A panel on lending at The Lodging Conference addressed the growing cost of construction, driven by labor issues. Lenders also shared how they’re looking at new deals.
PHOENIX—Keen to not repeat the mistakes of the past, lenders are taking a more careful approach to deals in the hotel industry.
A lot of due diligence has to be done up front before Western Alliance Bank will consider backing a transaction in the hotel space, Managing Director Chris Williams said during a session at The Lodging Conference titled “Financing your renovation or new construction.”
The deals have to be “pretty well dialed in” before the bank will close on a loan, he said. Western Alliance requires contingencies that average 7% to 8% of the total project cost, he said, adding that there was some initial pushback, but that quickly dissipated.
“At the end of the day, you just have to have it, because you don’t want to go back and try to rebalance or recut the loan,” he said.
Mike Jaynes, president of Hall Structured Finance, said it’s difficult to move forward on a project that’s not fully formed, with the understanding that costs are likely to continue to escalate while the details are worked out. If the company does sign on, it has to bake in a stiff contingency if there’s a long period of time before the deal can close, he said.
“That contingency and capital stack gets pretty hefty,” he said.
Labor, particularly cost of labor, is a big issue, panelists said.
Rickman Davis, loan officer at Live Oak Bank, said with unemployment in the low 3% range, it can be difficult to find affordable labor for construction projects.
There are, however, lending solutions which may help to free up capital to cover those rising costs.
A legislative program that’s active in about 20 states, property assessed clean energy lending sets up a framework for private capital to fund certain parts of construction that have a quantifiable impact on utilities, such as reduced water consumption, said Ethan Elser, VP at PACE Equity.
It’s a long-term special tax assessment on a property, typically 20 to 30 years at a fixed rate, and is designed to be an additional tool on the stack, with lower costs than mezzanine lending and preferred equity, he said. It can be used on a broad range of development, including new construction and renovations.
Some banks are not open to this program, some are in favor, and others are still evaluating it, Elser said. His company is always working with new lenders, and through this education process becomes more comfortable with other forms of lending, he said.
Williams said Western Alliance Bank has yet to decide whether to work with it.
“We’re looking at a transaction right now,” he said. “We’re going to have a discussion this afternoon and tomorrow with members of our senior loan committee. From my perspective, it sounds like a tax. We still have some things to flush out before we come to our final conclusion.”
Live Oak Bank Hotel Lending has included PACE lending in its stabilized debt service, Davis said. It wasn’t too difficult to get the credit team on board once they understood the acceleration piece, he said. The main challenge was getting the appraiser to understand how the company was looking at it, he said.
Appetite for deals
Popular Commercial Lending Group would rather work on rehab deals, so it pushes back on new construction as much as it can, said company President Darin Young.
The company isn’t actively soliciting new construction deals, and is selective when it does, opting to work with groups that have a proven track record, he said.
“For us, it’s an underwriting constraint we have,” he said, adding his company won’t take on more than it can deliver.
Clients have also become more conservative, as they are putting more equity into the deal or are taking more time to understand the market, Young said.
As long as there are good deals to be had, in strong markets with strong sponsors, capital won’t be an issue, Davis said.
Elser said his company’s piece in deals is usually 10% to 20% of the stack, so it’s not typically the main driver. It might be able to bring along a bank or lender it has a relationship with, he said, and if it can have a lender in the package, it’s good to go.