Search

×

Ground-up or rehab: Will your lender have the final say?

Hotel investors and developers are faced with an interesting decision about where they will be putting their investment dollars in the coming years. With lenders either exiting, over weighted with construction loans, or being far more conservative, investors and developers seek to acquire more underperforming existing hotel or adaptive reuse properties.

If a market is not over saturated with keys and the land is priced right, there are still construction projects that make good economic sense. The risk associated with new construction is the overall consensus by hotel experts that RevPARs and ADRs have peaked and that top end revenue could be impaired going forward. The days of calling up your relationship lenders and them falling over themselves to provide a 75% to 80% of cost construction loans are a fond memory. In addition, given how conservative the banks have become on lending on flagged hotel properties, (typically 50% to 60% of cost) sponsors are forced to put in or arrange for higher levels of equity or construction mezzanine debt. This additional equity and mezzanine debt is eating into the profitability on new construction transactions.

With hotel construction lenders recent conservatism, a group of lenders have stepped into the breach to provide developers an interesting alternative for their to-be-built flagged hotels. These lenders are providing non-recourse construction, except for completion guarantees, loans from 65% to 75% loan-to-cost. The lenders are being paid for taking on the higher leverage risk, typically 700 to 750 basis points above 30-day Libor. You maybe asking yourself, “Why would a developer pay the freight for the additional loan proceeds?“ Two reasons: First, many developers do not want to carry that much recourse debt on their balance sheets. Second, by packing those additional dollars into the debt stack and paying debt returns, it translates into far greater profitability for the project than paying equity returns on that capital. Lenders in the U.S. who are in this space are seeking loans nationwide from US$25 million to US$150 million.

Acquiring mismanaged or under capitalized hotel assets is a very competitive market place because the scarcity of quality transactions. Availability of these properties may become more plentiful in the coming months based upon an oversupply of keys in a market and sponsors who had cost over runs and do not have enough capital to finish there projects. These hotels are so highly sought after because of the price per pound theory of investing. If the property can be acquired at the right basis, plus all interior and exterior renovations and FF&E upgrades, an investor can be in at the right price per key and engineer a very profitable investment.

Unlike a construction project, which takes three years to stabilize, a renovation of an existing hotel can be done in 12 months. The shorter stabilization of the renovated asset provides cash flow sooner to the sponsor. On a national basis, we are seeing more adaptive reuse projects whereby developers and investors are buying office or industrial properties and turning them into hotel properties. The challenge for the sponsors of these projects is that it is not always easy to find a property that can be converted into the specification of what the flag requires.

The lenders in the renovation and adaptive reuse market are extremely aggressive now. With properties that have strong barriers to entry locations, good sponsorship and overall tight occupancy numbers, the lenders will loan from 70% to 80% of cost, (cost being defined as purchase price, all renovations and normal closing costs) two to three year terms, extension options, flexible prepayment, non-recourse at interest rates ranging from 4.25% to 5% over 30-day Libor. Loans considered are US$7 million to US$250 million and can close in as little as 30 days to accommodate quick close acquisitions. The lenders are sizing the loans based upon an exit debt yield of 11.5% to 12% on the third year stabilized net operating income number.

Ground up or rehab? Let’s hear what the lenders have to say.

 


Contributed by Steven Hamermesh, CEO, Clearview Realty Finance, Santa Monica, California

Comment