Hotel Financing, Debt or Equity?

Before you begin the search for a hotel property, make a complete capital check and a list of all the equity you have available to purchase and take over the property available. As a Hospitality Capital Advisory Consultant, I recommend a healthy lower equity limit for hotel and restaurant properties. For hotel and restaurant businesses, this should be around 32-36% of the investment cost (purchase price, costs, renovation costs, and costs for modifications or additions). With this healthy minimum of capital resources, Owners of hotel properties will be able to run such a business properly and even get through a bad season or a short period of an economic slowdown like Covid-19. If your available equity is significantly below this level, I would recommend refraining from purchasing and lease a hotel instead or buy a cheaper property.

While hotel financing continues to remain complex to secure, especially post Covid-19, with the help of the right capital advisors, good structures can be arranged. Now more than ever, lenders will continue to underwrite cautiously to minimize risk, and that is not expected to change in the near future. For an investor, developer, buyer, or owner seeking hotel financing, there are still plenty of lenders willing to provide those loans, even post-pandemic.

With high valuations and low cap rates for high-end city hotels, and we expect those trends to continue, the smartest borrowers understand that financing terms and options can vary widely. By working with an advisor who can present opportunities to a large network of funding sources, borrowers can find very competitive terms for their financing needs.

Equity

Finding equity for the acquisition, renovation or development of hotel projects requires some time, rigor, and expertise; however, the right capital advisor can identify these sources. Institutional investors are most interested in investing in larger hotels in Sub-saharan Africa, while high-net-worth individuals are the best bet for smaller hotel equity. Historically, one of the best sources of hotel equity has been through FDI offering Private Equity funds. Because these funds require job sustainability and generation both during construction and ongoing operations, hotels easily qualify for FDI funds, however, this option takes longer and is more expensive. 

Acquisitions

CMBS lenders provide the highest leverage for existing stabilized loans and are therefore one of the best sources for higher-leverage hotel acquisition financing. While most hotel lenders prefer to stay between 55% and 60% LTV in the current market, we have successfully achieved up to 65% -70% for borrowers, subject to a 10% -12% debt yield constraint. That financing level can then be topped off with an additional layer of mezzanine debt, bringing the total debt stack up to approximately 75 % to 80% LTV.

Renovation/ Redevelopment - Brownfield

Renovation or redevelopment of an existing hotel is a very cost-efficient option for hotel owners because it can be less expensive than building a new hotel from the ground up and equally. takes a shorter time to achieve ROI. These types of renovation/redevelopment loans can generally be obtained from banks or debt funds. Bank loans will generally be recourse but can provide a lower rate, while debt funds will be non-recourse but will be more expensive. Even with these sources, financial and strategic presentations to the lenders with a full analysis of the proposed renovation or redevelopment are required to achieve a favorable response from a lender.

Refinancing

Refinancing may be necessary if the hotel’s current financing is due and/or if the owner is seeking equity through a larger loan. This can give the owner an opportunity to capitalize on the hotel’s increased value and obtain cash to reinvest into new opportunities or complete renovations on the subject hotel that will increase value. These loans can be obtained from banks, CMBS lenders, debt funds, or life insurance companies and can be from 50% to 60% LTV, with rates between 5% and 9%, depending on the transaction.

Ground-up Development - Greenfield

For Greenfield hotel development, a bank or debt fund is the best source of financing. These lenders tend to cap their lending at 60% - 70% LTV, depending on whether the borrower chooses a recourse or non-recourse option. Mezzanine funds are typically used to add another layer of leverage to the capital stack. These lenders are eager to place capital and may price their loans between 10% and 14% fixed return. They are a good option for the borrower and can reduce the need to raise more equity. All of these funding types can supplement the construction financing provided by the senior lender. The challenge is coordinating all these multiple financing sources in order to make a project work.

Crowd Funding

Disruptive and alternative funding sources are in the rise within Hotel and Real Estate Developments, as more projects developed by independent owners seek funds from the general public with a fixed annual return of between 7% to 10% of Capital input with a buyback option and the potential to raise 100% capital required for your project. Interestingly enough, we are currently working on a similar model for an exclusive lodge concept in East Africa and the response has been immensely positive, However, more research needs to be done to better understand this area.

PROS & CONS OF EQUTY Vs DEBT

Cost Advantage: Equity Financing

In most cases, equity financing can be obtained at a much lower cost than other hotel loans. By selling shares in your property, you can take advantage of your existing equity to access the funding you need to manage renovations and new acquisitions while keeping the costs as low as possible for you and your company. In some cases, the only out-of-pocket costs you will incur will involve the legal process necessary to transfer ownership interests in your company and the fees associated with that process.

Control Advantage: Debt Financing

While taking on additional debt may not be especially appealing for your business operations, equity financing arrangements may limit your ability to make unilateral decisions about your hotels and the ways in which they are managed and renovated. Taking on partners is always a balancing act between acquiring the necessary capital and retaining control over your projects. Determining exactly how much control you are willing to surrender to access the funding available through equity financing is an essential step in determining whether debt financing or equity financing is the right choice for your project.

Convenience Advantage: Debt Financing

Opting for debt financing can provide you with added convenience when managing your hotel construction financing requirements. In many cases, you will have a greater range of options to choose from when selecting debt financing over equity financing. The process for debt financing is typically faster than that associated with equity finance arrangements, which can sometimes drag on for months while the various stakeholders and investors in your project provide the required information and funding needed to complete this process.

Access Advantage: Equity Financing

Business loans acquired through debt financing typically require an unblemished credit record and solid collateral for approval. By contrast, equity financing can be acquired through private investors who may not be as particular about the track record of the other investors. Because they are making an investment in a property rather than a borrower, equity investors can often overlook minor problems with cash flow and credit problems in the past.