Editor’s note: This is the first of four articles from the International Lodging Finance Council roundtable discussion held at this month’s Meet the Money conference. Coming Wednesday: Participants talk hotel values.
LOS ANGELES—The re-emergence of commercial mortgage-backed securities and the fact that there are lenders playing in the hotel space again are the two biggest changes in the hotel-lending environment in 2011, according to experts participating in an International Lodging Finance Council roundtable discussion held at this month’s Meet the Money conference.
Warren de Haan, chief originations officer and managing director for Starwood Property Trust Management LLC, said it’s refreshing to see lenders paying attention to potential borrowers who want to invest in existing hotel assets.
“Certainly the resurgence and the appetite for the CMBS marketplace to want to do hotels again at the senior mortgage level (is a big change),” de Haan said. “And the second change is the appetite and desire of sub-debt buyers to look at the hotel asset class again, to believe the hotel upside story again, and to also underwrite into assets where there is a clear disconnect between value and cash flow.”
Upper-end assets need a story
De Haan said on many upper-upscale and luxury hotel assets, there’s a significant disconnect between the cash flow and the value, which further necessitates the need for a lender who sees the fundamentals of the industry improving over time.
“Whereas prior to this you’d be thinking about (capitalization) rates in the 7% to 8% range, and we’re seeing cap rates inside 5%,” he said. “So from a financing perspective, if you’re trying to get to 70% or 75% loan-to-cost, logically you’re then going to be looking at debt yields or implied cap rates that are at levels that they historically haven’t been, or lower than they’ve historically been. So in order to get transactions done, you have to lean in and believe that the hotel story is here to stay for a while.”
Stefani Turner, VP-relationship manager with Wells Fargo Hospitality Finance Group, said her bank is dipping its toes back into the hotel-lending waters.
Wells Fargo Hospitality Finance Group
“We are willing to lend specifically on hotel assets,” she said. “It’s a somewhat well-defined box, if you will, but in most cases we are willing to lend into a repositioning or flag change—some kind of story. So I think that just in and of itself is a fundamental change enough to actually get some capital flowing back into it.”
Turner works on the balance-sheet side of the business, but said Wells Fargo’s CMBS experts are becoming more active.
“I’ve been successful in referring our customers where they may have an asset that they’re looking to place longer-term debt on that our CMBS shop has taken in and underwritten,” she said.
De Haan said it’s important to separate balance-sheet lending from CMBS lending because they are completely different animals. The peak-to-valley-to-gentle-sloping-uptrend in CMBS lending puts it in a unique spot in today’s market because more money enters the arena every day, he said.
“On the CMBS side, depending on the quality of the asset and the market it’s in, the tightest loans that we’re seeing are getting done on a trailing-12 basis, underwriting tightest, this is really the tightest, is 11, 10.5, 11, for a top-quality asset in a top-tier market,” de Haan said.
Rob Stiles, executive VP with Cushman & Wakefield Sonnenblick Goldman, and co-chair of the ILFC, said managing expectations is the key.
“It's going to be interesting to see what happens, but I don't think any of us in the last 15 years have seen a 10-cap for a gateway city, luxury, full-service hotel,”
Bruce Lowrey, managing director at Rockbridge Capital, said those types of trophy assets comprise a relatively small number of hotels in the United States, and the owners of midscale properties aren’t sure what to take away from announcements that luxury hotels are selling at high prices.
“Most people in this business own Holiday Inns, Hampton Inns and things like that,” he said. “That's my question: Are you seeing what's happening in this? I am confused, unclear as to how much credence to give to a transaction that happens at a Four Seasons or a JW (Marriott) in San Francisco—trophy asset, gateway city, 100% real estate—and how you say, 'OK, here's the metrics on how it was bought and sold and financed and where we think it's going to go and how much intrinsic long-term value there is,' and the ability to translate that (comparison), if you will, to a broader segment, and I'm just not sure that those things hold up.”
“I’m not sure it translates well,” Stiles said. “It's absolutely clear today there's a complete bifurcation of the business. Lenders are focused on gateway markets, full-service, luxury assets—and there are a lot of those assets.”
Stiles added that the majority of assets are limited-service properties in secondary and tertiary markets—and those have yet to start trading in meaningful numbers.
De Haan said SPT isn’t afraid to go to those markets, but the keys are monitoring potential new supply and the overall economic health of the market.
“The people around this table could probably figure out how to put up a select-service hotel in some market in about 15 minutes, buy the land for really next to nothing and work our way into something that's fine. So there's a new supply issue,” he said. “The other part of that is you have more visibility into the stronger markets and can figure out the supply/demand dynamics. A lot of the tertiary markets are really driven by one driver of demand and if that goes away, you're done.”
However, because limited-service hotels weren’t hit as hard during the recession as the luxury segment was, cash flows haven’t been as impaired, de Haan added.
“You typically will see more cash flow, better debt yields coming off of the select-service, limited-service assets, but the further up the spectrum you go, you see a larger disconnect between cash flow and value,” he said.
Mike Armstrong, principal with HREC, said the definition of premium brands changes in tertiary markets. Brands such as Courtyard by Marriott and Hilton Garden Inn are considered premium brands in those markets, yet lenders haven’t been beating down the doors to finance them.
“Major markets have more visibility,” Wells Fargo’s Turner said. “You can get more comfort with that. But really on the luxury side, we're not really looking to lend on luxury hotels that often because they can have the higher operating leverage and frankly have more risk because of that as well as the lower going in debt yields. So we're really not driven by the luxury assets either.
“We're looking for the good strong brands that are the right brands for the market that they're in that are managed well,” she added.