the near term. Recession talk seems minimal compared to the past couple of years, and the broader macroeconomic environment is robust, notwithstanding the possibility of a black swan event.
The expense side of the profit-and-loss statement is getting kicked hard by inflationary pressures that are likely to continue. This will affect flow-through and bottom-line profitability as insurance, energy, labor and food costs remain elevated.
Debt Scenarios
The high debt cost makes it hard for buyers, especially if they seek traditional leveraged loans. Most debt is priced at 60% to 70% loan to value, and lenders prefer strong cash flow.
The CMBS market is gaining momentum, and five-year fixed-rate debt is generally priced at 7% to 7.5%. Traditional lenders remain capital-constrained and are dealing with cumbersome regulatory requirements.
Mezzanine debt is priced at double-digits and is referred to as high octane or very expensive. Used on a short-term basis, it can be helpful. C-PACE debt is a great option to finance commercial property energy efficiency and renewable energy improvements; it uses borrowed capital secured by a tax assessment.
Equity Situation
Many equity players have not done deals in the last couple of years. Yes, money is waiting in the wings, but the returns must be there to make economic sense. The cost of debt is a limiting factor for transactions.
Hence, the combination of high interest rates, average industry fundamentals and return on equity requirements makes this a messy deal-making environment. For construction, the expenses are high across the board: debt, equity and construction costs!
Deal Flow
Hotel deals are picking up a bit, but from a low base. Debt is available, and prospective buyers are more comfortable with higher interest rates. Cash-flowing assets are in high demand.
Seller expectations are coming down slightly, but not enough to entice most investors who are hesitant to do deals with an adverse leverage profile where the borrowing costs exceed the profits.
Generally, lenders will continue to give borrowers time to find a new loan if debt service is being covered but the interest rate is adjusted. Sometimes, lenders push stressed owners to sell their properties, creating deal flow. CMBS lenders have virtually no flexibility.
Why is this important for hotel operators as well as owners? Good operators understand how owners must balance their franchisor, lender, partners and operator at a time when excess cash is not there.
Understandably, the brands want to see franchisees put money back into the hotels, but the lockdowns, closures and pandemic economy hurt us. Nobody wants to lose the hotel, but negotiations between the above parties will be needed to make the transition to renovated hotels seamless. Wages and costs have increased higher than revenues.
For developers, franchisors will offer “key money” more frequently to lure them into the brand or keep them in. Cooperation between seasoned veterans in the industry can result in good times ahead. Cooler heads will prevail. Good luck!
Robert Rauch, CHA, has been an owner-operator of hotels for several decades and is founding chairman of Brick Hospitality, owner of R. A. Rauch & Associates, Inc.
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