INVESTMENT
BRIDGE LOANS can offer necessary flexibility
SUCCEED BY GETTING ORGANIZED , MAKING A STRATEGIC PLAN AND CREATING PRO FORMAS SHOWING RECOVERY VERSUS THE MARKET AND COMPETITIVE SETS .
Contributed by JONATHAN FALIK , JF CAPITAL ADVISORS , NEW YORK CITY
Investors often think of hotels as a real estate investment . Those that make such investments quickly learn that a hotel is actually an operating business which resides on a piece of real estate . The investment is a balancing act between market dynamics , management and franchise agreements , F & B operating agreements and leases , union agreements , local ordinances , and loan agreements .
Often , hotel acquisitions or repositionings are financed using bridge debt . Bridge debt may be in the form of senior or mezzanine financing and is designed to “ bridge ” a hotel from its current operating and physical condition to a future more stabilized operating cash flow environment , suitable for permanent or traditional financing .
Bridge debt financing will command higher interest rates , have some onerous guaranties ( especially for completion of CapEx projects ), usually has a 1- to 3-year term ( though there may be extension options ), and generally has yield maintenance or a prepayment penalty . Many investors think of interest rates associated with bridge lending as exorbitant , yet it is almost always substantially cheaper than the required or implied return on an incremental equity investment .
We recently negotiated a bridge loan for a client which owns a full-service hotel in the Pacific Northwest with banquet and meeting space , leased out and self-operated restaurants , an expiring union agreement , and a sizeable offsite parking operation . The owner was also desirous of repositioning the hotel which required a renovation and an affiliation with a major international soft brand while also needing to repay existing maturing debt .
Traditional balance sheet lenders had a difficult time underwriting the hotel given all of the uncertainty during the depths of the COVID-19 pandemic . In addition , the required conversion PIP CapEx was not fully priced out , timing for conversion was uncertain , and the ultimate renegotiation and resolution of the union agreement hadn ’ t been completed . The loan profile was a non-starter for the CMBS market as there were too many moving parts and some time before the in-place cash flow would support the debt service .
The bridge financing that was negotiated carried a high coupon rate but provided the flexibility and the ability to negotiate PIP terms , negotiate with the union , and have enough runway to reposition the hotel and take advantage of a recovering economy and a return to post-COVID normalcy . The interest rate was substantially lower than the cost of any equity capital investment and the term allowed enough time to execute the business plan and reposition the hotel , while also returning to a strong cashflow position ( which will set up the future stabilized refinancing ). The bridge loan required new equity investment by the borrower and PIP completion guarantees , but provided a CapEx reserve with flexibility on use , and a debt service reserve .
As the industry recovers from the disastrous impacts of COVID-19 , an increasing number of borrowers will be looking to more expensive but flexible bridge loans as a solution and means of refinancing . This will result from depressed cashflow , depleted FF & E reserves , brand mandated CapEx or PIP requirements , combined with maturing loans ( in many cases with deferred interest expense ).
Borrowers can best position themselves by getting organized , creating a well thought out strategic plan which includes an approach to CapEx needs or PIPs , pro formas showing recovery versus the market and competitive sets , and the ability to refinance the bridge loan in the future .
JONATHAN FALIK
42 hotelsmag . com June 2022