As 2011 begins, most economic experts are in agreement that the United States is not headed for a double-dip recession and that we are in a sustained, albeit slow, recovery. Hotels are expected to show significant gains in performance with Colliers PKF Hospitality Research predicting a 3.3% increase in demand, an almost 4% increase in average daily rate, a 2.2% improvement in occupancy, and revenue-per-available-room growth of more than 6%. Recent data reported by STR shows year-over-year gains in occupancy, ADR and RevPAR for the fourth week of January.
Hotel lending still not robust
With good news in key performance metrics, why isn’t there more liquidity in the capital markets? While lenders like to see this type of directional data, there are several factors holding back robust lending including the almost US$300 billion in commercial real estate loans set to mature this year, the many institutions with non-performing loans still on the books, slow growth in employment and rising oil prices. Another factor is hotel commercial mortgage-backed securities delinquency. According to Trepp’s 5 January 2011 report, hotel delinquency was 14.31% in December 2010, and although this is a 25 basis-point drop, it is still the second worst performing asset class after multi-family.
Hotel financing—what to expect in 2011
If securing debt continues to be a challenge even in light of improving industry fundamentals, what should hotel owners and developers expect as they bring their projects to the capital markets in 2011?
1. More available debt—More and more lending will slowly become available. Financing for top-tier, name brand, stable property types anchored by experienced owners and operators will continue to be the easiest projects to finance. Properties in the mid to lower tier and in secondary and tertiary markets will gain more access to financing but will need exceptionally strong owner/operators with an excellent track record of success. The 5% rise in U.S. business travel spending estimated by the National Business Travel Association should help boost hotel performance and lender confidence in the asset class. In addition, as the economy improves and more jobs are created, debt will be more readily available to a broader range of borrowers.
2. Focus on refinancing and acquisition—Lenders will continue to focus on providing debt for acquisitions and refinance. With many new properties that came online after the peak not yet stabilized and the large number of maturing hotel loans that need to be refinanced, new construction lending will be almost non-existent. The appetite for acquisition deals among lenders will remain strong. For those interested in expanding their portfolio or investing in the hotel sector, the current environment presents a major and rare acquisition opportunity. In their October 2010 Market Perspective, Prudential Real Estate Investors predicts “unless the economy is sub-par, hotel performance should be solid for several years.” Improved performance means higher prices. In the near-term, there will not be better prices than now for hotel assets, and the availability of financing for this type of transaction makes acquisitions even more appealing.
3. Continuation of tighter underwriting—With many loans about to mature and non-performing ones still on the books, hotel deals will still be subject to strict underwriting standards. The best terms will continue to go to the projects with strong brands, sponsors and management teams; in urban locations; with cash being brought to the table. (See the 5 October 2010 article “5 new normals of hotel financing” for more details.)
4. Increased CMBS activity—After being left for dead in 2009, CMBS showed signs of life in 2010 with US$16.1 billion in issuances across asset classes. More lenders will be returning to the market and some are forecasting CMBS to reach as high as US$45 billion in 2011. The portion of these loans comprised of hotels will be small at first, but as the sector continues to recover it will grow. Underwriting for hotel properties will be strict. Properties will need to have in-place cash flow, loan-to-values between 60% and 70%, debt service coverage as high as 1.75x and debt yields of at least 12%.
5. Growth in non-recourse—Non-recourse lending will grow after about a two-year absence. The re-emergence of CMBS loans will be a major driver. As hotel performance continues to improve and property values increase and stabilize, more non-recourse debt will be available.
6. Rise in fixed rates—The availability of fixed-rate financing also will be driven by CMBS activity. In addition, fixed rates will be available to pristine projects in strong locations with low LTVs. As the economy and hotel fundamentals improve, and as some lenders become more aggressive, others will follow and fixed rates will be offered to more projects.
While hotel lending is nowhere near what it was at the peak, things are improving. 2011 is expected to bring continued improvement in performance and a slow increase in the availability of debt to a broader range of borrowers. Now is an excellent time to refinance. If you’re considering expanding your property portfolio or investing in the hotel sector, there is no time like the present to acquire a hotel, as prices are low and acquisition financing is available. As 2011 begins, we forecast brighter days ahead for hotel finance.
Jane Larkin is managing director of Larkin Hospitality Finance, a national hotel investment-banking firm focused exclusively on meeting the debt and equity financing needs of hotel owners and developers. She can be reached at jlarkin@larkinhf.com or (469) 916-8518.
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