opportunity to fill an important gap in the hotel financing space as a source of “ rescue capital ” to an industry desperately in need .
The mezzanine financing and preferred equity lending space was and continues to be a unique space for providers who concentrate on specialized asset classes such as hospitality . With many traditional lenders either on the sidelines or capped at historically low proceeds levels , a sizeable gap ( 20 % to 30 % of the capital stack ) emerged for debt funds and alternative lenders to provide attractively priced , riskadjusted loans , generally in the US $ 5 million to US $ 75 million range , to meet borrowers ’ desired leverage levels . ( For those who are unfamiliar , mezzanine and preferred equity financing are similar in that they are both subordinate to senior debt , but the legal rights that accompany each vary slightly .)
There are a range of scenarios in which one sees these loans in high demand – it could be a traditional refinance , acquisition , recapitalization or construction loan for example , or a hotelier may need a cash infusion to handle cost over runs to complete a new development .
Mezzanine debt / preferred equity investing in commercial real estate has been an established industry for more than two decades . Mezzanine debt is a financing vehicle that typically serves as a bridge between a project ’ s senior loan and the equity within a capital stack . The mezzanine debt position is subordinate to the senior loan and will bear losses ahead of the senior lender . In 2006 and 2007 , senior debt was readily available up to 80 % LTV , and mezzanine debt was available at up to 90 % LTV or greater .
In the most recent economic cycle ( 2010 – 2019 ), senior loans generally provided proceeds up to 70 % LTV , and mezzanine debt generally filled the gap from 70 % to 85 % LTV , depending on risk profile and asset type . As the market reformulates post-COVID , senior loans are now sizing at or less than 50 % LTV , resulting in a wider gap between senior debt and equity . This historically large gap provides an even greater opportunity for mezzanine lenders to supply capital at high yields while maintaining relatively low LTVs . Loan duration has remained consistent with loan terms generally ranging between one and five years , typically coterminus with the senior loan .
Borrowers generally find mezzanine debt / preferred equity attractive , as it has the potential to enhance equity returns while being less restrictive relative to senior debt . In addition , mezzanine debt reduces the equity requirement and is a lower cost of capital for borrowers compared to seeking additional equity . Borrowers often prefer mezzanine debt to additional equity from joint venture partners , as mezzanine debt allows borrowers to retain sole control of a project all “ upside ” of the underlying asset . The use of mezzanine debt also allows a borrower to target larger transactions and be more competitive in terms of pricing with a lower weighted average cost of capital .
Where we have been extremely successful is providing full-stack solutions for hotels that either opened right before or during the pandemic that still need time to achieve stabilized performance .
Last year , for example , we provided along with a life insurance company approximately US $ 206 million in total financing at a weighted average interest rate of LIBOR plus 500 basis points to four newly built Hyatt hotels in California and Oregon to facilitate a partnership buyout and refinance the existing construction .
Another reason this niche exists is that traditional senior lenders like banks and life insurance companies tend to shy away from hospitality and will only lend if their position is credit-enhanced by a subordinate lender with operational knowledge in case issues arise along the way .
Looking ahead , we are encouraged by the fact that consumer travel demand has hit record levels , and have already seen some markets return to nearly pre-pandemic performance . Our expectation is that we will see strong fundamentals return as soon as the third or fourth quarter of this year . But a full recovery of the hospitality sector is likely still a year off , and labor shortages , inflation , and now rising interest rates suggest that the recovery may be a bumpy one as well .
For this reason , we anticipate that there will continue to be heightened demand for mezzanine loans and preferred equity in the year ahead as the hoteliers continue to get their footing in a post-pandemic world . Our advice to them : seek a capital partner that is well capitalized , has operational expertise , and can offer flexibility in terms to structure the deal to give the borrower ’ s maximum benefit .
June 2022 hotelsmag . com 33