The
USDA Business & Industry loan program offers up to $25 million in lending
for smaller markets that meet the qualification criteria.
NATIONAL REPORT — For hospitality investors
looking to build or do major renovations for projects in smaller markets, the
USDA Business & Industry (B&I) loan program offers a creative solution
in a challenging credit environment.
In July, New York City-based Castle Peak
Holdings announced it had secured $19.975 million USDA B&I loan for the
refinance and renovation of two historic hospitality assets in Mendocino,
California: The Mendocino Hotel & Garden Suites and Hill House Inn. The
project will include comprehensive restorations of both hotels, which have
fallen into disrepair. Atlanta-based Thomas Financial Group, a wholly owned
subsidiary of Community Bankshares Inc., closed the loan.
David Better, partner at Castle Peak
Holdings, said the plan was an attractive option when the company realized the
location qualified for USDA financing.
“Those were previously markets that were
serviced by local or regional banks, and over the past few years that
financing source has become less and less readily available,” he said. “Then
you pair that with renovation or construction risk, there are fewer and fewer
traditional debt capital sources active in the market right now for heavy
renovation projects in these non-core MSA markets.”
This is the first USDA loan for Castle Peak,
which is the investment arm of the outdoor-focused and Marriott-supported
Trailborn hospitality brand, but Better said it likely won’t be the last.
Castle Peak focuses on converting assets in iconic outdoor destinations that
include national park gateways, beach towns, lake towns, ski and wine country
destinations, where it’s difficult to build hotels and where people can’t find
a strong 4-star lifestyle product.
“Our business strategy tends to be farther
away from core major metros and so we are always exploring creative programs
like the USDA to help us deliver great products in smaller markets,” he said.
About the USDA B&I
program
Zach Chandler, vice president of Thomas
Financial Group, said the program has been around since the 1980s and is a
focus for the company. He estimates Thomas has closed around $5 billion in
government-guaranteed lending (mostly through the USDA B&I program), with
about $1.5 billion of that for hospitality (assisted-living facilities are the
company’s other top niche).
The program can be used for a lot of different
types of construction for smaller towns (population 50,000 and under, and
usually away from major metro areas — the USDA has mapping software that
determines whether an area is eligible or not). Last January, LaGrange,
Georgia-based Community Bankshares acquired Thomas Financial Group (another of
Community Bankshares’ verticals, Phoenix Lender Services, services the USDA
loans as well).
Chandler said the USDA is a balance sheet
program and has a $25 million limit per project. So, some borrowers are able to
have multiple USDA loans at the same time.
“We have some borrowers that have $100-plus
million in outstanding loans with USDA because of the project basis,” he said.
“As long as the projects are in a different parcel and a different LLC, and
standalone revenue for debt service, then you can get another $25 million.”
The loans are 30-year, fully amortized with
no balloon payments. Chandler said the loan program also includes the ability
for unique capital structures, which can allow borrowers to add C-PACE,
historic or new market tax credits or even EB-5 as part of the capital stack.
(Better said Castle Peak’s deal in Mendocino included C-PACE, for example.)
The interest rate can vary depending on the
project and industry, but in general, a USDA B&I loan will have a lower
rate than an SBA loan, but a gross interest rate higher than a conventional
loan. But because of the amortization schedule, it will usually have the lowest
monthly payment.
The loans can be used in hospitality in a
number of different ways such as for acquisitions, renovations/expansions or
refinances. Chandler said that because of the basis, most of the USDA B&I
loans for Thomas end up as ground-up construction. The loan can also provide up
to 36 months of interest-only payments until the asset is cash flowing.
“So, they can get through the construction
permit up and then get through a ramp-up phase to stabilization so that they
have sufficient cash flow to be paying for the debt,” he said, noting the USDA
program is a construction-to-perm program (meaning the owner doesn’t need to
refinance once construction is done).
What we’ve seen is a lot of sponsors that have creative minds and creative capital stacks have been able to get a lot done and ultimately will be able to put themselves in a good spot for the future. Because it’s not getting any cheaper to build.
Zach Chandler
There is no preferred lender program, so
each deal gets submitted to the USDA, which does its own review. A potential
negative for borrowers is that the process takes time, Chandler said.
“It’s not going to be as quick as
conventional lending, and there are a couple of additions we have to do with
USDA that you don’t have to do with SBA,” he said.
Chandler said in a more normalized
interest-rate environment, borrowers have to get creative, and USDA can reward
that thinking.
“What we’ve seen is a lot of sponsors that
have creative minds and creative capital stacks have been able to get a lot
done and ultimately will be able to put themselves in a good spot for the
future,” he said. “Because it’s not getting any cheaper to build. Interest
rates are where they’re at. So, we have to figure out a way to get it done now and you’re putting yourself in a really good spot for the future.”
For the most part, because of the deal size,
Chandler said it’s usually more seasoned hoteliers who are taking part in this
program.
“This might be their third or fourth hotel.
Whether it’s boutique or select-service or full-service, they have their niche
that they have become experts in their own right,” he said.
Chandler said his company expects to be
doing even more hospitality financing in the future.
“We think the hospitality sector is one we
can really capitalize on. It’s harder for the conventional credit market to do
these deals right now. So, we see it as an opportunity for us to keep increasing
our percentage of deals for the hospitality industry,” he said.
USDA loans take time
Better said, from Castle Peak’s perspective,
USDA lending certainly takes longer than traditional financing, but it also
goes hand-in-hand with the fact that the program is really geared toward
material capital investment in real estate.
“It’s important to have a good intermediary
guiding you through that process,” he said. “So, as you level set with your
investors and your project teams, everyone’s rowing in the same direction.”
Better said since Castle Peak already owned
the two properties in Mendocino, it gave the company the flexibility and time
needed to get the process done.
The USDA is not a magic bullet or cheaper than everybody else as a financing solution, but it’s a triangulation of economics, duration and structure that we ultimately found very attractive.
David Better
“We were able to go through the process of
obtaining the USDA loan, whereas if you are buying a property, unless you’ve
got a willing counterparty to wait alongside you to make sure you get those
approvals, there can be some more timing pressure,” he said.
One of the benefits of using the USDA
program, Better said, is you can tailor the loan economics and structure based
on what the borrower cares most about.
“Depending on the duration and the
prepayment flexibility you want, there’s a rate trade-off,” he said. “The USDA
is not a magic bullet or cheaper than everybody else as a financing solution,
but it’s a triangulation of economics, duration and structure that we
ultimately found very attractive.”
But the program isn’t for all types of hospitality
investors, Better said.
“We are value-add hospitality investors. So, we are coming in and spending real money to upgrade the quality of the physical
plant... which allows us to qualify for something like this,” he said. “But for
the avoidance of doubt, the USDA is not an attractive solution, or frankly,
really a feasible one for someone who’s looking to buy a property, operate it
and flip out of it in three years.”