State of the Union
Although the coronavirus pandemic is in the rearview mirror, the hotel industry is still rebounding from the financial distress caused by the severely reduced number of travelers during that time. Years later, some positives have emerged for the industry. Lenders are cautiously optimistic about the potential for growth in hotel and hospitality investments. Increased consumer confidence, a rise in domestic travel, and a growing interest in experiential tourism are driving demand for new supply. Spread between cap rates and borrowing costs are narrow, attracting both institutional and non-institutional investors. Even though the gap between borrowing costs and cap rates are narrow, positive trends in hospitality along with projected interest rate declines make hotels an attractive investment compared to a lot of other real estate asset classes that are either overbuilt or suffering due to macro trends.
However, headwinds remain, including inflationary pressures, high construction costs, labor costs and rising insurance premiums. Considering the Feds’ interest rate campaign and its impact to the balance sheet, lenders are firm on new underwriting metrics while sponsors are weighing pros and cons of specialized loan products. Potential sellers on the other hand are holding out in hopes the interest rate curve turns in their favor, resulting in more demand and higher prices. Meanwhile, regional and community banks are still struggling with liquidity challenges while private lenders are stepping up to fill the gap.
One thing is for certain: there is ample anticipation of how the rate cuts may affect the market and how common loan product trends are shaping the industry throughout a volatile financing market.
With all of these variables in mind, there now exists an abundance of options for hotel financing based on particular circumstances and need. Here are a few and how they differentiate from one another:
CMBS Loans
Compared to a lackluster 2023, Commercial Mortgage-Backed Securities (CMBS) loans are witnessing renewed interest, but hotels are still under a watchful eye. As of July, hospitality delinquencies have increased by approximately 1% year over year. According to CredIQ, hotels have the highest average interest rate at 7.57%, along with a cap rate of 7.24% and a debt yield of 12.7% across various sectors. There is ongoing growth in hotel CMBS originations, which have risen by 45% compared to last year, and brings a sense of optimism to the hospitality sector. Industry analysts expect to see more significant CMBS transactions this year, driven by the possibility of continuing interest rate reductions.
SBA Loans
SBA loans continue to play a critical role in supporting small hospitality businesses. With a government backing guaranteeing a significant portion of the loan, operators who might not qualify for traditional financing find a lifeline in these products. The loan-to-value ratios can reach up to 85%, making it easier for hotel owners to secure financing for renovations, new acquisitions and even ground up construction.
SBA loans have long been favored by banks and non-institutional borrowers, but as banks pull back on hotel lending or hit concentration limits, capital is allocated only for the strongest projects. The SBA loan program is innately designed to help people who couldn’t get a regular bank loan. As such, one of the prime benefits of this program for sponsors is the lower equity injection. However, from a lending perspective, higher rates mean few properties are debt servicing at higher leverages forcing sellers to reset price expectations.
For 7a loans, which are typically variable rate loans for smaller economy scale hotels, consumer confidence is low as the recent rise in interest rates have turned borrowers away from this product. Despite signals that rates are heading in the opposite direction there is still apprehension for this product as buyers seek out fixed rate options.
Conventional Loans
Conventional loans remain a steady pillar in the hospitality lending landscape but are much harder to place in this environment, with LTV’s currently maxing out around 65%. The current market shows a slow growing willingness from lenders to back reliable borrowers with solid business plans and sizable portfolios. Conventional loans much like SBA loans are being reserved for the strongest of deals and flags. In the interim, banks are focusing on relationships and deposits that go beyond just the operating accounts alone.
As hospitality lending evolves in real time, conventional loans offer a tried-and-true approach for those looking to invest in quality flagged assets or refinance existing properties. The strong creditworthiness required for these loans reflects responsible lending in a recovering market, however, deals must meet stringent cash flow, brand, sponsor and market requirements to qualify.
Private Lending
The rise of private lending is reshaping the hospitality financing landscape, particularly for borrowers in need of quick access to capital or looking to do transitional and ground up projects. With flexible loan-to-value ratios and terms, private lenders are stepping in to fill gaps left by traditional financing. As operators seek to capitalize on immediate opportunities, such as distressed properties or urgent renovations, private lending offers the speed and responsiveness that the current market demands. Although interest rates may be higher, the ability to secure funding quickly can make a significant difference for hospitality sponsors looking to get their projects off the ground.
Private lenders don’t necessarily have the same liquidity constraints as their banking counterparts. However, finding projects that pencil to today’s rates seems to be fewer and far between compared to pre pandemic even despite the number of markets that have now recovered to pre-pandemic levels. High cost of construction, labor and insurance seem to be top three challenges to the P&L. Many sponsors that have previously been in ground up construction have moved to rehabs and conversions to preserve their Internal Rate of Return. As demand for new supply increases alongside disproportionate lending options, there is an anticipated shortage of new hotels, therefore it makes sense for a lot of construction and bridge lenders to be bullish for the right projects in the right markets.
Conclusion
As the hospitality lending industry continues to evolve, the focus on diverse financing products—including CMBS, SBA, conventional, and private lending—paves the way for continued industry growth. There seems to be a resurgence of creative gap financing options including EB5, PACE, Preferred Equity, Sellar Financing and even Mezzanine financing which is indicative of how bullish at least some investors are in the industry. These options may be used for either projection-based deals or as rescue capital for projects.
There is no lack of creativity in the capital stacks for hotel deals to counteract the constrained lending market overall. There are investors that are ready to push the capital stacks in the right markets contingent on positive Revenue Per Available Room trends. The outlook for hospitality lending remains promising, fueled by a resilient industry poised for recovery and expansion.
