Driftwood Capital expects a wave of distressed assets to hit the market within the next three to six months as government funding runs out. As a result, it has launched a new mezzanine lending fund to support struggling owners, lenders and those looking to acquire.
CORAL GABLES, Florida—Since launching development and acquisition funds in February, Driftwood Capital has now launched a new mezzanine lending fund aimed at helping hotel owners and lenders who are struggling through the pandemic.
Carlos Rodriguez Sr., CEO of Driftwood Capital, said the goal is to raise $100 million for the new lending fund, which will originate loans and preferred equity positions between a range of $3 million to $50 million.
He said there was and always will be a need for lending and new developments and acquisitions in the hotel industry, but the pandemic brought on more of an opportunity for it.
Typically, hotels are organized with special-purpose entities that usually distribute all the money they have to investors, leaving them with very little excess cash, he said. When there’s a downturn lasting for several months, like this one, the SPEs quickly lose all excess cash they had “and find themselves in need of extra money to cover debt service, cover payroll and so on.”
On top of that, Paycheck Protection Program loans are becoming exhausted, he said.
“All of a sudden, the hotel owner is left with the situation where they either need to borrow more money or they need to sell in order to be able to recoup some of the capital. Otherwise, if they can’t cover the debt service … the bank will come calling and take over the asset,” he said.
As a result, there’s a “tsunami of deals coming to the market in the near future” of either owners needing to sell or owners looking for loans to save their hotels, he said. This has led to an opportunity for companies, like Driftwood Capital, who are ready to deploy fresh capital.
David Steiner, managing director of capital at Driftwood Capital, anticipates these new deals will crop up within the next three to six months as the PPP and government stimulus run out and forbearance periods expire.
The financial markets have been temporality dislocated and banks are not financing as much to hotels, leaving a gap between how much a bank will lend and how much capital the potential buyer has, Rodriguez said.
If an owner doesn’t want to sell a hotel, companies like Driftwood Capital can come in as white knights and lend the owner that money to keep the doors open, he said. If an owner decides to sell, Driftwood can lend money to the potential buyer or Driftwood Capital could acquire the asset at a deep discount.
“What we saw when we were first launching … the two funds—the acquisition and development fund (in February)—and what we’re seeing on the lending fund when we were planning it, yes, it was business as usual and yes, we were seeing all these opportunities, but, frankly speaking, the opportunities will be increasing tenfold.”
He said the two previously launched funds are doing well. In the acquisitions fund, they have two deals they are hoping to sign in the next few days. In the development fund, they are actively working on four deals.
The new lending fund already has one loan it closed on, and it is actively looking at more, he said.
Steiner said since launching the lending fund, they are now a fully vertically integrated hospitality platform with the two previous funds and its sister company Driftwood Hospitality Management that manages all its assets and also serves as a third-party manager.
There is no competition within the three separate funds, he said. They all work well together to reach a similar goal.
“We have the knowledge within the Driftwood ecosystem to go out and explore new opportunities within each of our vehicles,” he said.
Rodriguez said Driftwood Capital has so far underwritten about 140 deals in 2020 and there are still plenty of deals to be had.
Steiner said while they are seeing several deals, they have the understanding of where the market is and it’s now more a question of whether they want to play now and invest or wait to find the better deal at more attractive levels.
For example, deals they saw at the beginning of the pandemic are now coming back around but at better and more attractive metrics and credit criteria, he said.
On the hotel side, Rodriguez has seen discounts of 20% to 30% from pre-COVID-19 acquisition prices. On the lending side, Steiner said they are looking to play with a more conservative loan-to-value ratio.
“Maybe pre-pandemic, we were looking to put out financing at 75%, 80%, now we’re a little bit more conservative,” Steiner said.
Rodriguez said there will be deeper discounts in some markets than in others because some hotel types, such as conference center hotels, are hurting more than resorts and extended stay.
There’s plenty of folks who have learned their lesson from the 2008 recession and have capital on hand, he said. There has also been a lot of funds in the industry that have been raised to take advantage of opportunities that have come from the pandemic.
“There’s going to be competition, for sure,” he said.