A shot in the arm: Navigating the hotel financing market

By Michael Phillips  

While a handful of restaurateurs and retailers might quibble, there’s little debate about the fact that the hospitality business has endured the most punishing economic impact of any sector from the COVID crisis over the last 12-14 months. Revenue losses and layoffs are par for the course, and many hotel owners and operators have had to get creative just to keep their doors open. But day-to-day operational and budgetary demands can pale before longer-term structural financing challenges. Hoteliers rightly view the success of vaccine distribution, lower COVID numbers and promising signs of economic recovery as the light at the end of a long, dark tunnel. But for many properties, their time in the sunshine may be limited unless they are able to restructure their existing deals to account for revenue losses. In this pivotal moment, understanding available financing options—including some of the more creative and complex debt and equity financing possibilities—is essential for those that want to strengthen their position for sustained success in a post-pandemic environment.

A steep drop—and a tentative recovery
While some markets fared better than others, pandemic performance in the hotel business was generally anemic across the board. In 2020, CBRE reported a 57.6% decline in operating revenue for the average hotel in its portfolio. Trepp reported that the Commercial Mortgage-Backed Servicer (CMBS) hotel loan delinquency rate increased to nearly 25% in June 2020—and the percentage in special servicing has remained at or near that level throughout the last year. The good news is that the post-COVID oasis shimmering on the horizon is proving to be no mirage, and national occupancy numbers are already back to approximately 60%. Just because the deep cost cutting may be coming to an end, a year or more of operating losses is a wound that won’t heal overnight. The burgeoning recovery will take time, and that timeline may be even longer for hotels that are largely reliant on business travel. The persistence of some work-from-home arrangements and continued uncertainty about the long-term prospects for the business travel market may create more urgency for hoteliers to look into recapitalizing their assets.

Getting creative
After a historically difficult year, requesting a suspension of amortization or interest payment forbearance from your lender is unlikely to be enough. In many cases, solving a struggling property’s financing challenges in a sustainable way requires a more comprehensive solution. Instead of managing loan obligations at a single property, borrowers may need to adopt a more holistic strategy. Those with quality assets who feel like they are operating with too little liquidity may consider exploring mezzanine capital, preferred equity or another creative capital solution. While banks and other regulated financial institutions in the CMBS world are somewhat limited in their ability to get creative, capital providers like debt funds and other non-regulated financial institutions have the flexibility to operate as nontraditional lenders.

Do’s and don’ts
Hoteliers looking to navigate this tenuous time and strengthen their position for the long term should:

  • Be transparent with current and potential lenders about both opportunities and risks.
  • Manage guest relationships for the long term by offering flexibility with group business booking, accommodating cancellations and changes whenever possible.
  • Talk to their lender before repurposing any facilities—even temporarily. Don’t risk devaluing your property for short-term gain.
  • Accept that not all lenders are created equal. From different restructuring/refinancing tools to industry experience and relationships, lender experiences and capabilities vary. Some are buyers/investors as well as lenders, opening more potential opportunities.
  • Prioritize solutions-oriented lenders who can be constructive and creative—and who are willing to discuss your entire CRE portfolio. Borrowing from a larger basket of assets is often more affordable.

While some markets and service categories are coming back faster than others, the recovery is still tentative. With labor shortages and wage inflation posing additional risks, lenders and investors alike would be wise to be proactive about addressing structural financing liabilities and positioning properties to thrive as the recovery progresses.

Michael Phillips is managing director/head of portfolio management at Cottonwood Group, a private equity real estate investment firm specializing in large-scale, highly structured and complex projects with substantial barrier-to-entry characteristics. He is responsible for the firm’s portfolio of more than $3 billion of real estate investments and is an expert in real estate credit, including first mortgage loans, A/B tranches, repurchase agreement structures and mezzanine debt.

This is a contributed piece to Hotel Business, authored by an industry professional. The thoughts expressed are the perspective of the bylined individual.

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