INVESTMENT
based on sales activity in the first half of 2022 and buyer expectations accounting for the current and forecast interest rate increasing materially by the time a transaction closes in 60 to 90 days . Additionally , lenders have reduced the loan-to-value ( LTV ) ratio on loans as more stringent underwriting inherently limits the purchase price of hotels .
The size of the active lender pool has shrunk as many lenders opt to remain on the sidelines and wait for a better read on the direction of the U . S . economy . Today ’ s borrowers have found themselves having to go outside of existing lending relationships and , in most cases , beyond their home market in search of active lenders . This new trend has caused an elongated transaction timeline given the longer financing contingency period .
Beyond the increase in interest rate , the execution cost has also significantly increased . The cost for interest rate cap often required for floating rate loans has increased considerably in the current interest rate environment . For the same term and strike rate , the cost has increased almost ten-fold when compared to last year . In hospitality , floating rate loans are often used to provide leverage on transitional , non-stabilized assets . Despite the strong recovery occurring in many markets and segments of the industry , many hospitality assets are still considered transitional from a loan underwriting standpoint , as they have only a limited historical operating period with a profitable bottom line .
The bridge lending sector of hospitality has been hit particularly hard . Bridge lenders will typically leverage their capital to solve for their desired investment return . With many of the A-note providers out of the market , bridge lenders are seeing their cost of capital increase , and the interest rate charged to borrowers of bridge loans has increased in turn . The combination of higher interest rates and execution costs has made floating-rate bridge products an expensive option . Without meaningful downward adjustments to the purchase price , it would almost be impossible to make a new acquisition pencil out using a bridge loan .
Given the rising cost of capital , lenders and borrowers have become more open to creative financing solutions that holistically make an investment worthwhile . Increasingly considered in the capital stack is PACE financing or ground leases , which can maximize investor returns when senior lenders are only able to contribute at lower leverage levels near 50 – 60 % LTV , down considerably from the historical average of 65 % to 70 % LTV . The lower leverage levels are typical for all lenders , including commercial banks , life companies , debt funds , CMBS ( commercial mortgage-backed security ) loan providers , and CLO ( collateralized loan obligations ) originators .
As with all deals , the details matter . Although these debt products can be used to increase the overall leverage , they also add complications to the deal . For example , when financing new construction and recently completed hotel projects , PACE financing may be a viable option ; however , this program is only available in certain markets as offered by the municipality . Furthermore , owners are only able to get additional leverage through a ground lease structure in cases where permissible by the senior lender .
Overall , when comparing the current capital markets condition with the global financial crisis ( GFC ) of 2007 / 08 , there is one stark difference . While during the GFC , there was a complete financial market
shutdown , including the credit market , in today ’ s market , there is still abundant liquidity .
Hospitality , as an industry , continues to show steady recovery since the onset of the COVID-19 pandemic . The strong growth in leisure demand and an earlier than expected return of group demand have filled most of the void from the weakened corporate travel demand .
We believe the current dislocation in the credit market will be short-lived . Lenders today are approaching new financing opportunities cautiously given the perceived headline risk . Real estate requires a long-term perspective , and in the mid-term , lenders active within hospitality should shift their perspective to focus on the fundamentals of the market , the merits of the deal , and their relationship with the sponsor .
In the meantime , despite being more expensive , hotel financing is available through local and regional banks , private lenders , investor-driven debt funds and CMBS originators .
60 hotelsmag . com Jan / Feb 2023