How equity is filling the gap in the refinance market

Hotel Investment Today is writing a series featuring interviews with hospitality experts about the current state of the hotel refinance market. Today, we interviewed Michael Weinberg, managing director of Berkadia, which offers advisory, investment sales, underwriting and loan origination services and products. For Part 1 with JLL’s Kevin Davis, click here. For Part 2 with Peachtree Group’s Jared Schlosser, click here.

NATIONAL REPORT - For hotel refinancing right now, one way or another, cash is king.

“Maybe 75% of the loans that we’ve underwritten this year have either had some sort of cash-in component to it, or you need to bring some equity to the table if you want a really attractive interest rate, or you’re going be dealing with a higher cost of capital,” said Michael Weinberg, managing director of Berkadia’s Orlando office.

Weinberg used the example of a two-asset deal in North Florida earlier this year. The borrower wanted the best cost of capital, which meant bringing $2 million in cash to the closing.

I’m delivering bad news. I’m telling borrowers to bring equity to the table to get a lower cost, or if they want it to be cash neutral and don’t want to bring equity to the table, the cost [of the loan] is much higher. They don’t like either of those solutions because neither is great news.

Michael Weinberg

Share this quote

“I’m delivering bad news,” Weinberg said. “I’m telling borrowers to bring equity to the table to get a lower cost, or if they want it to be cash neutral and don’t want to bring equity to the table, the cost [of the loan] is much higher. They don’t like either of those solutions because neither is great news when working with lenders.”

Weinberg said equity requirements are much higher because the credit standards are tighter. “That’s where the new equity has to come in to fill that gap,” he said. “More equity is definitely required, the underwriting standards are tighter, and the leverage is lower, just across the board.”

Weinberg said he’s starting to see a bigger deal flow pushing its way through the system. He said some of the increased flow is from market capitulation, while pending maturities also drive deals, especially for assets with good cash flow.

“It’s a very liquid debt market... It’s still very, very tough to get into construction debt. But there’s a bid on almost every asset,” he said.

Weinberg added that there still isn’t much action on the acquisition side. He said his team typically has three legs to its stool of financing: construction, acquisitions and refinancing. But right now, he joked, the stool is “wobbly.”

Last year, Weinberg said he did only one acquisition finance deal, which was highly unusual. For the first time in his capital markets career, he did no construction debt deals. But refinances are booming.

“There are maturities that have to be done,” he said. “Some of these we are pulling forward. So, even if the maturity was six or nine months away, the borrower has so much trapped equity, they’re trying to get some of that equity out, and CMBS is a good avenue to do that. But it’s just been significantly less transaction volume.”

Lenders putting on pressure

Weinberg said the biggest complaint he hears from banks and debt funds is that they aren’t getting enough payoffs.

“They’re not recycling the capital enough,” he said. “We are seeing lenders put pressure on their borrowers to repay them, more so than we’d seen before. In COVID, I thought that pressure would build up and come to fruition regarding deal flow, but the lenders kicked the can and gave extensions to the borrowers.”

Weinberg said he now sees a different tone from lenders, often forcing borrowers to refinance. “They are saying you need to pay me off at this maturity date, or if you’re not hitting a certain covenant or you’re not hitting a debt-service coverage ratio… You need to pay me off, and that’s forcing the hand of the borrowers.”  

Weinberg said he’s even seeing a change with debt funds. “The debt funds have been extending and trying to give a little bit of rope, [especially for assets] with a good idea and business plan and something where they see a light at the end of the tunnel,” he said. “But they’re going to be a little more aggressive about foreclosing some of these borrowers who aren’t doing what they’re supposed to or not following the letter of the law on the loan documents. The debt funds are more apt to take assets back.”

Weinberg also said delayed PIPs for hotels fuel refinances and sometimes even facilitate a sale. “That’s a huge factor in many groups saying, ‘I’m going to sell my asset instead of [refinancing] it’… because this PIP is big,” he said.

Making deals smaller

When asked whether these refinances are for individual assets or portfolios, Weinberg said the big loan market hasn’t been as efficient, pushing borrowers to chop up deals.

“I used to love to make deals bigger because I knew I could get a better cost of capital and better treatment,” he said. “Now, I’m telling [borrowers] if you have a $100 million deal, can we chop it into two and make it into two $50 million deals, and maybe there’s more capital out there.

There’s a lot of money out there that wants to be put to work, and that’s helping some sponsors that don’t have the equity to put in themselves.

Michael Weinberg

Share this quote

“There seems to be more liquidity in the smaller range [because of] less risk. There are some [lenders] who used to do big loans that are saying they’d rather put out a bunch of bets rather than a few big bets.”

Weinberg said a smaller loan philosophy is true for regional banks. He also mentioned that Wells Fargo, which has historically been a major hotel lender, “has taken its foot off the gas,” which has led to fewer larger-scale loans.

He said deals are taking longer to get done right now. “It takes longer to get the quotes out,” Weinberg said. “I wouldn’t say necessarily that the closing process is that much more cumbersome, but the underwriting process is taking a lot more time.”

Weinberg said one helpful thing is more players want to enter the hotel lending space. “There’s been this surge of folks trying to get into the space or do more within hospitality, which has benefited borrowers, and I think that’s helping compress the spread just a little bit,” he said.

Weinberg added that the most competitive part of the capital stack right now is for the preferred equity piece, which helps fill the gap when equity isn’t an option.

“There’s a lot of money out there that wants to be put to work, and that’s helping some sponsors that don’t have the equity to put in themselves,” he said. “[Borrowers] are filling their capital stacks with that either by a need or a desire to manufacture returns because it’s harder to hit your hurdles today.”