When it comes to securing financing for a hotel construction project, there are many factors that can influence the success of an application. The construction of a new hotel project is the most complex form of hotel financing.
From understanding loan-to-value ratios to right-sizing the information supplied in the quoting process, the nuances of hotel financing are unique in the commercial real estate industry. Securing an optimum hotel construction loan follows the same processes and principles as financing a new business.
If you’re not sure about having everything you need for a successful hotel construction loan, don’t worry – here are some essential tips for making a perfect bid.
First Things First – Understanding the Basics
Hotel construction loans require significant capital.
In addition, your hotel financing project needs to account for both large-scale down payments and the extended duration of time construction could take.
Acquiring hotel construction loans often present greater financing challenges than other properties. This is especially true when planning a high-end, boutique or non-branded hotel (non-flagged hotel) project. It can also be the case if you’re looking for a hotel construction loan to finance new builds, conversions and renovations.
Underwriting adjustments based around factors such as occupancy levels, franchise marketing, management, and furniture, fixtures and equipment (FF&E) are often implemented by hotel lenders. These situations arise when a borrower’s determination of net operating income (NOI) doesn’t fully align with the underwriting of the proposed hotel lender.
For most hotel properties, finding permanent financing with terms in excess of ten years requires assuring lenders that their collateral will not be down-flagged or become un-flagged during the hotel loan term, or even at the point of loan maturity.
Hotel Financing Options
Hotel loans are formulated by lenders as a combination of real estate and business loans, consolidated into a single-hospitality financing facility. The loan leverages the physical property – the structure of the hotel building itself – as pledged collateral.
As a result, the loan must receive approval in the same format as a traditional commercial real estate loan, complete with a requirement to prove the validity of the validity of the hospitality business as a viable and sound financial proposition.
Hotel Financing Requirements
There are specific metrics used by hospitality lending underwriters when determining the approval of potential hotel loans. Many lenders have their own formula of underwriting criteria for assessing the viability of a proposed project.
Chief among them is Revenue Per Available Room (RevPAR), calculated as the hotel’s average occupancy multiplied by its daily average rate. RevPAR is a critical metric when refinancing or using a hotel loan for renovation.
Capital sources will often assess comparable hotels in the vicinity or geographical region of your proposed build. Here are some of the other considerations lenders are going to evaluate when determining the viability of your proposed hotel.
- Market Research will aid in their determination of the viability of your project by analyzing the health of the market.
- Hotel Feasibility Studies provide insight into the specific sustainability and financial viability of the proposal. By looking into the required investment amount, financial determinants, expected revenue, rate of return investment, market viability and location study, among other considerations, the comprehensive probability outcomes of your proposed construction project are weighed against potential risk factors.
- Financial Characteristics such as the debt to equity ratio, debt yield and Net Cash Flow (NCF) are evaluated in determining the strength of your financing options.
By comprehending the financial characteristics of a hotel property, you’re able to assess the amount of debt you can assume and the amount of equity you’ll need in order to close the deal. It is important to note that some borrowers will simply default to the highest possible leverage, which equates to the smallest possible down payment.
Important Metrics for Hotel Lenders
- Revenue per Available Room (RevPAR index): Achieved by dividing the Revenue per Available Room with your hotel grouping comparator, and then multiplying your result by 100. A result of over 100 means you’re outperforming the market share, and anything sub-100 means you’re underperforming when contrasted against your competitors.
- Net Operating Income (NOI): Net Operating Income or Net Cash Flow (NCF) is the amount of net profit before paying off any debt, including interest or principal. Factoring in any non-cash expenses like depreciation or amortization, this number is used to determine your loan amount. To give you an example, at a net income of $250,000 with $200,000 interest and depreciation at $100,000, net cash flow will be $550,000. The higher the NOI, the higher the potential loan.
- Cap Rate: The capitalization rate is calculated by dividing a property’s NOI by the current market value. Expressed as a percentage, this ratio is an estimation of an investor’s potential return on investment. Cap rate is often utilized as a comparison of the relative value of similar real estate projects.
- Debt Yield: Calculated by dividing net operating income by the potential loan amount, the resulting percentage indicates the present ability to repay the loan, and 10% higher debt yield is widely accepted.
- Loan-to-Value Ratio (LTV): This metric is used because lenders will want to be able to sell the hotel property for at least the amount of the loan should the borrower default. LTV is calculated by dividing the loan amount by the market or appraised value of the property.
- Total Cost Basis: Defined as the total amount invested for construction or capital improvements since the hotel was built or acquired.
- Prepayment Penalties and Mitigation: A prepayment penalty is a fee that your lender may charge you to pay more than the allowed additional amount against your loan. Mitigation occurs when the borrower is delinquent in repaying the loan, or breaks the current terms of the agreement.
- Loan Assumption Option: This allows the new buyer to take over the loan when the current owner sells. The new borrower/owner will still require approval from the lender.
- Additional Debt: The accounting for subsequent incurrence of debt attributable to the original deal.
- Longer Open Period: Typically more desirable than short-term loans, due to the larger loan amount, lower interest rate and extended timeframe to repay the loan.
- Hotel Management Agreement HMA: This assesses the risk between the hotel manager and owner. Many provisions in the HMA cover elements of reimbursement obligations, termination rights, performance standards, indemnifications and subordination provisions.
Hotel Lending Sources
Banks remain one of the primary sources of securing hospitality financing, beginning with $20 million.
Banks can provide hotel construction financing through construction or bridge loans. Both are usually based-upon interest-only agreements with terms of 18 months to 5 years. Banks also offer revolving business lines of credit, which are utilized in reconstruction projects and FF&E expenditures.
The Small Business Administration offers a few programs to guarantee hotel financing loans.
- SBA 7a Loan Program: Also known as the Standard 7a loan, this program has a maximum loan amount of $5 million and guarantees 85% for loans of up to $150,000.
- SBA 504 Program: This loan provides long-term, fixed-rate financing of up to $5 million for major fixed assets that promote business growth and job creation.
- SBA Energy Efficient 504 Program: This program can finance green hotel projects of up to $20 million and greater, with a 90% LTC ratio and terms from 10 to 25 years.
Other Sources for Hotel Financing
- Franchise Exclusive Lending Programs: These programs offer incentives for chain or boutique hotels in order to capitalize on the brand value of a previously-established franchise.
- Private Direct Lenders: Working with a direct hotel lender is effective because it cuts out the middleman. When dealing with complicated financial structures, clarity and communication are key. Intermediaries can lengthen the process, as more parties will need to sign off on the proposed terms of the deal.
- Equity lender: These lenders allow for a significant amount of available financing by leveraging existing assets or property as collateral.
- Bridge Loan: This involves holding the borrower’s debt service for a set period while they transition to a different financial situation. Some bridge loans are obtained under the expectation of refinancing into a fixed-rate mortgage after the construction is completed and cash flow begins to come in via property rentals and tenant payments. Bridge loans typically offer up to 12 months of payment-free financing at a higher interest rate when compared to conventional loans.
- Mezzanine Debt: A versatile option that can be structured in a variety of ways, involving both debt and equity arrangements. Mezzanine debt operates like an add-on to the borrower’s main source of capital. As a result of being a higher-risk form of financing, mezzanine instruments come with higher costs.
- C-PACE Financing: Defined as a tool that can finance clean energy efficiency and renewable energy improvements on commercial property. C-PACE uses borrowed capital to pay for the upfront costs associated with renewable energy or energy efficiency considerations for the property. Borrowed C-PACE capital is repaid over time via a voluntary tax.
- CMBS Conduit Loans: Also known as conduit loans, this option pools together similar commercial mortgages in order to be sold on the secondary market. CMBS loans are known for their relaxed credit requirements, but are only available for income-generating properties, and cannot typically be used as construction loans.
The Value of Certainty
At Black Collie Capital, we specialize in working with our clients to create hotel financing applications that highlight the information borrowers and lenders are looking for.
By right-sizing the information given to the quoting process, you’re guaranteed to have your funding application considered by direct lenders who will recognize the precision and professionalism of your hotel construction financing terms.
After the deal is done, Black Collie Capital stays onboard your hotel property project to ensure the process remains smooth. We’re with you all the way, from hotel project proposal to hotel acquisition, construction and right up until a property manager is selected.
Black Collie Capital provides effortless access to real estate debt & equity financing and facilitates prudent investment decision-making.
Visit us today to start a conversation about your investment future, and enjoy the certainty Black Collie Capital solutions provide.