Navigating the Hospitality Industry as a First-Time Investor

Profitability

Being a first-time investor in the hospitality industry can be overwhelming, as multiple factors—the state of the market, who to invest with, what type of loan to apply for, and even how to approach the financing process—must be considered.

The good news for future hotel owners is that current market conditions remain favorable for growth. The hospitality industry did well in 2018, with a 0.5 percent increase in occupancy and 2.4 percent growth in average daily rate, leading to an increase of 2.9 percent in revenue per available room. And industry experts find that investors looking at hotel projects can continue to expect the market to remain strong in the near future. According to Jones Lang LaSalle’s 2019 Hotel Investment Outlook, hotel investments in the United States will remain relatively positive throughout 2020, almost mirroring 2018 market transactions and conditions.

Since hotel occupancy rates and revenue fluctuate more so than other industries that involve long-term leases and more predictable sources of income, lenders want to ensure that the new hotel developer understands the business side of the investment, so he or she can effectively manage the day-to-day operations of the hotel. Having prior experience in the operations side of the hotel industry is a significant advantage, so a first-time investor that doesn’t have this experience should definitely consider joining forces with a hotel management company or with a joint-venture partner that has the right experience.

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It’s paramount that first-time hotel investors be well-informed on what lenders are looking for in a borrower. Because the financing cycle is so complex, it’s advantageous for borrowers to be aware of lenders’ pain points in working without the entire package and to make the process as simple and seamless as possible. Fortunately, many of the missteps that first-time borrowers often make can be avoided. Here are five common ones investors should keep in mind:

Over-leveraging deals. 

It’s important that both a borrower’s debt and equity capital stack is buttoned down and that he or she is confident that the project is viable.

Taking short-term bridge loans.
In the rising interest rates environment, rates tend to influence hospitality borrowers’ debt-servicing capabilities and bottom line. Borrowers should stay away from short-term bridge loans and focus their efforts on finding loans with permanent fixed rates and give existing bridge construction loans a permanent home.
Not having an attorney review construction agreements and promissory notes.

It’s beneficial and highly recommended to have an experienced attorney look over these documents and explain any prepayment penalties, default provisions, and exit strategies. Borrowers must understand certain provisions or they may face higher costs. For example, a SBA loan’s promissory note may state that the interest rate during the construction phase is 8 percent and will fall to 6 percent after construction is complete. Such a loan could require all construction dollars to be repaid before the rate will be reduced—which could be a big obstacle for many borrowers, as it adds unplanned costs.

Not negotiating a provision for additional debt if needed.

In various cases, senior loans strictly prohibit taking on additional debt. If a hotel brand mandates renovations after a number of years has passed, borrowers with these loans will have to inject cash to avoid default or to refinance the hotel. It would be advantageous for borrowers to negotiate language permitting the borrower to add debt up to a certain amount to improve the property. Senior lenders can work this provision into their underwriting when they calculate the debt-coverage ratio.

Neglecting to negotiate guarantees.

Lenders tend to require a personal guarantee as part of the loan. To reduce risk, borrowers should request to have burn-off written into the agreement—i.e., have the loan state that, once stabilization is achieved or certain benchmarks are met, the lender will release the borrower from the personal guarantee, entirely or in part.

First-time investors must ensure they are negotiating a deal that meets their criteria as well as the lender’s. By taking into consideration how to best approach lenders, first-time investors will be well-equipped to find success in the hospitality industry and form mutually beneficial relationships with lenders for the long term.