Editor’s note: This is the final article in a series of four articles from the International Lodging Finance Council roundtable discussion held at this month’s Meet the Money conference.
Read part 1: “Big changes spark lending debate.”
Read part 2: “Hotel-valuation process gets more complex.”
Read Part 3: “CMBS loans aren’t attractive to all.”
View panelists explaining top issues in hotel lending.
LOS ANGELES—Rumors that construction financing exists for new hotels can be heard on and off during the industry’s various investment conferences. Financing experts participating in an International Lodging Finance Council roundtable held earlier this month said lenders are originating a few new-construction loans, but there won’t be an avalanche any time in the near future.
Bruce Lowrey, managing director at Columbus, Ohio-based RockBridge Capital, said there's a bell curve of probabilities that could happen as lenders find their way back into the hotel-construction loan business.
“The big part of that is the way it's always come back in the past. And I think that's the highest, most likely scenario, which is to say there are some deals that make sense and there are some deals that get done, but I think your question is when does it come back in earnest?” Lowrey said. “Most of us on the buy side or lending side are able to lend at discount-to-replacement cost in markets where that metric makes sense. And so as long as that's the case it just doesn’t make sense to do construction loans outside of the one-offs.”
Lowrey said the return of the commercial mortgage-backed securities market, or the emergence of another, yet-to-be-identified funding source, could drive up sales prices for existing hotels—and that opens the door for construction loans.
Lowrey added: “Some lenders will get to the point where they say ‘Instead of going getting involved in the bidding wars where it gets to the point where we were one of 20 bids to finance an old Holiday Inn out by the roadside, let’s make (a) loan on a new Courtyard or Residence Inn or Embassy Suites or something like that where you have real cash in the deal, where you have full recourse, and you've locked the guy up and you're going to get a shot at the refinance of that loan and the refinance of that loan.’”
Rob Stiles, senior VP for Cushman & Wakefield Sonnenblick Goldman, said one-off construction loans are the rule of the day.
“We've worked on a couple of things that are more what I would call completion financing where it could be 25(%) to 40% of total cost if you’ve got great sponsorship,” he said. “The issue is that in addition to completion recourse, the market's looking for a pretty heavy strip of repayment recourse. So at some point that sponsor has to weigh whether they're better off just getting a signature loan just through their lender that they have, you know, a wealth management broker.
“Once values move, and the reality is development costs have moved so far that even with two and three cap rates in San Francisco those assets trades are still way below replacement costs,” Stiles added.
Warren de Haan, chief originations officer and managing director at Starwood Property Trust Management LLC, cautioned that solely relying on replacement costs as a measuring stick for construction financing is a slippery slope.
“Replacement cost is just a data point.” he said. “It's going to cost you to build that asset in its entirety and replicate it, but you can put the Taj Mahal in Iowa and spend (US)$400,000 a key. There are just some hotels that have never performed. They were overbuilt, and I can name five of them here in Southern California that it's interesting what replacement cost is but at some level that's completely the wrong metric to use on that asset.”
De Haan said standard industry product, such as select-service hotels in secondary markets are a different story.
“You can take a select-service product, generally speaking, in secondary markets, and land costs generally comp out because construction cost is kind of the same, the package from there is kind of the same, it's a more homogenous asset class,” he said. “But go back to the primary markets in the big assets or resorts, the replacement cost thing—if you think back to 2006, 2007, it might have gotten you in a lot of trouble thinking about replacement cost.”
Risk premiums are a big consideration
In addition to construction financing, the risk premiums of hotels versus other asset classes when it comes to acquisition financing was a hot button for the panelists.
“(Hotels) are the one class of commercial real estate that has had (net operating income) bottom out,” Stiles said. “Office markets might be moving off the bottom in terms of rental rates, but you still have this overhang of above-market leases that are going to roll in the future so you still have falling NOI into the future. So hospitality has become the sure bet. NOI has troughed and it’s moving off the bottom and it hasn’t yet for other real estate industries.”
De Haan said there’s a rush to put money into assets with a good story to avoid putting the cash in a bank to earn 1% interest.
“A lot of guys have raised capital and need to put it up somewhere,” de Haan said. “We really need to start to looking at the intrinsic risk premium for hotels over other asset classes.
“To look at trailing 12 months or trailing three months and to look at the risk premium that people are paying for hotels, or not paying for hotels, versus other asset classes that have longer income streams—there has to be a risk premium,” he added.
He said terrorist attacks and new supply are factors when determining risk premium for hotels.
“It would be interesting to calculate that because on one hand, a 450-room hotel you’ve got some diversification and demand, versus an office building that’s got 35% in a law firm that goes bust, right? There were a lot of those,” Stiles said.
“The difference is they’re on the hook for five years, they’d really have to go super bust for you to become an unsecured creditor,” de Haan said.
Patrick Feltes, senior VP, hospitality finance and franchise finance for GE Capital, said many hotel investors are not weighing different alternatives for their capital use.
“They’re not sitting there saying, ‘I’ve got (US)$2 million of fresh equity I want to put into a project. Do I do this office building over here, or do I do this hotel over here?’” he said.
Stiles said opportunity funds do take that approach, but entrepreneurial hotel investors don’t.