Lenders speaking at the Hotel News Now Lender Roundtable said they are now baking expectations of a downturn into their underwriting.
PHOENIX—The hotel lending community is confident for the upcoming year, but the outlook gets hazier the further lenders look out.
Speaking during the recent Hotel News Now Lender Roundtable, Aries Capital Chairman and CEO Neil Freeman said he has some concerns when projecting more than 12 months.
“I’m worried about valuations in the next 24 months,” he said. “There are more loans due, and more and more supply. Every brand is creating more brands, which again is creating more and more supply. The market only has so much breadth and depth. In the next 12 months, we’re probably OK, but I think there’s another recession coming; it’s just a matter of when.”
Matt Mitchell, VP of Hall Structured Finance, said a downturn doesn’t mean there won’t be opportunities.
“Some markets are extremely hot now, and are at or near peak levels,” Mitchell said. “And we’re underwriting a bit more conservatively, but we’re still lending into the contractions of the market that we might foresee. If we underwrite appropriately and account for some markets being at peak levels, we can optimistically lend into a cycle that is entering a phase of less robust growth or contraction.”
Mike Muir, EVP of hotel lending at Live Oak Bank, said he is optimistic about the industry and believes concerns about supply are often overblown.
“Room supply (growth) is only projected to be 2%; that’s OK,” Muir said. “I’m not worried about that at all.”
He noted that supply growth is largely concentrated in a few large markets, which leaves opportunities in many secondary and tertiary markets.
Michael Watson, director and head of U.S. lending for BMO Harris Bank’s Hotel Finance Group, said this is a good environment for lenders even if the cycle is approaching its end.
“I recognize that a lot of people have concerns that we’re at the peak, but (late in the cycle) might be the best time to do hotel deals,” Watson said. “The key thing is not to be scared at the wrong time. If we’ve got courage and capital, we can be successful.”
The state of financing
Some lenders speaking at the roundtable said that there has been an increasing appetite for short-term bridge loans.
Heather Duvall, managing director of Access Point Financial, said this has been a particular focus for her company.
“We can close a mortgage in two weeks,” she said. “That gives the buyer the opportunity to close quickly and get renovated and stabilized (before the cycle turns). … Others are using (quick closing) as a bargaining chip in negotiating purchase price.”
Duvall said the interest rates for those loans typically are “blended around 8%,” and many buyers only keep it for the interest-only period.
Rick Rogovin, VP of Wells Fargo Bank’s Hospitality Finance Group, said he has seen activity with mezzanine financing for those that are overleveraged. He’s also seen a lot of active private-equity lending.
Franklin Lin, director of Deutsche Bank Commercial Real Estate Group, said he’s seen a trend of people buying properties at “fairly low cap rates.”
“I think it’s a function of treasuries being very low and everybody is starving for yields,” Lin said. “People talk about price per key to justify some of it. … But when lending debt yields start to go even further down, and they will, the question is when does it become too much?”
Rogovin said some low-cap-rate deals can be more complicated than they look on the surface.
“The question becomes: How are you defining the cap rate?” he said. “If you’re buying a property that’s a total turnaround, and it’s not been operated well in a number of years and needs a tremendous (property improvement plan), is underperforming in the market and its RevPAR penetration is 95% and should be 110%, then it’s not unusual for someone to buy that at a very low, single-digit cap rate.”
Freeman said we’re already past the peak, or at least at the deepest depths, for cap rates.
“I think they kind of got to their lowest level in (2013, 2014 and 2015),” he said. “Then some buyers started to say properties are not clearing at asking prices, and there were concerns that there was not a lot of upside. So they started cutting tougher deals, and I think (cap rates) are flat right now.”
A looming CMBS wall?
While there is concern among the lending community about the continued growth potential of the hotel industry and shifting supply-demand dynamics, there isn’t as much concern about a previously touted wave of maturing commercial mortgage-backed securities loans in need of refinancing.
Lin said that’s because the worries about the so-called “CMBS wall” and the reality that lenders have been facing are two different things.
“People talk about this big wall, but we really haven’t seen it that much,” he said. “There hasn’t been a wave of things that haven’t got done or couldn’t get done.”
Freeman said those concerns are overblown.
“We do a lot of CMBS, and I’ve never been too concerned with the wall of maturity,” he said. “If there’s a flow of capital, which there is, then even with prudent underwriting it can be refinanced.”
He said the people who really drew the short straw were those with five-year loans that originated in 2005 or 2006 and had to deal with a much less favorable lending market.
Lin said the CMBS marketplace mirrored what was seen in the larger industry of late, going from “frothy” in early 2015 to more conservative underwriting today.
What are lenders looking for?
Sources said lenders are looking for a combination of three things when putting together a deal:
• a good sponsor;
• the right brand; and
• a property with lots of potential.
Of those three, having a solid sponsor is the clearest indicator of success, which Muir compared to betting on the jockey and not the horse.
Mitchell said sponsors are key because they contain a level of knowledge that lenders simply can’t replicate.
“We loan on a national basis,” Mitchell said. “And we’re not intimately familiar with every market in the country, so a sponsor with a track record of success helps us feel more comfortable.”
“We underwrite to projections,” Duvall said. “And we’re largely looking at distressed assets, so we look at year two and year three, and while we look at borrowers’ projections, we have to come up with our own.”
At this point late in the cycle, lenders also look for stabilized assets, although the definition of “stabilized” can be a moving target.
“The beauty is in the eye of the beholder when you ask, ‘What does stabilized mean?’” Rogovin said. “Every time an asset sells, the (new) owners think it’s not stabilized. They all think they’re going to own it better.”
Both net operating income and revenue per available room are key metrics when looking at a project, sources said, although there was some disagreement about which of the two took priority.
“NOI really pays the bills,” Rogovin said. “You have to look at all the components.”
Watson agreed, to a point.
“We’re also a cash-flow lender,” he said. “But we also focus on RevPAR index for an individual property. … We look for room to save on expenses, and RevPAR penetration captures a lot of things going on in a comp set and market, unless they’ve got a quirky comp set.”
Michael Maguire, managing director of Aileron Capital Management, said he leans more toward looking at RevPAR than NOI.
“This is blue-collar lending,” he said. “Below revenue, there’s not much room for improvement unless it’s distressed. There’s no new mouse trap to make that any better, as long as expenses are in (a normal range).”
Mitchell agreed that revenue is the top priority, particularly with select-service properties and extended-stay hotels.
“With a good flag and management, you should have a good idea on what the margin should be, but that depends on the deal,” he said.
Maguire said the true key metric to look at during deals is price per key, because it can be difficult to overcome issues with a property that was noticeably overvalued.
“Everyone thinks you can get a property at any price and make money,” he said. “But if you’re not in for the right dollar per key—and valuation is really key. If you overpay there’s nothing you can do about it.”