Finding Debt and Equity When Capital Markets are Constricting

What we mostly hear these days are that debt and equity providers are still very much interested in the hotel business, but are pulling back on their hotel investments. The cost of debt capital is going up as the Fed continues to raise rates, and Loan-to-Values are going down as Lenders get more cautious in the face of new supply and slowing Revpar growth across the country. Private Equity Investors are also looking to take on less risk and trading upside for downside protection, with many looking to evolve from being LP investors to being Pref Equity Investors, mostly topping off around 85 percent in the Capital Stack.

So, what’s a Developer or Sponsor to do? Well believe it or not there is a ton of capital out there looking for a home in the hotel sector. On the debt-side we have the three buckets of need, cash flowing assets, those in transition, essentially “story deals”, and new construction. Finding refinance or acquisition financing for cash flowing assets is obviously the easier path, although given how hard Lenders are looking at loan placements these days, the project still has to make sense, have a strong Sponsor. Management expertise that is suited to the asset, brand and market is also becoming more of a focus. Capital for these debt placements may be from CMBS, Life Co., Balance Sheet and Debt Fund Lenders. We are finding that debt capital for “story deals” is largely about many of the same factors, but with added attention to per key cost basis, new supply impact, brand, and how that asset plans to penetrate its comp set. For these types of deals we are mostly finding capital from Debt Funds providing Bridge Loans. On ground up construction these days the LTC is sliding back to 50 to 60 percent, almost always with some level of recourse and you better have a strong Sponsor and one of the top brands to get those projects financed. Interesting that with the perception in the market being that there are not a lot of great buy opportunities in the market right now for domestic investors, that development remains the preferred investment vehicle for many hotel developers/investors, even in the face of many markets clearly getting overbuilt. So, for developers it is all about being able to tie up the right sites and being able to deliver financeable brands, and of course the numbers have to work.

On the Equity side, everyone wants a good value-add story, but there is less of that out there, particularly as the cost of renovation and repositioning continues to rise. Many first-time investors in hospitality are looking for yield, but sometimes that can be fool’s gold, as hotels are vulnerable to new supply. I favor the cost basis test in any hotel investment as the ultimate test of likely returns and a good exit strategy. Development remains in favor as strong Developers with a track record, and access to capital, coupled with new brands rolling out daily, to be a very viable alternative to acquisitions. If the cost to renovate and reposition is approaching replacement value, you might as well build, if you have the ability to do so. Off-shore equity continues to flood the market for existing assets, particularly on each coast. Private Equity investors based here, including REITs, are keeping their powder dry for what most likely will prove to be a better buy environment in 2018, but also starting to look at Development with the right Partners.

Money for hotel Investment? Debt available? Equity available? Yes, yes and yes, but make sure you are aligned with the right team, this cycle is sure to separate the players from the pretenders.

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