Key money, alternative financing close the funding gap
Key money, alternative financing close the funding gap
01 JUNE 2017 7:27 AM

Developers tap brand incentives and alternative financing methods as a way to get new-build projects done.

REPORT FROM THE U.S.—At a time when finding funding for hotel projects can be a challenge, hotel brands eager to expand their presence are offering incentives to developers to grease the wheels and help get new-construction deals done. And when that’s not enough, alternative funding sources like EB-5 lending are filling some of the remaining financing gaps. At least for now.

Multiple brands are currently offering developer incentives, but generally speaking, the younger, less-established brands are the ones most active in the space.

One example is Best Western Hotels & Resorts, which recently made changes to its bylaws and membership structure that now allow the company to develop, own and operate hotels. It is offering developer incentives for the first time ever, primarily to fuel growth of its recent Glo, Executive Residency and Vib brands.

“We look at incentives as a way to kick-start some of these new-construction brands, particularly Vib,” said Michael Morton, VP of owner relations at Best Western. “Where this has really helped us is where we don’t have a presence in primary, urban destination gateway locations. We knew we could go into markets like Chicago, Miami and LA, and because we didn’t have representation there, it would be easy for us to go and say to a developer, ‘Look, we know we have high demand here and we’re underrepresented, so you’ll get real good support, distribution and contribution from the brand.’”

Some of the incentives Best Western is offering include discounts on fee percentages, potentially for periods of one or two years, he said, as well as key money, equity positions and/or “very low interest” mezzanine loans. The incentives generally apply to new-construction products for the specific brands Best Western is trying to grow, while the strategy is to focus on select, key locations, rather than mass quantity.

“For us, we’re not looking to go out and start 50 projects and feed those,” Morton said. “We think if we can do the right ones in those right markets—10 or 12 of them—that’s a pretty good start for us, and it gives us distribution in those markets that we want to be in. We’ve looked at allocating roughly $20 million to $30 million of reserves and using that to feed this.”

Choice Hotels International is making a similar incentive push, aiming to drive growth of its Cambria brand, its dual-branded Sleep Inn/Mainstay Suites product and the new Truly Yours prototype for Comfort Inn. Company representatives said the franchisor is more than willing to get creative with developers in order to help get these properties built.

“We’re doing it through multiple opportunities, whether it’s through JV partnerships, or we’ve done some mezzanine lending and we’ve done key money,” said David Pepper, chief development officer for Choice Hotels. “On top of that, we are looking to help our developers with lending sources. We’re working on a couple projects where we hope to have new-construction financing sources available for some multi-unit developers to go out and build, mostly in the Cambria development world.”

For hoteliers, such incentives can be just what they need to push a deal over the edge. According to developers who spoke with Hotel News Now, incentives are frequently necessary to get new-construction projects done these days, as well as the entire realm of alternative financing methods.

“We’ve done a few deals where we got key money. Without the key money, the deals worked, but the key money is what took it to being feasible,” said Jatin Desai, chief investment officer of Peachtree Hotel Group. “It worked in our mind, but the key money was really necessary to make it pencil enough to do the development and take some risk off the table. In some cases where you’re not able to get key money, you can get credit enhancements.”

But with a new president in the White House and potential tax code and regulatory changes on the horizon, many wonder if the nature and availability of alternative financing methods will remain favorable in the coming years. This is particularly true when it comes to EB-5 lending, which essentially grants EB-5 visas to foreign companies who invest at least $500,000 in U.S. projects employing 10 or more workers here. China, India and Mexico have been widely active in the program, but some believe new policies might at least somewhat change those kinds of investments in the future.

“EB-5 has been on the floor for a long time to be redone. Every time it comes to the vote, they keep on extending it,” Desai said. “Looking at the political environment, our president uses EB-5 [in Trump developments], so I don’t think they’re going to get rid of the program. But they might change the parameters.”

Tax code changes may have a specific impact upon key money in future deals, sources said. Both Best Western and Choice are frequently using key money incentives for new-construction projects, and Best Western’s Morton explained the party affected by a potential tax change—either the brand or the developer—will ultimately determine the impact of such a change to the overall pool of key money deals in the works.

“My understanding is that the way the key money incentive is going to be taxed will change in 2018. I don’t know the specifics on it, but I’ve heard that,” Morton said. “If that changes dramatically from the way the brands are taxed on it, then you’ll see a significant change in the way all the brands are offering key money incentives. If it’s the way the recipient of that key money is taxed, that would also change it. It really depends on if the tax impact is going to be on the recipient or the brands.”

Others noted that although one financing window might close, others could potentially open. While the status of EB-5 and key money could change for the worse under new regulations, the kind of aggressive tax cuts being proposed by the current administration could more than make up for the loss of these incentives.

“Tax reform could be huge for our developer. If they really do what they say they’re going to do with the tax cut, it could be a real windfall for our owners,” Pepper said. “Right now, they’re getting taxed at 35% to 39%. If those rates go to 15%, there’s going to be a lot more profitability for our owners. That puts more money into their pockets to go out and do more projects.”

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