This year, the lodging financial cycle is approaching a peak. Demand is high, supply is slowly rising to meet it, and growth outlook for the next few years is extremely positive. As of May, the lodging industry has experienced 61 straight months of economic expansion following the Great Recession, according to Scott Andrews, senior managing director responsible for hospitality financing at GE Capital, Franchise Finance, a lender in the limited-service and extended stay hospitality markets. Andrews adds that the hotel operators who learned how to manage their expenses on a very lean budget during the downturn are prime candidates for financing everything from new-build properties to renovations, as their experience and demonstrated prudence make them a good bet for lenders. And these lenders now have more liquid capital to invest in projects than they have had in recent memory.
With financing now more readily available, hoteliers have a number of opportunities to expand their portfolios or improve upon existing properties.
From the Ground Up
Guestroom demand for the first quarter of 2015 was up 4.2 percent, running four times greater than new supply growth, according to Lodging Econometrics. This is a choice market for hoteliers who are looking to expand their portfolios and invest in new-build hotels. Jon Wright, president and CEO of Access Point Financial, a direct lender focused on the hospitality industry, says that while new construction is a response to high demand, loans to build these properties are not given out lightly. “New construction is a very high demand generator, but these loans are also one of the highest risk loans a lender can make,” he explains. “This is because the typical loan life is 18 to 24 months, and no matter how well someone might budget, there are too many variables that could change in that timeframe.”
Because of the high-risk nature of new-build loans, most lenders tend to be partial to borrowers with a proven track record. “Even today, it’s very tough to get new construction financing if you’ve never done it before. It really comes down to having demonstrated experience in not only developing the property, but also ramping it up and stabilizing it,” Andrews says. He adds that prospective borrowers should also have a strong understanding of their proposed market. Andrews continues, “A deal made today will look different in a couple of years when there are three or four new hotels added into a marketplace. We really want our borrowers to be aware of what impact that new supply will have on their new properties and be able to articulate that to us.”
A Fresh Face
While new builds may be enticing, many hoteliers aren’t necessarily looking to open a property at this point in time. However, with the economy on the upswing and their existing properties becoming more profitable, it is an ideal time for many hoteliers to renovate. Lodging Econometrics reported that during the first quarter of 2015, 513 hotels have either announced a renovation or are currently renovating, an increase of 34 percent from the first quarter of 2014. Andrews says that in today’s market, it’s relatively easy for most hoteliers to get a loan for small or moderate renovations like a lobby conversion or room improvements.
“It’s when you’re doing a deep renovation that things can be more difficult,” says Andrews. “If you’re converting one brand to another, or converting an office building into a hotel, you will likely find yourself in the same situation as a new-build borrower in that you need that demonstrated expertise to move forward with a loan.”
An area where lenders, especially banks, are willing to take a higher risk on renovation loans is when it comes to property improvement plans (PIPs). “Loans for lodging projects have always been a niche product,” explains Bruce Daubner, senior managing director at Integra Realty Resources, a company that offers commercial real estate market research and consulting services. “It’s not one of the four core real estate products, which are apartment, industrial, office, and multi-family, but there are banks that want to diversify their loan portfolios and are willing to put money out there for PIPs.”
PIPs are much more prominent today than they were just five years ago during the economic downturn. Daubner says that many of the big brands were lenient regarding their brand standards from 2009 to 2011 because they knew their franchisees were struggling. When the economy turned around in 2012 and 2013, brands started to push those standards back to the forefront, which created those opportunities for banks to expand their portfolios through financing the now necessary PIPs.
If a hotel is unable to secure the financing for and execute a PIP, it may be dropped by a brand and scooped up by an investor looking to acquire new properties.
Seizing Acquisition Opportunities
With the current state of market, some hoteliers may be looking to acquire new properties for their portfolios without doing construction. Wright says that in this situation, the competitive nature of a healthy market drives how these transactions occur, which is faster than ever before. This is because known entities, foreign investors with cash, and REITs are buying both trophy assets and middle market portfolios. “Borrowers now have to be able to respond quickly to opportunities. If a lender is competitive with pricing but will take 60 to 90 days to approve the loan, getting a good rate isn’t good enough. The money’s there, it’s just a matter of which borrower and lender is in the best position to take advantage of the opportunity,” he says.
As borrowers seek loans for new or upgraded properties and start completing their building and renovation cycles, hoteliers who have not yet taken advantage of the robust economic climate may find themselves at a disadvantage. Andrews cautions, “Knowing that there’s new and upgraded supply coming into the market, now is the time to invest in your hotel and bring it up to standards to be able to compete with the ‘shiny new penny’ properties that are going to open in the next few years. Now is a great time to reinvest in your hotel.”
