A panel of hotel financing experts at the ALIS Summer Update in Atlanta share why lenders continue to be cautious about new hotel construction despite the industry performing well.
ATLANTA—Capital has been an ongoing challenge for developers looking to build new hotels around the United States.
The cost of construction is high, both in materials as well as labor. The hotel industry has steadied after recent concerns over a downturn, but just about everyone recognizes it is still late in the cycle. Lenders, wary from the last recession and regulatory restrictions, have been careful with their approvals.
A group of hotel financing experts on the “Capital for development” panel at the ALIS Summer Update in Atlanta discussed the current hotel lending environment for new hotel construction.
Stonehill Strategic Capital President Mathew Crosswy said he doesn’t know how long the hotel industry’s up cycle is going to last, but his company is making investments with the understanding that there could be disruptions in the market.
“Now we’re going to core markets, more high barriers, more long-term plays where we can hold for seven to 10 years to mitigate the risks,” he said.
Looking back at the recession, he said, the fundamentals of the industry are stronger now than they were then. There’s been more discipline in supply compared to the mid- to late 2000s, and underwriting fundamentals with banks are stronger, he said.
“Equity is tending to be much smarter,” he said. “Deals are not just fueled by financial engineering.”
The last downturn was so severe, it’s still on everyone’s minds, which is why capital has been less available, Crosswy said. Banks have pulled back on what they’ll allow, and there haven’t been any major institutional equity players, he said.
Aries Conlon Capital Principal Neil Freeman said there is still a lot of capital, a lot of debt and a reasonable amount of equity for real estate deals, especially cash-flowing hotel properties.
On the construction side, he said he expects much of the hotels in the pipeline planning stage, perhaps even half, will be delayed. Debt capital for new construction for non-cash flowing properties, of all asset types, is drying up, he said.
“You’re lucky if you can get 65%, and a lot of times it’s 50%, and a lot of times it’s just, ‘No, we’re not doing hotels; we’re not doing any construction,’” he said.
Banks have cut back, which is why at least larger projects are being picked up by nonbank players, such as Blackstone, that raise capital and lend that out at higher rates than the banks.
Using a common baseball analogy to describe the cycle, Freeman said that prior to the United States presidential election, the industry could have been in the eighth inning, but because of the tax bill and other stimulants now may be in the seventh. The game has been extended for maybe another two years, he said.
The cost to develop hotels while rates are fairly stagnant, with new supply coming on market, makes it hard to get a deal to pencil, he said.
On the macroeconomic side, interest rates are going up, Embassy National Bank Chairman Nitin Shah said. In his role as a lender, he’s trying to figure out if a borrower can withstand those rates increasing over the next two to five years, he said.
On the microeconomic side, when he goes to the Office of the Comptroller of the Currency, he hears concerns about having too much money in real estate, particularly in hotels, he said. That can lead to being written up and, in some cases, being shut down as a lender, he said.
Lenders are choosing deals that have the financial strength, a good brand attached and a great location, among other factors, he said. Construction lending is becoming difficult because it is expensive and time consuming, he said.
“There’s just too much risk as opposed to taking that same capital and deploying it somewhere else,” he said.
Different project types
Stonehill loves mixed-use developments, Crosswy said, but it’s a private debt fund and exclusively finances and invests in the hospitality side. While the company can’t finance the other asset classes, he said, it can create additional value by carving off the hotel component. These projects are beneficial because of the added amenities provided, but some caution is necessary, he said.
“With a lot of these mixed-use projects, everything has to come together, sometimes in different phases,” he said. “You don’t want to get in phase one and stuck with just the hotel, and parking is always an issue, so there are a number of different variables that create risks as well.”
Under the scrutiny of regulators, banks are often looking for reasons to say no, Aries Conlon Capital’s Freeman said.
He said his company is working on a deal with three adjacent, standalone, but attached properties, each with a different loan structure, which the banks are having a hard time with. Separating these into separate deals with different loans and different parcels would make it easier, he said.
Nobody has the full experience of financing a dual-branded property for 10 to 15 years, Shah said, so no one knows what to do if one of the brands fails. Would the owner be able to rebrand it, he asked, and what should the bank do?
“There are a lot of questions about dual brands that are not answered because no one has gone through it,” he said. “We still have to wait for it to pass.”
Crosswy said dual-branded hotels can protect the market from additional supply. It’s almost the same concept as having cross collateralization by having the two assets, he said.
However, developers need to fully consider which brands they choose, he said, as putting an inferior brand next to a better-performing one won’t command the best rates.
“You just have to be thoughtful about how you’re dual-branding these hotels and not just putting these two together and going vertical,” he said.
One pairing that works well is an extended-stay brand with a select-service brand, Freeman said. The two attract different guests, or it could be the same guests, but they’re having different stays, he said. The two easiest to finance are the Hilton and Marriott International brands, he said.
“If you have two strong Hilton brands and two strong Marriott brands, I don’t think dual-branding hurts you,” he said.
Advice for new developers
The best way for a new developer to get into the business is to look for Small Business Administration loans, which are made for start-up entrepreneurs, Shah said.
With SBA, the government comes in and guarantees up to 75% of the loan, so lenders are more inclined to take a risk on someone looking to get a start, he said. Underwriting still goes through as if it were a part of a regular loan, but the chances of being approved are much higher, he added.
“Plus there is a secondary market for us to sell the guaranteed portion somewhere else,” he said. “That secondary market is very active.”
Chances of success are increased by working with experienced lenders who understand the hotel industry and branding, and can offer guidance and advice on first-time projects, he said.
Someone going through their first hotel deal should augment their project with strong expertise in the form of a management company that manages a lot of properties and puts in some sliver equity, Freeman said.