With the Federal Reserve Bank moving aggressively to curtail inflation by raising interest rates, and further increases expected, trouble could be ahead for hotel owners who have commercial mortgage-backed securities, or CMBS, loans due in coming quarters.
CoStar data shows $6.8 billion in CMBS loans backed by hotel properties coming due over the course of the remainder of this year that are probably being renegotiated. In the next two years, first $15.3 billion and then $14.6 billion of CMBS loans backed by hotel properties are scheduled to come due.
After interest rates increased rapidly over the past few quarters, it is likely the original interest rate was materially lower than rates currently available in the market. Given the same income levels, higher interest payments would result in a decreased interest coverage ratio that reflects the ability of a borrower to pay back a loan. Maintaining a certain interest coverage ratio is part of the borrower's responsibility when the loan is taken out, and higher interest rates could result in the borrowers defaulting on this loan covenant.
Between 2017 and 2019, the average origination interest rate was 4.8%. Between 2021 and 2022 so far this year, the origination interest rate has increased to 5.6%. No data is available for mid-2020 because no hotel CMBS loans originated during that time.
Even those hotel owners ready and willing to cover higher interest rate payments may face a secondary conundrum: the lack of available lenders. Some industry participants describe the current CMBS environment as being “frozen” as a number of lenders have opted to wait on the sidelines to gain a better sense of their own borrowing costs.
For hotel owners who have to refinance, the options are limited but may include decreasing the loan amount by raising additional equity, acquiring bridge loans from non-CMBS lenders until the regular availability returns, or handing back the keys and walking away from the deal should a loan modification effort prove unsuccessful. From talking to industry participants, all options are on the table and willing counterparts for all scenarios are available, for a price.
In 2020, many investment funds were well capitalized and eager to take advantage of distressed assets, but the expected wave of property foreclosures never materialized. In this higher interest rate environment, those funds may see their opportunity after all.