Why ‘pioneering’ can keep refis from penciling

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 Straw, executive vice president for capital markets for CBRE, which brokers financial deals. For Part 1 with JLL’s Kevin Davis, click here. For Part 2 with Peachtree Group’s Jared Schlosser, click here. For Part 3 with Berkadia’s Michael Weinberg, click here.

NATIONAL REPORT — In today’s capital environment, especially for refinances, hotel deals that are penciling generally work on both sides.

“If the equity makes sense, and the borrower can make it pencil, the lender typically can as well,” said Michael Straw, executive vice president for capital markets for CBRE.

He said when the lender can’t make a deal pencil, there is usually a “pioneering” strategy behind the borrower’s underwriting. 

“When the borrower’s underwriting is possibly a bit too aggressive, that’s where lenders struggle,” Straw said.

What Straw means by pioneering is that the investment has a visionary aspect that is difficult to quantify. “Maybe it does work, and there’s a certain aspect of visionary investment that would make that deal compelling to the equity,” he said. “But lenders are risk averse by nature, and so when dealing with those pioneering fact patterns, it’s much more difficult to buy into it.”

State of the market

Straw said CBRE’s refinance pipeline is robust and has been for the better part of the last 18 months. Last year, the company closed just north of $3.4 billion in hotel deals, with nearly 90% of that being refinancing (there’s a ‘touch’ of construction financing and almost no acquisitions). Through mid-May, CBRE has already closed over $1.5 billion in financing at roughly the same ratio.

He said the lack of acquisitions reflects a dislocation in the market on the equity side. But he said it also reflects a lack of pressure on many owners right now. “There’s no pressure on these owners to sell assets at what they deem to be depressed prices because the performance is otherwise really strong,” Straw said. “To just have a trade driven by the capital markets doesn’t necessarily make sense for them.”

He said the lending market has changed greatly since 2021, especially for the “A-note” primary lender in the capital stack. “One of the things that lenders are really focused on is how they find leverage for their positions,” Straw said.

He said earlier this year and especially late last year that the A-note market was “sparse,” but that has now changed. “There’s a much deeper bench in that 0% to 50-55% [loan-to-value] space, where there’s much more leverage out there,” he said. “That’s still a challenge compared to 2021 when the bank market was so active, and signing leverage wasn’t a challenge. Even though it’s improving, that’s still a real challenge for lenders.”

Event-driven refinances

Straw said CBRE has been able to finance some distressed scenarios. He said where they are seeing more pressure points is more market-driven.

There’s a much deeper bench in that 0 to 50-55% [loan-to-value] space, where there’s much more leverage out there... Even though it’s improving, that’s still a real challenge for lenders.

Michael Straw

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“We’ve worked on some difficult transactions in Chicago, San Francisco and Silicon Valley, where there’s this more headline risk about making an investment in these markets that have taken the brunt of the post-COVID environment,” he said. 

Straw added that CBRE has succeeded in those transactions by “hand-holding” lenders and battling the disconnect between perception and reality. “There is this broader narrative in the marketplace about how challenged these locations are, but if you actually look at performance at these hotels, they’re doing just fine. They are showing some real signs of growth, and month-over-month while we’re in the market with these deals, they’re often showing real-time improvement that helps the execution overall.”

Straw said CBRE is seeing three kinds of event-driven refinances: debt maturity, rate-cap expiration, and cash-out refinance, in which some of the property’s equity is returned to investors.

He said even if it’s not a dramatic cash-out, returning equity is a better outcome than selling the asset, especially if it means “doing it in a way where it’s not adding stress to the asset.”

“Usually, we’re able to pursue a modest cash-out while also bringing in their interest expense,” Straw said. “It’s a win on both sides in terms of returning some equity to the investor base and lowering ongoing stress on the asset.”

No more waiting on rates

Straw said the days of waiting on interest rate cuts have passed. “Last year, we saw a lot of hand wringing and waiting around for interest rates to do something… The investors we speak to most regularly aren’t thinking about pricing in cuts as much as last year,” he said. “The expectation is that the magnitude or the velocity of any rate cuts is not going to change the landscape. Even if there are rate cuts this year, I don’t think anyone’s expecting that to change the dynamic of whether that’s a refinance or an acquisition.”

Straw said it’s generally taking longer to complete deals these days (whereas the average used to be 10 to 12 weeks, it’s now 12 to 16 weeks). “I think part of it in the hotel world specifically is because there’s a lot of activity,” he said. “Lenders are working diligently but also picking their spots and spending a lot of time in the diligence process to understand and underwrite these deals appropriately, and trying to bid it to win it.”

Straw also said the lender landscape has become more competitive. “When lenders are looking at the spectrum of opportunity in the commercial real estate landscape, hotels have been a bright spot,” he said.