NEW YORK — Inflationary pressure and rising interest rates are further complicating the recovery for U.S. hotel owners, but it’s still possible for them to make deals work.
During the “Financing — The Capital Stack” panel at the ALIS Summer Update 2022 conference in New York, hotel industry and lending executives spoke about the state of hotel financing and what owners and developers need to keep in mind as they work through deals and new projects.
There’s been a lot of market volatility, but deals are continuing to get done, said Kyle Berman, vice president at KSL Capital Partners. Those deals tend to involve higher-quality assets with limited capital expenditure needs, strong performance during the pandemic and strong cash-flow profiles. The borrowers also typically have significant hospitality experience and strong track records.
Lenders have been favoring leisure-oriented properties with higher demand, he said. Conversely, properties in more urban markets that are in the earlier stages of recovery and require more capital expenditures have had a harder time obtaining financing.
“Something we've seen in the market over the past few months in markets like San Francisco, deals that maybe someone was looking to buy something a few months ago and tied up a property at a certain price, that price is no longer reflective of the current market conditions and, in certain scenarios, those types of deals are falling apart,” Berman said.
Getting Creative
Deal-making in the hotel industry is about looking toward the horizon and being in it for the long game, McNeill Investment Group CEO Chris Ropko said. Find a good deal and make the capital stack work, but nothing lasts forever, he said. Owners can switch out of the capital stack, but that just means being thoughtful.
If an owner is constrained, that means they may have to take a pause, he said.
“Several people have said that pricing hasn’t corrected enough to a point where it makes the positive leverage attractive enough to chase some of the deals we’re seeing out there,” Ropko said. “On the flip side, if you have flexibility with your capital, your equity sources, migrate up and down the capital structure.”
If a buyer wants a hotel priced at $150,000 per key but can’t buy it for that much, the buyer should provide market leverage of $150,000 per key on the return, he said.
Would-be developers need to look at a market’s horizon and ask themselves what their strategy is, said Sanat Patel, co-founder and chief lending officer at Avana Capital. It could be to build, stabilize the property and then sell. It could be build, stabilize, put it on the balance sheet and then “ride the cash-flow train,” he said.
“Developers have to first ask that question,” he said. “That’s what I mean when I asked, ‘What’s your strategy with this?’ Then you can flex your capital stack accordingly.”
CHMWarnick Senior Vice President Mark VanStekelenburg said his company is seeing larger mixed-use or master plan developments starting to come back, and they’re going full steam ahead. The hotel component only makes up about 10% of the whole product. If these kinds of projects can add sports or entertainment into the mix, it’s an even better product.
These projects are based on ongoing synergy, he said. Each element may not work on its own, but they do when combined with these other asset classes.
Patel agreed, adding that “each asset should complement each other so that they can drive demand for each other.”
Advice for Hoteliers
From an underwriting perspective, lenders need to know where first-time hoteliers are starting from, Patel said. The hoteliers need to have reserves in hand, because hotels are an operating business and management makes the cash flow to pay the debt. Hoteliers without reserves will face challenges when trying to borrow.
They should look at what demand exists in a market, the new construction in the area, and the demographics of who is coming in and who is leaving, he said. California lost a lot of business because of its tax structure, and those companies went to places such as Phoenix and similar markets.
Lenders look at all these different factors when considering investment, Patel said.
“In the last five years, we’ve seen a lot of guys coming in because, ‘Oh, it’s sexy to own a hotel,’” he said. “It’s no longer sexy after COVID, trust me.”
New hoteliers must think of this is as an operating business and figure out the cash-flow aspect, Patel said. Without cash flow, owners need to be willing to put money into the hotel and figure out at what level because the more of their own money they put into it, the higher the return they want.
Owners looking to refinance should get ahead of the increasing interest rates as much and as soon as they can, Berman said. Those who have a loan maturity coming up should talk to their existing lender as quickly as possible. Figuring out whether they could extend their loan is probably the first step, he said.
Whatever the process, it’s usually best for owners to work with a lender they have worked with before, he said.
“Doing a new deal with a lender you haven’t worked with before, it’s just going to make it even more challenging,” he said.
When working with owners looking to sell an asset, VanStekelenburg said he tells them they need to have a road map if they don’t have significant cash flow. If their market is on pace to recover occupancy this year and rate next year, they better be at 100% or more of their competitive set.
Everyone continues to struggle in the full-service and big-box hotel segments when reopening proportionally with solid, continuous demand, he said. With big-box hotels, they can reopen their restaurants as a way to test the demand. There have to be key things such as breakfast, but the full-service and boutique hotels should lead the way in testing that space.
On the acquisition side, it’s about getting the expertise, either in-house or through partnerships, VanStekelenburg said. For those who are developing, they need to develop the hotel as a purpose-built hotel from the beginning.
“A lot of these new entrants are bringing non-hotel architects, not enough folks familiar with it,” he said. “That kind of issue can be a monstrous expense, if ever recoverable.”