Hotel brands compete with one another to add new product as fast as possible, but their ultimate success relies on smart growth. That’s why hotel companies consider the sophistication and the capital structure of the real estate owner before striking a deal.
Unlike other commercial property types that sign long-term leases, hotels have daily turnover and rate changes. This has the potential to create a lot of value when managed well, but there’s also a lot more risk involved for lenders. For this reason, hotel deals aren’t as seamless to underwrite. “Hotels are more challenging than other real estate assets,” explains John Svec, managing director of Largo Real Estate Advisors. “Lenders who are unfamiliar with our business avoid hotel lending, while others know the business well and actively lend on hotels.”
Good, well-managed hotels with strong ownership are finding plenty of debt and excellent terms, Svec says. Although lenders are loosening their purse strings, there is much more scrutiny and control involved when considering a deal. “Scrutiny and underwriting have become more rigorous since the last recession,” Svec explains. “New bank regulations and stricter oversight are forcing lenders—and appraisers—to be more diligent and conservative.”
Unless developers have a great track record and a solid project, new construction remains difficult to finance. “With so much new construction and a limited allocation of money for hotels, banks are cherry-picking the best deals and strongest borrowers,” Svec says. It also helps to build relationships with financial institutions. “Good lender and broker relationships get borrowers lower rates, better terms, and loans when credit is tight, and financing for tougher deals.”
In 2016, Svec says lenders are anticipating the top of a cycle and underwriting cash flows below the trailing 12 months to lower hotel valuations and avoid over-leveraging. Interest rates will rise as Chinese and European economies recover, he adds. “Banks do the same thing hotels do when demand outstrips supply—raise rates. So hotels with reasonable debt at today’s low fixed rates will have a valuable competitive advantage.”