NATIONAL REPORT—For lenders, it was business as usual at the beginning of the year. Transactions and refinances were revealed nearly every day, and it looked to be a prosperous year.
“CMBS lending for hotels was extremely active, providing the best terms for acquisitions and refinances,” said Taylor W. Grace, managing partner, MidCap Hotel Loans. “The ability to finance PIPs and pull cash out of hotel assets also made CMBS a great financing option. For ground-up construction and value-add situations, debt via the SBA 504 program and from private equity bridge lenders was also readily available. Conventional banks were the only lending source experiencing a slight pullback as some had already filled their hotel lending buckets.”
Mike Armstrong, principal, HREC Investment Advisors, noted that business was “firing on all cylinders,” adding, “Rates were at a historical low and lots of money was available from lenders of all types including CMBS, bridge, commercial banks, etc. Hotels were operating at an all-time high and supply was growing at a steady pace, which increased the demand for financing.”
Lori Tirado, managing director, business development at Access Point Financial, pointed out that all of these positives were happening despite the 2019 downgrade in RevPAR.
“Any RevPAR growth was primarily due to a hotel owner effectively driving ADR. As such, numerous types of lenders were still active in the hospitality space, although lending over the last 12 months has become slightly more conservative, with certain securitized lenders capping off at 65% as-is LTV [loan-to-value], where they may have been at 70% in prior years,” she said. “Similarly, a bridge lender threshold has been modified in the last 12 months where they once would be at 80% SLTV [supervisory loan-to-value], and now are not exceeding 75% SLTV. Regardless of all of this, if there was a need for a hotel, a strong and experienced operator backing the hotel and a franchised brand, it was not overly difficult to secure the desired financing.”
According to Geoffrey E. Davis, senior principal, Davis Hotel Capital Inc., low interest rates were fueling a lot of activity and a number of hotel owners were looking to refinance over selling their assets.
Then COVID-19 hit, and the landscape changed dramatically. Many hotels were forced to close temporarily, while others opened their doors to house medical personnel and first responders, as well as those recovering from the virus. Numerous owners have had to lay off or furlough employees for the foreseeable future. Lending opportunities became few and far between.
“Lending has come to a temporary standstill for most lenders,” said Armstrong. “However, there are some private lenders—hard money—and commercial banks still willing to provide acquisition financing to strong borrowers with discounted opportunities.”
Private equity investors are also providing “opportunistic” bridge debt, according to Davis. “This capital can be utilized to assist in loan modifications, establish long-term interest reserves, do renovations and to finish construction projects,” he said.
Grace added, “The pandemic has turned the hotel lending landscape upside down. CMBS lending for hotels has ground to a halt for the moment. Even the SBA programs, which are typically more reliable in troubled markets, have slowed down dramatically, primarily due to the backlog of applications under the CARES Act. Bridge lending remains available, though these lenders are being very selective.”
When the U.S. and the rest of the world will be ready to open for business still remains to be seen. But when the “stay-at-home” orders are lifted and states lessen restrictions, expectations are there will be a slow roll to lending opportunities.
“Ideally, in the second half of 2020, hotel owners will begin the road to recovery and the lending environment will look far different than it did in the first two months of the year. With the right owner, asset and location, deals will happen,” said Tirado. “Sponsorship will be of the utmost importance though, in addition to how the asset weathered the storm. A lender will take a hard look at the asset pre-COVID-19, during the pandemic and how it looks today.”
She continued, “The challenge will be determining what a stabilized asset looks like in 12 months. Leverage will be lowered; interest rates will likely be up to account for the risk; and more structure will be put into place to allow a lender to feel comfortable closing on the transaction. Also, another factor will be determining what a valid cap rate is in the specific market, which will dramatically impact the hotel’s value.”
For Grace, the recovery of the lending landscape will depend on if the recovery is as swift as the pandemic’s appearance, “resulting in the often discussed ‘V-shaped’ curve.”
He added, “At MidCap, we believe there will still be hotel lending available in the short term once things reopen, though it will be much more difficult to secure and take longer than normal to consummate.”
The recovery could take at least two years, according to some of the multi-unit hotel owners that Davis’ firm has talked to.
“First to come back will be drive-to leisure, as people will want to get out of the house,” he said. “After that, business travel will pick up and last to come back will be group and convention business. Hotels will continue to find debt a challenge as lenders will be very conservative.”
As far as what type of funding will be available once the recovery begins, Armstrong noted, “There will be a need for all types of lending. There are new capital sources forming to take advantage of distressed situations and to provide rescue capital to assist owners with operating shortfalls and property improvements. Construction financing will be difficult to obtain in the near future.”
Davis noted that his firm is working with a number of private equity/family office investors “to establish ‘rescue capital’ in the form of preferred equity, mezzanine and bridge debt,” adding, “Construction will remain out of favor except for the very best projects with strong sponsors, and there will be debt available for distressed acquisitions, restructurings and creative deal structuring.”
Tirado expects there will be alternative lenders willing to take on additional risk, and charging their clients more fees and increased rates.
“Most of these loans will be floating rate bridge loans,” she noted. “Also, I think a lot of the opportunities for these types of lenders will come from the sale of properties. People will be selling at a discount to recoup equity that they need to survive and rebuild.”
For Grace’s firm, its focus will not be on the type of debt available, but more on the type of hotels that will be able to secure debt, he pointed out.
“Without a doubt, economy and midscale hotels, particularly in the extended-stay segment, will be best positioned to obtain financing in the short term,” he added. “When you combine the ability of economy extended-stay hotels to withstand the current shock with the rock-bottom interest rate environment caused by the crisis, it is our view that the third and fourth quarters of 2020 will present an excellent opportunity to finance these hotels.”
Both Tirado and Armstrong see the second half of 2020 as the beginning of the recovery for the industry.
“I am hopeful lending will pick up the last half of this year,” said Armstrong. “Banks, debt funds and CMBS have liquidity and need to make loans to remain in business. Once we see an increase in travel and hotels start to recover, there will be an increase in demand for favorable debt.”
“After the pandemic, any improvement will begin with occupancy as people start traveling again, and that will slowly be followed by ADR,” Tirado noted. “I am not sure if lending does go back to the level we were at before; however, I do think the landscape will adjust and we will adhere to a new normal, at least for a while. To truly get back to the occupancy and ADR levels the industry was at pre-COVID-19, it will likely take three to five years based on our analysis of previous cycles.”
Grace sees a quicker time frame of 18 to 24 months for the industry to get back to pre-pandemic levels. “That being said, again, not all hotels are created equal in a black swan event like this,” he pointed out. “The economy extended-stay hotels should have the lending winds at their backs as soon as the second half of 2020. At the other end of the spectrum, full-service hotels dependent upon air travel, large events and tourism have a long road to recovery ahead of them.”
Davis said that during a webinar his firm hosted featuring senior hotel industry leaders, the consensus was that it will take at least two years from the time a vaccine or cure is found to get back to 2019 levels, and added, “The asset class will see some long-range devaluations, most likely in the range of 10 to 20%, but in that lies opportunity for investors, lenders and good operators.”