5 strategies to secure better loan terms

For almost a year now, experts in our industry have been following a pattern. First, we say that interest rates have hit their peak. Then, month after month, we’ve watched them tick up even higher. But high interest rates are just a piece of a much larger puzzle comprising the hospitality lending environment, and with the right strategy, there are ways to lessen their impact on loan terms.

The lodging investment landscape is complex and dynamic. Investor demand is shifting from equity to debt, causing spreads to decrease and competition from non-bank lenders such as debt funds, commercial mortgage-backed securities, collateralized loan obligations, and life insurance companies to increase. Banks continue to be tight on liquidity and more selective regarding new opportunities. Only a small number of international and larger regional banks are actively originating hotel debt, while most local lenders are pushing for larger depository relationships to even consider new deals and relationships.

Further, lenders’ appetite is highest for transactions on limited-service deals with loan amounts under $20 million. The larger the loan, the more difficult it is to execute, which is an issue for hotel developers.

We’re seeing most lenders max out at 65% loan-to-value when, in previous years, it was more like 75%. Lenders are also concerned about hotel values holding up in this rate environment. To mitigate risk, they’re quoting terms at lower leverages.

Ryan Bosch

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It’s not all bad news, though. There has been an increase in hotel allocations versus office and multifamily from big lenders. Seeking a loan with realistic interest rates and leverage is key in this climate, especially when working with local banks. Given the increased cost of debt, leverage is down from what we saw 18 months ago. We’re seeing most lenders max out at 65% loan-to-value when, in previous years, it was more like 75%. Lenders are also concerned about hotel values holding up in this rate environment. To mitigate risk, they’re quoting terms at lower leverages.

Game plan

If you are looking to develop, acquire, or refinance in the current lodging investment landscape, here are a few strategies that have effectively secured more favorable loan terms.

1. Have realistic expectations. This was mentioned above and cannot be stressed enough. The market is tight; there isn’t a lot of liquid capital available, so do not go to a lender and pitch a deal with unrealistic terms. Know your leverage, research rates, and do not seek to cash out. Lenders are not going to spin their wheels on a deal that they won’t be able to execute and they’re not going to take a chance on someone who comes off as inexperienced or who hasn’t done their research. Borrowers with realistic expectations are the ones who will be able to formulate the best strategy for keeping costs as low as possible and moving their projects forward.

2. Lean on or build relationships. Get to know your local banks and lenders and their appetite for lending. In an environment where banks are tight on liquidity and looking to shore up balance sheets, consider utilizing a depository relationship as a carrot to entice the bank you want to work with. These relationships go a long way toward building trust between lenders and potential borrowers, establishing a strong foundation that can be built on when the right deal comes along. It also gives borrowers a track record with a lender, making them look like a less risky investment. In a challenging capital markets environment, having a few solid relationship lenders in your pocket can mean all the difference.

3. Be cautious of pre-payment penalties. Borrowers should be cautious of prepayment penalties when locking into longer-term debt. In today's environment, more than ever, banks specifically do not want to cash out. They want to see a higher amount of skin in the game at this point in the cycle to keep borrowers motivated on asset management. While I’m no economist, most experts agree we’re likely at peak interest rates without a black swan outlier pushing us higher. Given the combination of equity staying in deals longer and rates where they are, most borrowers want to maintain flexibility on refinancing in the next 36-48 months if rates drop or banks loosen on the availability to cash out.

4. Explore shorter-term debt vehicles. With the amount of capital pouring into debt funds, we’re seeing spreads compress more than ever. The difference between lower-cost floating-rate debt funds and amortizing bank loans is slimming. If your refinancing needs include cashing out to recapitalize investors or accommodate a larger PIP, the short-term loan market can be a good vehicle with spreads tighter than you may have seen in the past. Even on the perm side, we’re rarely seeing 10-year CMBS loans get executed, with five-year money being the go-to-choice for most borrowers. One thing to look out for and always make sure you’re negotiating is the floor interest rate. Lenders that are leveraging on the back end typically will try to keep the floor set to where it is on closing day, but there’s typically room to negotiate that down and capture some upside if rates move downward.

5. Engage a capital advisor. If you are having difficulty securing a loan from your typical go-to lenders, consider working with a capital advisor. Capital advisors have a pulse on the market, are constantly in communication with lenders, and have a much broader range of capital sources than your typical borrower. Especially when working with lenders outside of local and regional banks, the expertise of a capital advisor could make the difference between a “yes” and a “no” when it comes to financing a project.

Contributed by Ryan Bosch, Principal, Arriba Capital, Scottsdale, Arizona

The views and opinions expressed in this content do not necessarily reflect the opinions of Hotel Investment Today or Northstar Travel Group and its affiliates.