Why USDA program can be attractive option

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).

Zach Chandler

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

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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

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“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.”