At Luxury Hotel Advisors, we find that while price is not always a dominant factor in making a hotel investment, high net worth individuals and family offices are seeking investment returns. In some cases, they have a longer investment horizon which provides greater flexibility in asset positioning, marketing and operational strategies to achieve maximum investment returns.
While these investors may be very savvy in other industries, luxury hotels can present a unique and challenging opportunity as these assets are not simply a real estate investment but also an investment in an operating business. The capital structure used to finance a hotel acquisition will be critical to maximizing investment returns.
Capitalization
Although high net worth individuals and family offices may have the financial resources to pay all cash for acquisitions and improvements, in order to optimize the investment and return on their equity, investors may want to consider financing the acquisitions and capital improvements with some debt financing. The amount of debt should be determined on the property’s ability to meet all debt service requirements.
This is usually calculated based on the principal loan amount, interest rate, coverage ratios required, and the net cash flow generated by the property. Current debt markets are much tighter and interest rates higher as inflation concerns continue, but there is availability for quality assets and strong borrowers.
The metrics most important to lenders in underwriting, sizing, and pricing hotels loans is location and quality of asset. Other factors include the borrower’s experience and track record, liquidity and strength of balance sheet and source and mix of demand for the property. As the hospitality industry is still recovering from Covid, construction lending markets are the most constrained.
Sources of Lending
Some commonly uses hotel mortgage options include:
Conventional – These are loans offered by conventional lenders like banks, savings institutions, or credit unions. Terms typically run from 3 to 10 years with amortizations up to 25 years. This can be especially attractive for smaller hotels with qualified borrowers.
Conduit/CMBS – These loans are securitized by a first-position mortgage on the hotel and are generally best for hoteliers with large, branded hotels or resorts. They are offered by commercial banks, investment banks, or conduit lenders. These loans tend to have more flexible underwriting guidelines and offer a fixed interest rate and standard amortization from 25 to 30 years.
Insurance – These loans are offered by life insurance companies and can go up to hundreds of millions of dollars. Underwriting standards are very stringent but offer competitive interest rates. It is only for well-established, low-leveraged hospitality properties in primary markets with loan amounts generally in excess of $25 million.
SBA – These loans are offered by lenders in partnership with the Federal Government Small Business Administration, who guarantees a large portion of the mortgage. Interest rates, terms and amortization schedules can range substantially depending on the program, underwritten cash flow, whether branded or independent, and the property location.
Hotel Lending Guidelines
Lending guidelines may vary between different types of loans and different lenders. However, there are some standard guidelines in place for most forms of commercial hotel loans. Net Operating Income is especially important in determining if the financing is possible and, if so, the total mortgage amount.
It is used for the calculation of debt/service ratio, debt yield and ultimately the valuation of the property once the appropriate cap rate is applied.
Other common metrics reviewed by lenders include Revenue per Available Room (RevPar), Average Daily Rate (ADR), property occupancy over the last few years, and the total cost basis in the property. Loans may be either on a Non-Recourse Basis or Recourse Basis, although the underwriting criteria for Non-Recourse loans will be much stricter.
A banker, investment banker or mortgage banker can assist you in finding the most suitable lender and type of loan for your hotel acquisition. For more articles on hotel investment and ownership, visit LHA Articles.