Hotel Financing Revisited
This is the second article of a five-part series exploring the current environment and options for long term, fixed-rate financing of hotels. We cover both recent beneficial shifts in hospitality lending and the risks associated with refinancing as the peak of the market cycle predictably gives way to down cycle effects. The central theme surrounds the importance of proactively managing a hotel’s mortgage financing costs to take advantage of refinancing opportunities and to reduce the possibility of financial distress in any business scenario.
Unlike any other time in our industry, conditions in today’s hospitality and capital markets will allow many owners to balance these goals. Much has changed to the benefit of hoteliers since you last sought long-term financing. The question then is, “When is the right time to refinance my hotel mortgage?” The recommendation here is to lock in the benefits of refinancing during today’s optimal conditions. By proactively protecting cash flow you leave yourself room to maneuver as we inevitably slide into the down slope of the hotel business cycle.
When Maximizing The Loan Amount Is Your Goal
Not so long ago it was virtually impossible to get a hotel loan greater than 70% loan-to-value (LTV). Today, owners can often times obtain a loan of upwards of 75% LTV in either a conventional or commercial mortgage-backed security (CMBS) conduit program.
The ability to refinance at a higher LTV (i.e. higher leverage) creates an opportunity to recapture (“cash out”) equity. A portion of the refinance proceeds are used to pay off the existing loan, and the remaining funds (the recaptured equity) are returned to the owners (e.g. pay for property renovations, buy out remaining equity partners in the hotel, invest in another property, fund a retirement investment account).
When Payment Savings Is Your Goal
The all-in interest rate on most fixed-interest rate, long-term hotel loans is comprised of a spread plus the prevailing 10-year Treasury yield. Today, the capital markets are such that spreads can be negotiated significantly lower than in the past – the current supply of capital and demand for hotel loans combine to benefit hoteliers. In addition, today’s 10-year Treasury (4.60% as of 2/26/07) is historically low (vs. average of 5.88% since 1990). An improved all-in interest rate provides immediate cash flow savings to the borrower.
Savings are also achieved by increasing the amortization schedule over which loan payments are calculated. Whereas hotels typically garnered either 20 or 25-year amortization in the past, today it’s possible to negotiate 30-year amortization. Longer amortization lowers monthly mortgage payments and further conserves cash flow.
When You Want It All – An Example
Let’s say you took out a $4 million CMBS/conduit loan on your hotel nine years ago at a fixed rate of 8.25% and 25-year amortization. The loan matures in 8 months, but you can refinance early at a relatively low prepayment premium. In addition to refinancing the remaining $3.4 million balance you want to recapture equity to invest in a new hotel acquisition or development.
You want it all: A larger loan to recapture equity, a lower cost interest rate, and longer amortization. The “best” of the below four options depends on the owner’s unique needs and goals. In each scenario it’s possible to realize considerable benefits by refinancing early to take advantage of today’s favorable market.
Negotiate Your Best Deal
Strategic negotiation starts with targeting either a lender or mortgage broker that understands the hotel business. Once found (and through proper negotiation and trade-offs), it’s often possible to balance your key hotel refinancing goals. As in all negotiations, the borrower’s hand is strengthened in proportion to the strength of his deal. In our industry, strength stems from the hotel’s cash flow, history, market, flag, and borrower’s management experience.
Current Realities Of The Hotel CycleRecent hotel valuations have increased dramatically with rising profitability, falling cap rates, and a healthy investor appetite for our sector. Still, hotels are a risky investment. Our industry is vulnerable to a weakening economy, ADR & occupancy growth have likely peaked, and this year we’ll see room supply growth outpace demand growth. The future is not gloomy, but it is important to prepare for RevPAR decline.
Consider refinancing to lock in payment savings on your current hotel mortgage debt. It will be easier to ride out a down market when you obtained inexpensive debt during good times. Also, just because you’re able to obtain a full leverage loan doesn’t mean you should borrow that much. Leave yourself some room to maneuver as we slide into the next phase of the cycle.
About First American Realty Associates | First American Realty Associates, LLC () is a national hospitality company that focuses exclusively on hotel financing including construction, acquisition, refinancing, renovation, and repositioning/conversion loans. The firm has long-time lender relationships with banks, credit and finance companies, CMBS conduits, and insurance companies. Founded by Joe Epstein in 1976, and with offices in New Jersey and Texas, First American has financed 512 hotels across 44 states totaling $2.05 billion. Its licensed professionals have over 50 years combined Hospitality and Financial Services experience. They are members of the Mortgage Bankers Association (MBA), American Hotel & Lodging Association (AH&LA), and Certified Commercial Investment Member Institute (CCIM).
About The Author | Cameron J. Larkin is Senior Vice President of Hospitality Financing & Business Development at First American Realty. He has 15 years experience in the financial services and management consulting industries. Prior to First American Realty Larkin spent ten years working across six of GE Capital’s finance businesses in the US and Europe. Prior to GE Capital he was a Senior Consultant with Andersen Consulting (now Accenture) for 3 years.
A native Vermonter now living in Dallas, Larkin earned his MBA from Columbia University and a B.S. in Business Administration from the University of Vermont.
Cameron J. LarkinMore from Cameron J. Larkin