Although owners are hoping to take advantage of the latest cut in U.S. interest rates, hotel lenders, at least for the near term, are seeing too much uncertainty to comfortably make new deals or refinance old ones.
REPORT FROM THE U.S.—A decision by the Federal Reserve to cut interest rates to nearly zero typically could be expected to create a flurry of activity by hotel owners looking to buy, build or refinance. However, in this case, that’s unlikely until lenders feel more comfortable issuing more debt.
Lenders aren’t doing anything with the hotel sector at the moment amid uncertainty over how prolonged the effects of the coronavirus pandemic will be, said Peter Berk, president of PMZ Realty Capital’s hotel finance group. People aren’t going to want to travel, which is critical for the hotel industry, until restrictions loosen and they don’t have to worry about getting sick, he said.
“It’s great that they cut the rates, but it didn’t matter,” he said, referring to the stock market falling about 2,000 points the day the Fed announced its latest cut. “In the long run, it’ll be good. I think it will make our V-shaped recovery.”
When that starts to happen, though, is just a guess, he said.
Current lending environment
Commercial mortgage-backed securities AAA paper is up 150 basis points after the Fed reduced rates and new CMBS issuance has stopped, said Greg Porter, SVP of mortgage brokerage at HREC Investment Advisors. What that means to CMBS lenders is that every loan on their books is now held at a loss, he said. They would need to securitize those loans before they’re comfortable lending again, he said.
CMBS lenders are in the business of underwriting cash flow, and it’s difficult to underwrite a future trailing 12-month cash flow until there’s more certainty on when hotel business returns to normal, he said.
“They can’t sell what they can’t predict,” he said. “CMBS is the first to react, because their time horizon is 60 to 90 days before they securitize the loan. They have a shorter time horizon. They’ve got a very uncertain situation in the next 60 to 90 days.”
Bond buyers are “on strike” and won’t accept that risk, he said. CMBS for hotels is off the table for now, he said.
Debt funds specialize in bridge lending, so they’re bridging to a cash flow one to three years out, he said. Because there’s so much uncertainty of what future cash flow looks like, their line lenders won’t allow them to fund into that risk, he said.
What owners are seeking
Berk said he’s heard from a lot of clients who want to take advantage of the new rates now, but can’t until lenders are ready to make deals.
While he’s seeing some cash-out refinances, most hoteliers are looking for loans from their local banks for new development, he said.
Hoteliers looking to start a new construction project are told by the banks that while a loan otherwise might be approved, they are currently at capacity with the borrower, he said. The banks are asking for payments on existing loans to free up the capacity to loan more money, he said.
“People have new projects, shovel ready, ready to go,” he said. “The local bank is saying they’re ready to go. They want to limit their exposure, and sometimes they’re legally required to limit their exposure, to any one or two people.”
Drew Noecker, managing director of brokerage and advisory at HVS, said owners are taking a city-by-city approach to deals, as how they minimize exposure and take care of their guests is market-specific, he said.
For owners, the best thing to do in most cases is ride out their existing loans, Porter said. Those who have no option but to refinance now will be forced into a higher rate, he said. A regular non-recourse hotel bridge loan deal in January would have been 70% loan to cost, LIBOR +3.75%, but that same loan today would price at an 8.5% coupon.*
Owners who stay with an existing loan until it matures or it has an extension option can avoid refinancing at a higher rate, Porter said.
“On the bright side, we’re starting to see new and once-dormant lenders enter the space left vacant by CMBS and the debt funds, so we expect the market to evolve to meet demand,” he said.
Noecker said the next two to three weeks are going to be evaluation periods for the banks. As things begin to calm down, he said, optimism with return. There will be quality deals in markets where now occupancy might be down to 15% to 20%, he said. There’s going to be appetite for cash-flowing deals on the lender side, he said.
Once it becomes clearer how long the pandemic will last, companies with capital will come out and acquire strong assets at a good position, he said.
“That will be helped by the availability of debt at very low interest rates,” he said.
Berk added: “Once things start to gel again, I anticipate we’ll get really busy, and I have a whole list of people who want to do things and refinance the hotels and loans coming due.”
*Correction, 25 March 2020: This story has been updated to correct a statement about interest rates.