Part 2 of this special deal report from the Hunter Hotel Investment Conference zeroes in on playing the angles of today’s economy to bolster your case for debt or equity.
Panelists speaking at the “Structuring deals for success” session at the 2023 Hunter Hotel Investment Conference held March 21 -23 in Atlanta provided expert guidance on how to leverage the opportunities of the current market to create a stronger story for loan officers and potential capital partners.
In part 2 of Hotel Investment Today's coverage, moderator Greg Remeikis, partner, CohnReznik, delved into strategies to strengthen the case for loans or capital injections with panelists Ben Brunt, managing principal, chief investment officer, Noble Investment Group; Nelson Knight, president, real estate and investment, Apple Hospitality REIT; Brian Waldman, chief investment officer, Peachtree Hotel Group; and Mike Wilbert, managing director, Mission Hill Hospitality.
They shared these tactics for getting money at a time when the banking crisis is making it easy to say no to all but the best deals.
1. Solve for the spread. “There is still a [considerable] bid-ask spread between buyer and seller. The cost of debt is a major factor in that,” Wilbert said. “We are finding success being more creative with the seller on the equity stack to solve for whatever that spread is, whether it's an earn out, whether it's staying in the deal or whether it's a piece for seller financing. At this point, however, I don't think the market has shifted nor has what the seller is expecting in terms of return pressure.”
2. Watch for recap opportunities. “Recap will be meaningful over the next few years,” Brunt said. “There are a variety of ways to structure it, including a recap where you agree to a value and then new equity comes in and you carry on as partners.” Waldman agreed, adding that he’s made several preferred equity investments on the other side of the capital stack.
Recap will be meaningful over the next few years.
3. Look for the details that can make the numbers work. “You always want to be ready for success, but not every opportunity to succeed is going to arrive on the front end,” Brunt said. “Maybe you can’t get to 65% [LTV]. So, maybe you start at 60% and work on an earn out based on asset performance. Or you ask that after the asset is built and open and you hit a certain threshold, you could get a decrease in the spread. We spend a lot of time focusing on little tweaks that contribute to success.”
4. Center your story for construction loans around opening in a stronger market. The panelists agreed that construction loans are “very expensive” and, barring something unforeseen, will continue to be. They’re also going to remain hard to get. And, they’re risky. Waldman had this advice for developers who share his enthusiasm for new-builds: “I’m a strong believer that ‘new’ wins overall, especially when you’re talking about power brands. There’s a strong argument for development. I like the current story. Whatever noise we’re in today, we’re capitalizing that risk for the next 24 months. Hopefully we’ll be opening at a much better point in the cycle. But that story is only going to work in markets where you can justify rate and prove the demand is there. You also need a good general contractor with a good plan on how to get the asset built.”
5. Explore retroactive applications for Property-assessed Clean Energy (PACE) loans. PACE lending can be a useful tool to manage unforeseen construction costs—even after the fact. “It’s not a national program and each jurisdiction has its own rules, but where you do have retroactive PACE it can solve problems where the sponsor may not have the equity but the construction lender will consent to it,” Waldman said. Remeikis added, “I’ve seen developers use it to help bail themselves out of significant cost overrun issues they hadn’t contemplated on the front end.”
6. Enlist brand support in creating a compelling P&L forecast. “We have an Embassy Suites in Madison, Wisconsin, under a development takeout. Historically, that is a less efficient box. But the brand was willing to work with us and we were able to find significant savings through efficiencies in the square footage in the public spaces and guestrooms,” Knight said. “Its sister brand, Homewood Suites, just went through a complete revamp of its prototype to allow more guestrooms and reduce the square footage. Brands want to continue to build a pipeline and they’ll work with you to accomplish that.”
7. Consider both the risk-free rate and the risk premium. “This is one of the first times in history when you saw the risk-free rate blow out and the risk premium above that," Waldman said. "Historically, what’s happened is the risk-free rate went up as the spread would pull back. I think that’s more of a factor of supply and demand [than] of capital in the market. So, people keep asking what happens if the Federal Reserve keeps moving interest rates up 25 bps. That’s not the right question. The right question is who’s out there lending? Because if no one’s lending or if the lenders who are still in the market have the ability to push spreads out or the market warrants it based on supply and demand, you’re going to have wider rate ranges. But I do see more lenders coming back into the market, which will create competition. Eventually the CMBS will come back as well.
There’s a strong argument for development.
8. Expand the appeal of refinancing, conversion or construction loans by remapping select-service’s square footage to capture new demand drivers. “Demand for select-service has shifted. We’ve found that a lot of smaller and medium-sized groups are traveling as we come out of the pandemic. That’s creating a need for more meeting space in these two product types,” Brunt said. Working with the brand, his team built out brand-standard boardroom setups to 3,000 sq. ft for a 165-room select-service asset. “We wanted to make sure that we can accommodate multiple types of demand; not just the traditional corporate transient traveler that was the focus of these asset classes,” he said. "In uncertain times, this multi-market positioning could be an appealing value-add for financial institutions looking for projects with lots of levers to pull.”
9. Make it easier for lenders to say yes to debt earmarked for renovations or PIPs by focusing on upgrades that align with changing lifestyles and workstyles and diversify the profit base. “The addition of bleisure elements that motivate travelers to tack on a day or two is helping in the shoulder periods. Monday through Wednesday used to be peak performance days. Now, we’re seeing good results on Sundays and Thursdays,” Waldman said. Knight is reporting positive contributions from locally accented offers such as markets and sweet shops. “We went through every space in the hotel and considered how to use it to give the customer something unique and capture a little more share of wallet,” he said. “Markets have been huge for us.” Hybrid and remote workers are also creating a new segment of demand as well. “They may be getting out of the office some or all of the week, but they still have to be back in the office for meetings. That’s really good business for the local hotels,” Waldman said. It’s also justifying elevated FF&E in the guestrooms and guest bathrooms, as well as borderless workspaces and dedicated structures for pop-up meetings throughout the public spaces. Supported by the latest tech, these improvements monetize the entire asset.
10. Look for the right underwriting equation. Knight pointed out that while some markets have dramatically outperformed over the last two to three years, there’s already some pullback. He recommended underwriting into markets that, even with a slight dip, can stabilize above 2019 levels and support development or acquisition.