How to Finance Hotel Development in 2012....Alternate financing for new hotel construction in a brave new world
By Catherine DeBono Holmes, Chair of JMBM’s Investment Capital Law Group
As the speakers at NYU are telling us, hotel development is happening again! And the pace is picking up. To be sure, only the best projects will get financing with great locations, experienced developers and sound fundamentals. But even then, financing can remain a challenge.
Here is an article about this that recently appeared in Hotel Business, written by my partner Catherine Holmes. It is a good read.
Alternative financing for hotel development:
EB-5, New Markets Tax Credits, Historic Tax Credits and other public financing incentives
by Catherine DeBono Holmes
This article was first published by Hotel Business on May 21, 2012
Four years after the collapse of the traditional financing markets for new hotel developments, most hotel developers are still struggling to find the necessary financing to fill the capital stack required to build new hotels. Even for developers with access to construction loans, loan to cost ratios are hovering at 50%, and equity providers expect returns in the mid-teens to the mid-twenties. As a result, the "feasibility gap" between a typical project's cost and its value is still too high, and hotel developments around the country are stalled.
Meanwhile, most cities and states are no longer providing public dollars to support private development. In California, for example, all community redevelopment agencies were abolished by the California legislature in 2011, and $1.7 billion that had been earmarked for redevelopment projects by approximately 400 redevelopment agencies state was instead required to be returned to state and local governments to fill operating budget deficits.
In other states as well, many governmental entities have no public dollars available, or are unwilling to use public dollars to support hotel development. Even in those areas where government financing is available, the time required to obtain approval is usually much longer than anticipated - often taking two to five years or more. There is also the risk that during that time mayors and city council members will change, and they may not support the projects approved by the prior administrations.
In this economic climate, some hotel developers around the country are assembling multiple alternative financing sources for their hotel projects, such as EB-5 immigrant investor financing, new markets tax credits, historic tax credits (for renovation of historic buildings), and other forms of public incentives.
Putting a package of financing sources together takes time and expertise to make it all work. In most cases, the developer has to assemble all of the pieces in advance, before any one component of alternative can be obtained. That does not necessarily mean that all of the financings have to close or be funded at the same time, but that the developer has a commitment from each financing source that if the other financing conditions are met, the developer will receive the full amount of financing necessary to complete the development in accordance with the project budget. Several of these financing sources not only must be structured to meet legal qualification requirements , they must also be sold to private investors. Therefore, it is important for a developer to make sure the project itself and the financing structure will appeal to the private investors in the alternative financing vehicles used by the developer.
One combination of alternative financing that is gaining in popularity is the use of both EB-5 financing and New Markets Tax Credits on a single project. Since both programs are designed to aid development in low income or high unemployment areas, and both are intended to support job creation, there is a natural synergy between these two financing sources.
The EB-5 immigrant investor programhas raised billions of dollars in financing for job-creating U.S. businesses since 1992, and is poised this year to top all records for the amount of financing raised for U.S. businesses. As of March 20, 2012, there had already been 2,405 EB-5 visas issued for the first quarter of 2012, with Chinese nationals dominating the list (accounting for nearly 70% of EB-5 visas issued in 2011 and 2012 to date). A total of 10,000 EB-5 visas are authorized to be issued each year, which could result in several billion dollars of financing annually. Hotel developers seeking EB-5 financing need to determine how many direct and indirect jobs their project will create, using an economic model approved by the U.S. Citizenship and Immigration Services (USCIS). For every 10 direct and indirect jobs, one investor visa can be issued. Each investor is required to invest $1,000,000 or $500,000 for a project located in a "targeted employment area", defined as an area with unemployment of 150% or more of the national average. In the market for EB-5 investments today, almost all EB-5 investments are made at the $500,000 level. EB-5 financing typically raises between 20% and 70% of total project costs, depending upon the number of jobs that can be created by the project.
The New Markets Tax Credits
(or NMTC) program allocates a specified amount of tax credits each year to be used for project development in urban and rural low-income census tracts to help finance community development projects, stimulate economic growth and create jobs. For the fiscal year 2012, a total of $3.6 billion was allocated by the U. S. Treasury Department's Community Development Financial Institutions Fund to 70 private financing sources, including banks and private lenders. Those entities in turn sell investments in the tax credits, and invest the proceeds of sale as equity and debt in qualifying projects. In aggregate, the NMTC benefit generally ranges from 15-25% of total project costs, provided the deal is structured efficiently and enough NMTC credit allocation can be identified.
Some of the other forms of public hotel development incentives available today include:
- Historic tax credits for rehabilitation of income producing historic buildings or non-historic buildings placed in service before 1936 (which are also generally sold to investors in a manner similar to NMTC)
- Special tax districts, e.g. specially designated districts where the costs of infrastructure improvements are funded with special assessment bonds paid for by property owners over a long term as part of their property taxes
- Ground lease or sale of publicly-owned land
- Lease revenue bonds, industrial development bonds and certificates of participation
- Public agency credit enhancements
- Sales tax sharing, sales tax revenue bonds, isolated project revenues (sales tax, sewer/water fees) reinvested in projects.
Assembling multiple sources of alternative financing is undoubtedly a complex and challenging task, but under the constraints of the financial markets today, that is sometimes the only way that new hotel projects will be built.
Catherine Holmes is a transaction and finance partner with JMBM's Global Hospitality Group® and Chinese Investment Group™ and specializes in resort and hotel purchase and sale transactions, resort and urban mixed-use financing and development including EB-5 financing and public and private securities offerings, hotel management and franchise agreements, and hospitality asset workouts. Contact Catherine at +1 310.201.3553 or email@example.com. For more information about EB-5 financing:
- EB-5 Lawyer Alert #2: Update on developments in California on TEA designation procedure
- EB-5 ALERT: California's new TEA approach will discourage EB-5 capital
- EB-5 Lawyer with the latest wrinkle in EB-5 financing for hotels – the Tenant Occupancy Issue
- Financing new hotel development today: Finding the right "regional center" and negotiating terms for your EB-5 financing
- Chinese investment in U.S. hotels: what the real estate professionals want to know
- Hotel Development Lawyers: 10 things you can do to win the "race" for EB-5 capital for your hotel development project
- Hotel Investment: Why Asian investors are targeting U.S. hotels for purchase and investment, and what could it mean for you?
- Hotel Developers: Why a "regional center" may be the key to financing your next hotel development or expansion. And what you need to know . . .
- How to use the EB-5 Immigrant Investor Visa Program for financing
JMBM's Global Hospitality Group® provides business and legal advice to hotel owners, developers and investors, based on practical experience gained from more than $71 billion of hotel transactions, 1,000 hotel management agreements, 1,000 franchise agreements, and 3,800 properties worldwide. The Chinese Investment Group™ within the practice is a dedicated team of hotel and real estate lawyers that provide a gateway for Chinese investment in the United States. The Group and its network of reliable professional resources help Chinese investors identify, analyze, evaluate, validate, acquire, finance and manage hotel and real estate opportunities. We have closed more than $1.5 billion of EB-5 financing for our developer clients and sourced more than half of that.