REPORT FROM THE U.S.—Volatility in the market may not be affecting the appetite for commercial mortgage debt and hotel investment but it is having an effect on loan terms.
During the second of a two-part the Americas Lodging Investment Summit Summer Update webinar series, hotel lenders said borrowers are looking for—and sometimes securing—higher leverage levels. However, “dramatically” rising interest rates have delayed the close of some acquisitions and significantly altered the dynamics of many others.
“The same loan that would’ve closed at 4.5% or 4.7% (two weeks ago) is now at 5.5% (interest rate),” said Jeff Bucaro, senior VP at Aries Capital.
The quick rise in interest rates has at least one lender shifting focus from debt yield to debt service. Mark Fluent, head of commercial real estate banking with Deutsche Bank, said since rates rose to the mid-5s for 10-year money, his team is looking at loans differently.
He said: “120, 130 debt-service coverage seems to be the new minimum.” Debt service coverage refers to the amount of cash flow available to meet annual debt interest and principal payments.
It’s an optimal market for balance-sheet lenders because their terms aren’t directly correlated to what’s happening in the U.S. Treasury, said Warren de Haan, chief originations officer and managing director at Starwood Property Trust.
“As a balance-sheet lender, I like this environment; it creates pause,” he said. “While it’s not an underlying credit concern, it’s a capital market concern when guys are exiting into the bond market.”
Higher leverage levels
All lenders on the panel agreed buyers and developers are looking for higher leverage today than at the beginning of this year. However, the panelists differed on what “high leverage” means.
Fluent said higher leverage in today’s market usually means 70% to 80% debt on a deal. He said anyone requesting more than that is attempting a thin deal with poor sponsorship.
Bucaro said, on the fixed-rates side, first mortgage debt ratio is topping off at 70%.
“I haven’t seen 80%,” he said. “Maybe 77%, 78%, but even then it’s got to be a pretty good story. If the property is already at 117% (revenue-per-available-room index), there’s not much more room to grow.”
However, Rob Stiles, managing director and principal of RobertDouglas Hotel Capital Advisors, said his firm is seeing requests for high-leverage financing in the 80% to 85% range.
“Those deals are getting done, but they’re fantastic sponsorship, really good properties, with good in-place cash flow,” he said.
Little construction lending
While Bucaro said Aries has closed a handful of new constructions loans this year, they’re few and far between. Successful new development financing is typically a small deal with a local bank and borrowers that have a solid track record, he said.
“The key is having a good relationship with the lender,” he said.
He also said new-build borrowers are paying high costs for their debt, with lenders asking for “a 9 or 10 coupon,” he said.
“There’s always recourse and there’s always completion guarantees.”
De Haan said lenders are still firm on their requirements for new construction debt. Fluent concurred.
“We’re not super aggressive in pursuing construction opportunities,” he said.
What will kill a deal?
While the lending environment has loosened, there still are a significant amount of obstacles to securing a loan.
For Deutsche Bank, the main hurdle is a property that is not competing well in its peer group or a property with a need for near-term capital injection or property-improvement plan.
“Today everyone wants to have a self-contained loan that through either structure or upfront reserves, but you have to have a way to meet the PIP program,” he said.
Bucaro said low barriers to entry will kill a deal. In oil and gas markets where the only barrier is the ability to secure financing, Aries will tread carefully because an influx of new supply could break a market.
“That gives us concern when we’re refinancing a deal,” he said. “Previous sponsor issues also give us concern. If the borrower had problems and acted with integrity we can get around it; if they acted without integrity it’s going to be a problem.”
All the panelists suggested borrowers disclose before mortgage issues.
“Nine times out of 10 you ask the question and they say, ‘No, I’m clean.’ Then you Google it and their name pops up a million times,” Bucaro said. “That’s just a killer.”
Terms changing
While the private-equity experts in the first part of the ALIS Summer Update predicted a rosy near-term outlook, the lenders Thursday said volatile markets and rising interest rates are affecting lending terms.
“(Capitalization) rates are really all over the board,” he said. “It depends on the market. Seeing a 10-cap on a smaller, limited-service asset would not surprise me in the least.”
Fluent said the next six months will be a telling time period for how much new construction affects the hotel landscape.
“Lenders have gotten in this mode where they’re saying there’s no possibility of new supply but were going to start seeing it, and it’s going to change the fundamentals,” he said.
Stiles said interest rate pressure is going to become more visible between now and the end of the year and, while lenders appear disciplined, new construction could prove too attractive.
Bucaro was more level-headed, saying underwriting metrics six months from now will be about the same as they are today.
“Rates are as inexpensive as they’ve ever been. If I can put an asset to bed on non-recourse with rates near 4% or 4.5%, I’d be all over it.”