SAN DIEGO—The death of commercial mortgage-backed securities in the hotel industry has been greatly exaggerated. While their overall health might remain fragile, CMBS loans still are kicking during what is becoming an era of frantic desperation for the refinancing of existing hotel loans.
Lenders participating in an International Lodging Finance Council roundtable discussion with HotelNewsNow.com in late January said they definitely have noticed the return of the CMBS structure to the market—even if it isn’t going full speed.
“CMBS is here to stay, but it will be a long time before it approaches where it was at its peak,” said Bruce Lowrey, managing director of RockBridge Capital’s Investment Origination Group.
Lowrey said the hotel market reached its zenith in the frenetic years of 2006 and 2007 when there were more than US$200 billion a year in CMBS loans. What has followed is a dramatic dropoff: about US$10 billion in CMBS loans were issued last year. He said he has seen projections for CMBS loans in 2011 range from US$20 billion to US$70 billion.
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Mike Armstrong |
“I’m going to go out on a limb here: In 2011, we’ll see the return of CMBS,” said Mike Armstrong, a principal who specializes in mortgage brokering for HREC. “I think it will come back in a strong way this year.”
Despite the optimism, there are reasons to traverse the CMBS trail cautiously, according to Fred van Overbeek, managing director with Prudential.
“A lot of the hotels that went back to lenders during this downturn were hotels that were in the CMBS market, which were underwritten at the top of the market,” he said. “With CMBS underwriting, it was prospective. The loan was almost a bad loan the day it was originated, in terms of the amount of leverage that was on it. … Sometimes with the CMBS deals, there’s no room to renegotiate what you’re trying to do. If it needs a fix, that’s a much more difficult proposition in terms of negotiating some sort of paydown or restructuring. For many of these public companies, they find themselves in situations of trying to work something out with the lender and can’t get it done.”
Lowrey said the cost of capital is clearly an advantage of the securitization lending business, but it has created “a divorce” in the relationship between the borrower and the lender.
“(In the current environment) you’ve instituted a third-party servicer whose fiduciary responsibility is the REMIC Trust and is powerfully de-incentivized from working with the borrower,” he said. “No matter how well-intentioned those documents are to try to contemplate all the different things that may happen over the life of the loan, inevitably something comes up that needs a subjective decision, and it’s very hard for that servicer to lean in the favor of the borrower.”
Undulating landscape
The rest of the lending landscape for hotels appears to be just as murky—with signs of life beginning to emerge.
Bettina Graef, head of hotel properties and structured property finance for Germany-based Aareal Bank, said the hotel fundamentals in Europe picked up sooner than those in the United States, and there’s a little less fluctuation in net operating income and cash flow.
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Bettina Graef |
“We will never go crazy with doing (loan-to-values) of 85% on the upper market, but at the same time we won’t go down as much, 45-50%,” she said. “We currently are a cash-flow lender. … We’re a little bit more lenient on the yield on debt in Europe. We need (central business district), business property, limited-resort properties.”
But even with all of the optimism in the industry, there still are plenty of distressed assets that need to be addressed.
Lowrey said RockBridge’s expertise as a fixer of distressed properties has kept it busy for most of the past two years.
“There are broken deals that are operationally broken—the property is capital starved, there is a level of functional and economic obsolescence—tired management, for example, (that has) been taken over and the property really needs to be rebuilt,” he said. “More of them, though, are broken from a capital stack perspective. They can’t be refinanced; they can’t be sold at a level that gets any of the equity out. So, they need to be rebuilt in one form or another. It may be shared pain, where the lender has to take a discounted payoff, or the borrower has to put more money in or bring more equity in from another way to rebuild it. We’re seeing both of those opportunities.”
Armstrong said HREC’s hotel brokerage side of the business has more than 60 listings—about half of which can be considered distressed assets. The other half are private sellers who think now is a good time to put the property on the market.
There is hope—and hoops
But there is some sun on the horizon, the panelists said.
“You have credit coming back into the market. You have equity owners more willing to recapitalize projects now that they’ve seen the stability in the market,”v Van Overbeek said. “I think the worst is over, that’s my sense.”
But things won’t go back to good old days overnight.
Graef said the whole loan approval process that has changed. “Pre-crisis it was a little easier, now it takes more work,” he said.
Van Overbeek said a 30-day close is still doable, but there are more steps to take.
“The key is to coordinate the due diligence up front so the third-party reports can be shared,” he said. “If it’s a high probability acquisition, borrowers need to give the lender an early heads up so they can get a running start.”
And of course, the simpler a deal is, the more of chance it has of being funded.
“What’s different is when you start adding complex origination structures, or ownership structures, ground lease—all those things take time and will probably kick it out or make it a difficult project to do at all,” van Overbeek said.