08 Jul2013

Q&A on New Hotel Construction Financing (Angelo Stambules, Capital Markets)

Recent volatility in the capital markets has resulted in rate adjustments of between 75 and 125 bases points.  To this point however, the availability of capital has not been disrupted.  Lenders remain open for business, borrowers are still able to secure financing below the historical norm and we continue to experience a rising volume of inquiries for development financing.

Who is providing construction financing? To-date, the large commercial and regional banks have been the primary sources for construction loans on the larger in-fill suburban and urban projects. These lenders are typically looking at minimum loan amounts of $10 million.  Another source of financing for large, urban hotels has been the emergence of the EB5 program.  This government program allows foreign nationals to obtain green cards when they invest at least $500,000 in new or troubled projects. Though the process is long and cumbersome, it has provided a source for low cost capital, especially early in the cycle when construction lending was all but non-existent.  For larger projects, $100 million plus, in major urban markets, a few insurance companies will also consider construction financing; however, the terms from these lenders are typically conservative and leverage levels do not often exceed 50%.  For smaller projects, in addition to the SBA option, smaller regional and community banks are once again stepping up to assist coveted developers who are pursuing projects within their local footprint. 

What are the main characteristics of new hotel projects that are being financed?  Other than in NYC, where construction lending has been available for a couple of years now, construction lenders have been pretty disciplined about the types of projects they will pursue.  Urban, select service hotels in the top U.S. markets have had the easiest time attracting lenders as a result of the more efficient operating model they offer and relative simplicity to construct.  That said, no matter the quality of the market, brand or location, sponsorship remains the single most important characteristic to the construction lenders that are active.  Sponsors must demonstrate a track record of successful projects of similar size and scope, be prepared to put up substantial cash of their own, as well as have a balance sheet that allows lenders to sleep at night knowing they have a deep pocketed borrower who will support the project when the inevitable cost overrun occurs.

What are the primary differences between construction loans pre 2008 and today?  Prior to the "great recession" a large portion of the development involved a for sale, residential and/or timeshare component.  Much of this development was focused on high-end urban and resort product.  So far, we have not seen these types of projects gain much traction with construction lenders.  That said, as the housing market continues to recover, we have heard that mixed-use development projects are being dusted off and tested for viability.  

What are major terms of construction loans these days - leverage, guarantees, etc?  For projects seeking debt of $10 million or more, construction lenders are offering leverage at a pretty broad range of 50 - 70% loan-to-cost.  All lenders require completion guarantees, and except for the very rarest of circumstances, partial or full recourse, and/or other credit support, is necessary post completion.  This recourse often burns down, sometimes to zero, as the property stabilizes and achieves certain debt yield or debt service coverage ratios.  As for pricing, construction financing is typically pegged over LIBOR.  Overall, interest rates on construction loans have compressed by as much as 150 basis points over the past 18 months reflecting spreads in the low 200 - 300 over LIBOR range.  As bank balance sheets have gotten healthy, the pace of existing loan run-off has also picked up. This, coupled with the CMBS markets taking share from balance sheet lenders, has resulted in a greater number of lenders looking to construction loans as their best option to fill real estate allocations. As such, so long as hotel fundamentals stay positive, expect loan terms to continue to improve.

Who is providing financing for renovation/repositioning of hotels?  The loan market for renovation/repositioning loans has a broader range of potential lenders. The large commercial and regional banks as well as the smaller regional and community banks that are looking at ground up construction are also players for renovation/repositioning projects.  So are the life companies, but again, it is at conservative terms and leverage.  Mortgage REITS, mortgage funds and credit companies are also potential sources of funding these projects.  These groups, however, prefer some in-place cash flow continues during the re-development process and the scope of the renovations are moderate.  The benefit of these groups is that they are often more focused on the real estate and less on sponsorship credit.  Hence, recourse levels can be contained, and in some case eliminated.  If there is an executable story that does not require significant additional market lift to work, the likelihood of a successful financing improves.

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