Global Hotel Report: Hotel financing

Thursday, 25 Jul, 2002 0

The latest Global Hotel Network Report takes a look at “Hotel Financing” from the perspective of Paul Fitzpatrick, senior managing director of Insignia/ESG Hotel Partners (New York). He explains:

It’s mid-year 2002, and in conversations at hospitality seminars or with developers and bankers in the offices of the industry’s brokerage community, you will undoubtedly hear the dreaded words…”hotel financing.” Better yet, you will hear people discussing how to fund new hotel development and construction. Invariably, most conversations will draw parallels between today’s financing environment and that of a decade ago. But are they really similar? Today’s marketplace is not ripe with a glut of over-leveraged hotels on the verge of handing over the deed or filing Chapter 11, nor are there any issues with the cost of capital today or serious concerns relative to oversupply. Rather, in 2002 we are coping with the aftermath of September 11, a slowly improving economic landscape and a Wall Street investment community coming up short on new innovative capital vehicles and finding itself addressing its own monumental credibility issues.

So what is a hotel owner/developer to do? First of all, let’s agree that while a straight refinance or acquisition financing is challenging, trying to finance new hotel construction might be viewed as a fool’s journey. With the precipitous drop in hotel revenues post-September 11 and the reality of slower growth numbers facing the industry for the immediate future, the task of supporting new hotel feasibility projections and demand assumptions when seeking a construction loan has become all the more challenging. The availability – and cost – of capital are not issues. A year ago, prime was 7 percent; today, it is 4.75 percent. LIBOR is 1.97 percent versus 3.68 percent at this time last year. On the longer maturities, however, there has been little or no downward rate movement. The 10-year treasuries today are 4.83 percent versus 5.13 percent last year, and the yield on the 30-year bond (granted, a rapidly fading vestige of by-gone times) is only 13 basis points lower now than last year – 5.46 percent versus 5.59 percent. So there is plenty of capital on the sidelines looking for investment opportunities and extremely attractive short-time rates. How can these two opportunities be harnessed, in a way that benefits the hotel developer?

Over the past 30 years, the timely introduction of creative and opportunistic finance vehicles has provided the extra octane to fuel the capital needs of the hospitality industry. Whether it was the tax-driven limited partnership structures, tapping the public equity markets with a REIT or introducing unimaginable amounts of market liquidity through the CMBS program, we have become accustomed to such capital market creativity. Lenders given the directive to provide debt for income-producing properties look first towards the Class ‘A’ office building, the multi-family garden apartment or a fully leased retail center. The surety of leases and the predictability of these markets will always rank higher than “an operating business” like a hotel. However, with so much capital on the sidelines and a new focus on hard assets versus a telecom or dot-com story, isn’t that creative financing window once again presenting itself? Corporate scandals, the faltering credibility of Wall Street powerhouses and anemic returns in the traditional equity arenas should provide an attractive backdrop and rationale upon which today’s hotel developer can capitalize.

Capital being managed by the country’s leading private banks, money managers and other fiduciaries on behalf of individuals, pension accounts and non-profit entities represent an emerging potential source of funds for the hospitality industry. Obviously, many of these same sources provided much of the funding behind the major opportunity and venture funds that have been active over the past decade. However, a new phenomenon is now taking place. Yield hurdles have fallen, investment program industry segmentation is changing, and the fundamentals of the hospitality sector are looking more attractive.

Again, with a focus on capital for new hotel development, what does this emerging trend mean? On a one-off basis, developers and their brokers should be seeking out this private capital for bridge loans, mezzanine pieces and preferred equity to bring their financing up to 70 to 85 percent loan-to-value, on terms that make the financial projections achievable. As much as possible, they should seek open ended construction/mini-perm loans with local and regional banks, taking advantage of the current historically low short-term interest rates. These loans require full recourse, but they also provide the bank other business relationship opportunities and typically present the best platform relative to flexibility in introducing junior debt, whether secured or unsecured to the capital structure. Financing for sound, new hotel development is not impossible. The answer is to be creative and aggressive in seeking out capital. Identifying new private capital sources and taking advantage of the current attractive rates and lower yield hurdles in formulating a layered capital structure are key to making future operating projections seem achievable in light of the tougher underwriting loan standards.

On the macro stage, there are numerous sponsors formulating plans for “new” funds to provide mezzanine capital to the hospitality industry. These 2002 models will differ from the last generation of opportunity funds in three ways: yield expectations will be lower, holding periods more flexible and a higher percentage of the capital will be from private individuals as opposed to institutional dollars.

Will this new generation of funds become the octane to fuel hotel development? Keep your engines revved over the next several months, and we’ll see.

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CONTACT INFORMATION
Global Hospitality Resources, Inc.
www.globalhotelnetwork.com
13444 Pantera Road
San Diego, California, 92130 USA
Telephone: 858-793-3366 Fax: 858-793-3367
E-mail: mailto:[email protected]

Read previous Global Hotel Network (SM) Reports:
17 April: Global Hotel Report: The state of the UK hospitality industry; 21 March: The impact of Argentina’s financial crisis on its hospitality industry; 26 February: The impact of Sept 11 on Hong Kong’s hospitality industry; 21 January: The State of the Latin America Hospitality Industry; 12 November: The State of Asia Pacific’s Hospitality Industry; 25 October: Asia Pacific Hotel Investment Sentiments; 25 October: Canadian Hotel Financing Trends; 24 September: US Hotel Finance Market; 20 August: Curitiba; 6 August: San Diego; 23 July: Poland; 9 July: Europe; 25 June: Caribbean; 11 June: Asia Pacific; 24 May: UK; 14 May: US; 18 April: Barcelona; 9 April: Perth; 3 April: West Los Angeles / Santa Monica; 27 March: Sydney; 12 March: Lagos & Abuja; 5 March: Prague; 26 February: Seoul; 19 February: Bahamas; 12 February: Calgary; 5 February: Beirut; 29 January: London; 22 January: Hong Kong; 15 January: Phoenix; 11 January: French Riviera; 5 January: Jaipur; 18 December: Geneva; 12 December: Boston; 4 December: Mumbai; 27 November: Tokyo; 22 November: Las Vegas; 17 November: Shanghai; 6 November: Budapest; 30 October: Kuala Lumpur / Penang; 23 October: Lisbon; 20 October: Buenos Aires; 13 October: Madrid; 4 October: New York City; 27 September: Jakarta/Bali; 20 September: Manila; 14 September: Dubai; 7 September: Montreal; 31 August: Los Angeles; 22 August: Cancun; 15 August: Adelaide; 8 August: Istanbul; 1 August: Brasilia; 24 July: Cairo; 17 July: Jerusalem; 6 July: Delhi.