Judging by the volume of calls and emails I receive from developers looking to build new hotels, you would think it was 2006. Fortunately or unfortunately, it is 2011. Construction financing is scarce, and debt for refinance and acquisitions rules the day in the world of hotel finance.
More than 80% of commercial real-estate loan closings this year have been for the refinancing or acquisition of a property. Most industry analysts don’t expect debt for development to return in earnest for another two to three years. What hotel owners, operators and developers need to understand is why financing for new development is not more available and why now is the time to refinance or buy.
Little construction financing
Many hotel developers own good land that they are eager to put to use. Labor is relatively cheap and it seems like the right time in the hotel cycle to get new product ready to take advantage of increased demand once the industry is in full recovery. But the future-looking perspective of the developer is at odds with the current view of a lender. Borrowers are talking about demand one or two years out while banks want to look at the numbers today. This is why it is often difficult for the two sides to have a meaningful conversation in a down market.
In addition, there are several other reasons preventing construction financing from flowing more freely:
- Demand. While demand is improving, it is not overwhelming supply. Industry data and forecasts support modest growth—STR forecasts occupancy for 2011 and 2012 to be less than 60% (58.5% and 59.5%, respectively), and the U.S. Travel Association predicts only a 1.8% increase in total domestic person trips for 2011. With US$4 a gallon gas in some areas prompting travelers to cancel spring break trips and rethink summer vacations, lenders aren’t ready to loosen the purse strings for development projects.
- Supply. The U.S. hotel market is still in the process of absorbing the more than 480,000 new rooms that came online between 2007 and 2010. Many of these properties are not yet stabilized because of the impact of the economic crisis on demand, suppressing the need for new supply.
- Existing debt. Lenders still are dealing with many maturing hotel loans. Coupled with the US$18.5 billion in commercial mortgage-backed securities maturities between now and the end of 2012, there is not much appetite for new development. Banks are focused on trying to free up their balance sheets by a) getting strong borrowers to refinance or pay down principal and b) modify or sell distressed loans. While the secondary market has returned, it is not as robust as in the past, meaning many lenders will be focused on the above for a while, limiting the availability of capital for new projects for another two to three years.
- Cost of materials. While labor may be less expensive in this economic environment, lenders and developers know the high price of oil drives up the cost of materials, making new construction a less desirable way to deploy capital, especially with the plethora of available refinance and acquisition opportunities.
Buy or refinance
Because of the lack of financing available, smart developers are looking at others ways to grow their business. According to Lodging Econometrics’ 2011 U.S. Real Estate Trends Outlook Report, new projects are at a low not seen since 2004 and will remain that way into 2012. Furthermore, scheduled project starts have decreased by 15% with developers pushing projects in the pipeline from schedule starts in the next 12 months to early planning.
Instead, the availability of debt for refinancing and renovation has hoteliers implementing delayed property improvements and brand refreshes. Brands are offering incentives for owners and franchisees to upgrade to new standards or design schemes. In this environment, renovations should be considered before contemplating new builds.
In addition, the improved performance of the sector has developers looking to cash out through the sale of properties, and others are looking to acquire assets while prices are still relatively low. According to HVS’s 2010 Survey of Major and Mid-Market U.S. Hotel Transactions, the number of deals nearly doubled from 2009, and Lodging Econometrics states the number of hotel deals in the first quarter of 2011 is on about the same pace as the first quarter of last year. With financing available for acquisitions, more deals will continue to get done, with some prognosticators forecasting at least US$13 billion in deal volume this year.
For owners looking to create something new, consider acquiring unique or older properties in good locations to convert or re-flag. Financing for conversions is easier to get done than ground-up construction.
Act now
For owners with cash, now is the time to act. Lodging Econometrics reports hotel prices have rebounded during the past six quarters, and buyers, especially those in top markets, are paying premium prices. These primary locations are quickly becoming seller’s markets, with better deals to be found in secondary and tertiary areas. While some deals have approached 2007 levels, most properties are still available for less than peak pricing.
Before making the rounds with a development deal, consider the lending and overall economic environment. Look at your portfolio to see if there is a way to deploy capital through property improvements or renovations. Consider refinancing to unlock money for a refresh. If you want to add to your investments, review acquisition opportunities. Savvy investors understand that if you can purchase an asset for 20-30% less than replacement cost, it’s better to buy, not build.
So put away the hard hats. Now is the time to seek financing for a refinance, renovation or acquisition. It’s not time to build.
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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