Strict underwriting standards rule the day

As the national economy slows, a decline in hotel development is becoming more apparent. Hotel lenders have tightened their belts and are extremely picky about the projects they are willing to finance. Wall Street perceives the hotel market as somewhat overbuilt and generally more risky than other asset classes.

However, most properties are still performing quite well, particularly the mid-price sector. This hotel segment is benefiting because there is a significant amount of “trading down” taking place, especially in the business travel sector. Many large corporations are asking their employees to save money by staying in hotels a tier below what they are used to. For example, a former Marriott Courtyard visitor may now be staying in a Fairfield Inn by Marriott.

The current climate for hotel lending is extremely tight as new construction funds are hard to come by and available only at low loan-to-cost ratios and above-average pricing. It is difficult to obtain financing unless the hotel is a top brand such as Marriott or Hilton and is in a great location. Even refinance dollars are hard to obtain. Hotel developers will find several cities perceived by lenders as overbuilt and therefore “off-limits.”

In short, lenders are seeking lower exposures and lending money only to top-tier branded properties. To attract public or private capital, developers and operators need to produce superior returns on invested capital by optimizing rate and occupancy, carefully monitoring operating expenses, marketing creatively and aggressively, building only in slam-dunk locations and affiliating with the best brands.

Private capital still dominates the market for hotel equity. There is some institutional capital available, but only for very high-profile, large deals in prime locations. Most individual hotel deals are too small for the larger funds. Therefore, the funds are developing entity relationships with established developer/operators to close multiple deals.

Fairfield, Calif.-based Presidio Hotel Group is in the process of closing an 80-room Hilton Garden Inn in Napa, Calif. Presidio had a $12.4 million budget and received senior financing from a regional investment bank in the amount of $8.1 million and raised $4.3 million through a private syndication. The senior loan was priced at 9.25% and two points paid upfront. The four-year loan is a construction loan for one year and then converts to a three-year, mini-perm deal. The minimum return to equity was 15% plus a good slice of the upside.

The company was able to obtain financing for this project because of an exceptional location in a market with high barriers to entry. Napa is a world-class destination within driving distance of a still-vibrant San Francisco Bay Area economy. The Hilton brand is one of the strongest in the hotel industry, and the Hilton Garden Inn is an upscale product that can accommodate both leisure and corporate traffic. Furthermore, the Napa market is undeserved by upscale flagged hotels and is a difficult place to obtain approvals.

Hotel lending will not pick up until an economic recovery is in sight. We are living in a climate in which corporate earnings are declining but the consumer continues to purchase at pre-recession rates. Institutions are wary and will wait until they see a bottom to the current down cycle. We may have to go through several painful quarters. In the intermediate term, the discipline of today's lenders will constrain supply and benefit existing owners.

Edward R. DeLorme is principal and director of capital markets for Fairfield, Calif.-based Presidio Hotel Group LLC.

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