REPORT FROM THE U.S.—Hotel lenders are increasingly emphasizing loan returns when evaluating debt deals.
Debt yield, or the cash-on-cash return a lender could get on an asset if it foreclosed on day one, is becoming an increasingly important metric for lenders as the hotel sector continues to regain its footing, according to sources interviewed for this report.
D.J. Effler, senior VP at Bellwether Enterprise Real Estate Capital LLC, said debt yield seems to be the most important underwriting term anyone is looking at these days.
“I think debt yield is the metric as far as sizing up a loan is concerned,” Effler said. “In hotel financing, it’s all about cash flow, and debt yield is a measure of this.”
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David Mumford |
David Mumford, senior principal at hotel brokerage Mumford Company, added that it appears lenders are willing to strike deals. But, as the focus on debt yield shows, lenders want to ensure they’re chasing the best deals with quality assets and sponsors. “What we’re hearing now is that it’s a good time to be in the market for hotel financing, particularly hotels with a track record of performance and in a good brand family,” Mumford said.
Debt yield terms
Effler said debt yield wasn’t as high profile an underwriting term in the past because cash flow was difficult to come by during the downturn. So other terms, such as capitalization rates and loan to value, were used more frequently.
Such terms, however, proved problematic during the downturn, he said. “People were putting their finger in the air and saying, ‘What’s a good cap rate right now?’”
But now, debt availability seems to be getting better as each day passes, and the industry continues to see operating metrics climb, Effler said, which has brought debt yields to the fore.
Six months ago, for example, lenders were looking for debt yield of approximately 12%. Today, that number has narrowed to 11%, Effler said. “You could get below 11 with the best deals,” he said.
According to the second-quarter Hotel Investors Gauge survey, lenders reported requiring an average debt coverage ratio of 1.3, though responses fell in a range of 1.2 to 1.4. (The Hotel Investors Gauge survey is available to paid subscribers of The Hotel Investment Barometer, a sister publication of HotelNewsNow.com.)
A year ago, debt coverage ratio was at approximately the same level, according to the Hotel Investors Gauge.
Cautiousness remains
Still, despite the fact that some loan deals are getting done, Mumford said there remains a lot of cautiousness out there on the lending side.
“A lot of banks are not looking for new relationships,” he said.
Donald Wise, co-founder and senior managing director of Turnbull Capital Group, said much of the underwriting today leans more toward the conservative side. “We’re just kind of back to old-school banking,” he said.
For instance, he pointed out that debt coverage ratios—the cash flow lenders want borrowers to have available to meet interest payments and repay debt—are in the range of 1.4 to 1.8. A ratio of 1 means the borrower is able to cover 100% of annual debt payments.
Wise added that any lender who requests a debt coverage ratio of 2 means that lender is anxious to lend.
Effler said lenders do want to ensure cash flow is in place before jumping on a deal. Given the improving state of the industry, he said that shouldn’t prove to be a problem for much longer.
“I feel good about the next few years (from) the … standpoint of (revenue per available room) and (net operating income),” he said.