Editor’s note: This is the second of four articles from the International Lodging Finance Council roundtable discussion held at this month’s Meet the Money conference. Read Part 1: “Big changes spark lending debate.” Coming Thursday: CMBS loans aren’t a good fit for everyone.
LOS ANGELES—Establishing the value of a hotel hitting the trading block has never been an exact science, and it’s gotten even tougher in the post-recession global economy.
Patrick Feltes, senior VP for hospitality finance and franchise finance for GE Capital, said during an International Lodging Finance Council roundtable discussion that establishing the value of a hotel is “probably our biggest challenge.”
“The old days of having (a company) do an appraisal, hand it to you, throw it on the desk, it says 65% (loan-to-value ratio) and you just go with it are long gone,” he said.
Patrick Feltes, GE Capital
A tricky road
The roundtable, held in conjunction with the Meet the Money conference earlier this month, revealed lenders still require appraisals for hotels involved in any transaction, but the road to those appraisals is more treacherous than ever.
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“We’re all in the same situation,” Feltes said. “You may have 1.6 cash-flow coverage on a (capitalization) rate basis, it’s 6% to get to the values you’d need. This is not a 6% market, and trying to get the folks we need to underwrite these things, it’s very, very difficult to move that stone, so to speak.
“We’re trying to redefine evaluation. We’re looking at things like replacement costs, for example, as well as focusing on that cash flow. Not so much the cap rate, but on cash flow itself.”
Feltes said the most basic definition of a cap rate doesn’t include it being an evaluation tool, so the emphasis on that when valuing a hotel could be overblown.
“If you get to the heart of it, you go back to your Finance 101 textbook, it’s simply an interest rate that values the cash flow into perpetuity. Period,” he said. “And it doesn’t even account for any kind of appreciation of that cash flow going forward. It’s a simple cap rate. It’s telling you that you’re going to get that same cap rate on the exact same cash flow every year in perpetuity.
“And no one, if they’re given that explanation, would ever say that’s an evaluation tool. Yet our business is so hung up on it that it’s very difficult to unlock that notion from even the underwriting folks and the risk folks who ought to know better, quite frankly. So we’re trying to redefine it by looking at straight cash flow, looking at replacement costs.”
Stefani Turner, VP and relationship manager with Wells Fargo Hospitality Finance Group, said there are other ways to view the value of a hotel.
“The other thing we look at is just the per-key amount of the loan versus the per-key amount of the equity going in. Is it a well-capitalized transaction?” she said.
“It’s virtually the same thing,” Feltes said. “We look at replacement costs versus dollar per key. But it’s a moving target these days.”
Warren de Haan, chief originations officer and managing director for Starwood Property Trust Management LLC, said the meaning of appraisals is relative based on the cycle during which they were conducted.
“It’s really interesting to watch human psychology go from appraisals that were getting done in 2006 and 2007, and even then you look at them and you go, ‘This is not even possible.’ It’s out of the realm of anything, even on your best day,” he said. “Then you go into 2008 and then you get these appraisals and you look at them and you go, ‘That is completely out of the realm of anything.”
“The pendulum always over swings,” added Rob Stiles, executive VP with Cushman & Wakefield Sonnenblick Goldman, and co-chair of the ILFC.
“It does over swing, so you sit on two sides of it,” de Haan said. “Now we’re back to a spot where we’ve gone from a complete bear market, borderline depression, to a bull market again.”
SPT focuses on market intrinsics, the sponsor, the flag and new supply when it establishes its internal value of a hotel, de Haan said.
“We’ve seen such a swing, and the swings are complete opposites, so there’s almost no normalization in that equation,” he said. “But, you know, the truth is, we also need to look to the market itself to see where assets are trading. You have to bring that into consideration, too. Where are we in the universe of acquisitions of hotels? There was no capital for it, and now there’s way too much capital for it.”
The rush of liquidity into the hotel market further exacerbates the problem because assets can trade at inflated values based on the vast amount of equity waiting for quality hotels to come to market. So, while keeping an eye on market prices is wise, it’s not the end all, be all when it comes to valuations.
“It’s interesting, and it’s a data point, but really, valuation and market-clearing price are actually two different things,” de Haan said. “We really are trying to get to a true intrinsic valuation as opposed to a market-clearing price.
De Haan said SPT’s approach also includes comparing hotels targeted for acquisition or disposition with similar assets previously financed, acquired or sold.