Hotel owners who have deferred maintenance costs find themselves at the end of the line in 2011. It’s time to write the check, recapitalize—or make the call to the broker.
Editor’s note: This article was originally posted on 29 March 2011. The article was chosen as part of Hotel News Now’s look back at 10 years of the hotel industry.
REPORT FROM THE U.S.—With deferred maintenance costs piling up and brands clamping down on required upgrades, hotel owners will be spending more money in 2011 than past years. Trouble is, banks aren’t offering straight renovation loans, so hotel owners are left with a few options: sell, refinance—or get out the checkbook.
According to a Bank of America Merrill Lynch report, 2011 total capital expenditure for all the hotel companies in the analysts’ portfolio is expected to be up 76% year-over-year. Each individual hotel company in the portfolio is expected to spend at least 30% more than last year.
“Total CapEx in 2011 of nearly (US)$2.1 billion is in line with 2006 and 2008 levels and just 13% below the dollars spent at the peak in 2007,” the report reads.
Of the companies Bank of America Merrill Lynch analyzes, Host Hotels and Resorts and Starwood Hotels & Resorts Worldwide plan to write the biggest checks in 2011. Most spending will go toward major repositionings, such as Host adding the Westin sign to the New York Helmsley and upgrading the Sheraton New York Hotel & Towers, and Starwood overhauling the Grand Hotel Florence and adding the St. Regis flag.
“We plan to spend about 6% of revenues in a given year,” said Stephen Schafer, VP of investor relations for FelCor. “Our capital expenditure strategy is to renovate between six and eight properties every year so that our portfolio won’t have anything more than minimal disruption in a given year.”
Host, Starwood and FelCor won’t need to visit banks for assistance, but small owners—such as those forced to comply with Holiday Inn’s relaunch or add new lobbies to their Courtyard by Marriott or Hampton Inn properties—might not have the same-sized balance sheets.
Acquire and renovate
In some cases, those owners will simply opt out of spending capital and contact a broker to bring the property to market.
“The most likely option is the owner will say, ‘I don’t want to write this check, I want to get out of this and let the next guy worry about it,’” said Ryan Krauch, principal at Mesa West Capital.
In order to maintain the brand flag, the new potential owner would then have to be approved by the franchise and would be required to uphold the brand’s property-improvement plan, which is how the necessary upgrades would be completed.
“With the life cycle of the majority of our portfolio, we typically factor in a major renovation upon acquisition, which is part of the deal, and we maintain the properties through the (furniture, fixtures and equipment) reserve,” said Thom Geshay, senior VP of business development for Davidson Hotel Company. “We also typically sell the properties before the next major renovation is due.”
For Rockbridge Capital, a key part of the business plan is taking a look at those capital-starved assets as they come to market and determining whether investing in a renovation and reposition will produce adequate returns. The company recently bought a Park Inn by Radisson near Louisville, Kentucky, and has begun to renovate and reflag it as a Marriott.
“We tend to lever most of our transactions. On the front end, we’re looking for debt and equity,” said Adam Valente, senior VP at Rockbridge. “Typically the renovation component is involved in the majority of transactions. Trying to finance later, after the fact, is much more difficult.”
Valente said he has seen plenty of cases of capital-strained owners “stuck” and forced to sell or take on additional debt.
For those owners who don’t want to unload the property and can’t afford capital improvements, one option that is much more prevalent today than even six months ago is to seek out a bridge loan. A bridge loan is short-term, enables owners to do minor renovations and is underwritten based on future value and future cash flows.
During 2011, real-estate investment trust FelCor Lodging Trust will renovate six properties for a total spend of US$84 million and redevelop the Fairmont Copley Plaza in Boston, which the company purchased in 2010.
“The best way to get renovation financing today is to roll the request into an overall refinance or acquisition loan. Lenders will most likely require one loan,” said Jane Larkin, managing director of Larkin Hospitality Finance. “I am currently working with a client to refinance his property and a portion of the loan proceeds will go towards property improvements.”
For example, if an owner of a Holiday Inn has an existing loan for US$8 million and needs an additional US$2 million to uphold a PIP, a new lender can offer a US$10-million bridge loan that will pay off the original debt and offer some extra cash for the renovation. The expectation from the lender is the property will be worth exponentially more once the renovations are complete.
“Once the renovation is done, the income is expected to go from US$500,000 to US$1 million a year, for example. And then they’ll take out a permanent loan once it has stabilized,” said Shlomi Ronen, managing director of Lucent Capital. “As a result, we’re comfortable being in the transitional mode.”
If an owner has a cash-flowing property, they should consider an overall refinance that includes money for property improvements, Larkin said.
“We’re definitely doing them,” Mesa West’s Krauch said. “You need to have some sort of value plan; a good business plan and a good sponsor.”
“Yes, they are available today,” Ronen added. “We’re still not back to 2005 where you can get this type of financing in every market across the country. They’re available in select markets that are showing stability, where the rates are still in kind of an upward trajectory.”