BOSTON—There’s a simple indicator to know when construction financing is in full bloom again for hotel developers, according to Christopher Jordan, executive VP and group head of the hospitality finance group for Wells Fargo & Company. It’s all about the continued comeback of commercial, mortgage-backed securities.
“The catalyst for more banking interest in construction is when the CMBS market heats up and disintermediates the bank markets,” Jordan said during a Hotel Equity and Lender Perspectives conference session about getting large deals done. “When underwriting gets more aggressive and hotel (net operating income) cash flows can be traced to prior peaks so you can pull out proceeds and the CMBS really takes share, that’s when the bank market, by the process of elimination, gets forced into more construction lending to create revenue.”
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Archon Capital’s Barry Olson said he is beginning to hear more conversations around the country about hotel-construction financing.
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That scenario isn’t imminent, so what should the industry expect in the meantime?
“Until then, it’s still going to be limited, choppy, hit or miss,” Jordan said.
“Macro-wise it’s not heading in that direction for the banks,” said David Harris, director of global real-estate investment banking for Deutsche Bank Securities. “There’s a lot of regulation. These kinds of risks are really being frowned upon by ratings agencies.”
Construction debt continues to trickle from a nearly bone-dry tap, and lenders have good reasons to keep it that way, according to the panelists. But also there could be thirst-quenching libations in the offing for developers.
“From a risk-adjusted process, what do I need to charge for a construction loan to make sense?” said Barry Olson, managing director and COO at Archon Capital. “If I’m going to have to charge an appropriate rate for a construction loan with my book, it’s going to crush the construction loan because I’m not going to make money on it for three years. Mathematically I’m not your guy.”
“Our next fund, we might think about it but not in our current fund structure,” he added. “We’re seeing locations around the country where the conversation is out there. It just doesn’t fit for us this time.”
"How can we play in that space if we’re really trying to get 8s, 9s 10s (debt yield) for the whole loan?” said Stuart Silberberg, managing director for Starwood Property Trust. “Someone looking at a traditional construction loan with pricing in the 4, 5, 6, 7% range, A) it’s not likely to be us and, B) it’s probably a harder market to find non-recourse construction lending like that.
Sponsorship is key, but we’re not there yet. The market is getting there. There will be people who will go after yield on the construction lending side in six months or less.”
Harris said it’s a simple case of CMBS lenders getting comfortable with the idea of extending their position on the risk spectrum—and no one is sure when that comfort level will be achieved.
Cash flow determines a lot
That leaves the acquisition market as the primary driver of hotel debt. Again, NOI is king when those deals are considered and trailing 12-month performance is the governor.
“We use first-year underwritten cash flow,” said Timothy Kenny, managing director, Cornerstone Real Estate Advisers. “We’ll assume that there’s growth there, depending on what market and pent-up demand, we may use 5% growth rate. In some deals where a new owner comes in and the hotel has been mismanaged, we’ve used 7% or 8% growth rates.”
“Historically trailing 12-month cash flow is probably the chief metric, but we will lean forward, we will look at what is the business plan and in virtually all cases our clients have a well-thought-out business plan to extract value,” Jordan said.
He cited the Liberty Hotel in Boston as an example. Wells Fargo spent a lot of time with the borrower last year and the eventual loan came in at a little over 7 in-place debt yield, Jordan said.
“The hardest thing for this group is what kind of growth rate you use going forward,” Kenny said. “We’re not using the 8 to 9% (revenue per available room) growth we saw on charts yesterday (during a general session), but we want to be realistic. If you use a straight 2% or 3% growth rate, a lot of these deals you can’t get to work.”
There are other metrics in play as well.
Jordan said in addition to T12 cash flow, Wells Fargo looks at debt yield, loan per key and replacement costs as some of the other metrics in play.
“We try to triangulate between those metrics and not get singularly focused on one metric,” he said.
Harris said paying attention to what ratings agencies are saying is essential when dealing with securitized debt.
“Where we get a little more flexible is when we are using our balance sheet,” he said. “We can take a look at assets that have incredible per-key value propositions and make loans. We can write to very high loan-to-values, even 80, 85%. There’s going to be a cost to that kind of capital.”
There is liquidity out there
Jordan said there’s more liquidity in the market even though European financiers, who traditionally have been active in the hotel space, have retreated completely or provide only capital with high costs.
“Net-net there is higher liquidity,” he said. “We see more generalist real-estate lending groups out of the domestic banks dabbling in hospitality.”
That’s a good omen, according to moderator Robert Stiles, executive managing director, Cushman & Wakefield Sonnenblick Goldman.
“For borrowers, if you get more people dabbling, that’s good news,” he said.
Kenny said some insurance companies are getting back into lending B pieces and “hotel financing is typically 75 to 100 basis points wider than other loans we’re doing.”
Silberberg said the pace has picked up for large hotel deals that are more than $25 million.
“Today we see hotel deals getting done for 9, 10, 11 on the debt-yield side, depending on the type of the deal,” he said. “It’s much tighter than it was. It’s bringing a lot more hotel paper into the market … all the uncertainty that was in the last six months of the year lifted a little bit; there was a flood of hotel deals that came our way.”
He projected that approximately 40% of the debt volume SPT will engage in this year will be in the hotel industry.
