U.S. Hotel Construction Spending is up Over 30% from Prior Year

Demand Drives Construction Spending

by Terry Stidham

According to Kermit Baker, chief economist with the American Institute of Architects, spending in the hotel industry through July was up nearly 30% to $15.2 billion. The increase far outpaced the other commercial/industrial sectors of commercial (+1.6%), manufacturing (+0.2%) and office (-2.1%), he said during a Reed Construction Data webinar titled “The 2014 outlook: Emerging opportunities for construction.”

Baker said architecture firms are also beginning to slowly build up their project backlog levels, a sign that more work is coming in. The AIA’s Architecture Billings Index for September registered a 54.3. Any score higher than 50 indicate billings growth. “Design activity is clearly pointing to an uptick in construction activity,” Baker said.

Bill Wilhelm, executive VP at R.D. Olson Construction, said he is seeing more interest in ground-up development.

There were a total of 2,767 projects comprising 333,775 rooms in the in construction, final planning or planning stages as of September, according to data from STR, parent company of Hotel News Now.

R.D. Olson is commencing construction on the $45-million, 100-room Bicycle Casino Hotel in Bell Gardens, California. Construction on the nearly 118,000-square-foot hotel is expected to be completed during the first quarter of 2015. “We’re seeing more ground-up opportunities over the next six to eight months,” he said. “People want to get off the shelves and get into the dance.”

Marty Collins, president and CEO of real estate investment and development company Gatehouse Capital Corporation, said he has noted a pickup in the amount of the sector’s activity. Much of the hotel construction focus has shifted to select-service hotels, which is what largely comprises Gatehouse’s pipeline, Collins said. The company is looking at markets including Houston, Dallas and Fort Worth, Texas.

“Clearly, you’ve seen supply increasing. The difference today is there is a little bit more of an urban focus,” he said.

Debt Availability


Some lenders are loosening the reins on their underwriting standards relating to construction financing but not doing so in large numbers.

According to the “Federal Reserve Board senior loan officer opinion survey in July,” 76% of respondents said their credit standards were unchanged, with 18% saying standards had eased and the remaining 6% reporting tighter standards. By comparison, 50% of respondents reported stronger demands for loans; 42% said they were seeing the same level of loan demand; and 8% said there was weaker demand.

The lack of movement in underwriting is a surprise given how tight lenders were with credit during the downturn, Baker said. “Modest easing is still a little disappointing.”

Renovation financing is a little easier to come by than new construction, which is proving to be difficult for many, Cicero said.

Most of the debt that is available comes by way of regional banks, Collins said. Increasing performance within the sector is helping to smooth some of the fears lenders might have when approached about a potential project, sources said.

Regardless, “terms are challenging,” Wilhelm said of the debt developers are able to find.

Points of Emphasis

While there are some new builds going up, a lot of the activity today is related to renovation projects, sources said. Owners are still trying to get caught up on their property improvement plans, which are driving a lot of the action.

Cicero said brands are no longer as forgiving about pushing PIPs off as they were during the downturn. “Now they’re seeing the need to get back on it.”

Much of the work is focused on infrastructure improvements, Cicero said, including heating, ventilation and air conditioning; lighting systems; power; and mechanical.

Wilhelm said guest-facing areas are also seeing work, such as lobbies, restaurants and meeting rooms, for instance.

As for costs, Wilhelm and Cicero said they have seen slight increases in raw material prices, but nothing dramatic. Cicero said the increases amount to about the cost of inflation—2% to 3% cost increases a year.

“Nothing that’s too far out of line,” Cicero said.

A bigger concern is finding skilled labor and planning for the project, he said. “It takes six months to a year from the time you start planning to the time you start working in the building.”

Looking ahead, Wilhelm said he expects the recent spate of hotel construction spending activity to continue, especially as the overall industry recovers.

“We see a good environment for the next three years,” he said.

Financing for Hotel Construction is Pouring In

Financing for Hotel Construction is Pouring In

Damian Ghigliotty with The New York Observer recently posted the following post in the Mortgage Observer

“When New York’s largest independent hotel developer and owner, BD Hotels, began exploring sources of capital this year for its latest projects, the company’s co-founders decided to diversify their approach to construction financing due to a growing of number of potential lenders. 

Richard Born and Ira Drukier, who partnered in 1986 and now own and operate 25 hotels in New York, including the Maritime Hotel in Chelsea and the Bowery Hotel in the East Village, are in talks with a foreign investor to provide secondary capital for an upcoming development in Midtown, while sticking with a traditional bank for their first construction loan. 

“There’s just so much money being designated for New York City hospitality now,” Dr. Born, who did four years of surgical residency before going into the real estate business, told Mortgage Observer. “Especially with all of the foreign sources coming in.” 

New York, the country’s premier hotel market, is a ripe financing field for developers with enough experience, brand recognition and equity of their own. At the same time, new entrants coming into the hospitality financing market and the return of traditional lenders have spurred more hotel deals throughout the United States. That increase has most recently led to a major uptick in hotel financing in secondary markets, from New Orleans to Cincinnati. 

Hotel loans made up about $5.7 billion of multiborrower securitizations in the first three quarters of 2013, more than double the $2.5 billion of hotel loans contributed to conduits in the same time period last year, a recent study from Cushman & Wakefield shows. Overall, the number of active lenders in the hotel sector today has increased by about 20 percent in the past year, said Ernest Lee, director in the global hospitality group in the equity, debt and structured finance division at the New York-based real estate services firm.
 

On top of growing interest from alternative lenders and foreign investors, many regional and national U.S. loan originators and brokerage firms are expanding their hotel financing platforms in 2013. “There is a tremendous increase in appetite for hospitality lending,” said Jared Kelso, managing director of Cushman & Wakefield’s global hospitality group, which arranges debt and equity for hotel owners. “We’ve seen the market for transitional assets, or bridge lending, almost double in size, which is incredibly important for the hotel industry. On top of that, we’ve seen over 10 new whole loan platforms for transitional assets enter the hospitality space this year alone.” 

In April, Mr. Kelso’s group closed a $55 million floating-rate acquisition loan from Natixis Real Estate Capital for the Hyatt Union Square hotel at 134 Fourth Avenue, among other hotel deals they could not discuss publicly. Mr. Kelso noted that hotel construction financing from banks and other lenders is also picking up as many of them are being pushed into the hotel space for better yields due to “intense competition to lend on other asset classes, such as Class A office buildings.” 

But even as capital has started to flow into hotels again, borrowing is still not as easy as it was prior to the financial crisis, Dr. Born said. “The debt market today is clearly head and shoulders above where it was in 2009 when there was no debt market,” he explained. “But it is still not as frothy as it was at the peak of the market in 2007. 

Michael Nash, chief investment officer of Blackstone Real Estate Debt Strategies, echoed that sentiment, adding that large construction loans are still a challenge for many developers to get. “New York as an exception has actually had a decent amount of supply, but in other major markets it’s harder to build new hotels. The numbers are hard to justify,” Mr. Nash said. “The financing on the construction side is still virtually impossible, so it makes it easier for us to pick and choose our spots.” 

Hotels, by and large, are considered the riskiest real estate asset class to lend on due to their operating models. The average hotel’s occupants move in and out on a nightly to weekly basis, making each month’s income that much more uncertain and upkeep that much more costly. Even in top markets where occupancy remains high, significant capital is required every four to five years to keep a hotel’s maintenance up to standard, according to the hotel developers and financiers Mortgage Observer spoke to. 

“It’s an extremely variable model and is subject to peaks and valleys more than any other real estate asset class,” Mr. Kelso said. “So the net operating income available to pay debt service can go from three times debt service coverage to a fraction of that in the space of a year.” 

As a result, transitional floating-rate capital has always been a vital component of hotel financing. Before the market collapsed in 2008, there were a large number of domestic banks and international lenders providing floating-rate loans to the hospitality industry. Many of those lenders—Capmark Financial Group and Hypo Real Estate Holding among them—shut down their financing platforms in 2009, making it that much harder for developers to secure loans for construction, as well as for less risky upgrading and refinancing, Mr. Kelso noted. As commercial real estate lending as a whole started to pick back up in 2011, fixed-rate capital available for stable hotels came back first, he said. 

The pool of those willing to finance hotel projects in October includes private equity, local, regional and national banks, life insurance companies and both floating-rate and fixed-rate CMBS lenders, as well as mortgage REITs, debt funds and foreign investors. As of late 2013, about 85 percent of the lenders that were active in the hotel-financing space prior to the downturn have returned, hotel financing experts say.” 

Hotel Finance News

Financing Your Next Deal

Hotel Construction and Investments continue to  show signs of increased activity. Since the middle of last year lenders have been experiencing an increase in loan applications. Investors feel the time is right to get back into the market. But if you haven’t financed a hotel within the last couple of years, don’t assume your past experiences will guide you through the process. Today’s hotel lender market is vastly different than it was a few years ago.

 

10-20 percent down payments are still out there, but you have to know where to look and be prepared to provide required documentation. Some lenders are starting to look for more skin in the game. SBA lenders are requiring 20 percent plus down. Acquisitions that are in some form of distress and borrowers seeking funding for turnaround properties should be prepared to invest 30-35 percent equity in the transaction. Fundamentals of the market, i.e. occupancy, location, RevPAR, as well as an increased percentage of equity will most likely become the norm in the future, even from strong borrowers.

 

National lenders are seeing sophisticated owners and developers seeking funding for their hospitality projects outside of their usual sources as many local and regional banks have ceased originating hospitality loans.

 

In 2009, local and regional banks originated approximately 65 percent of all hotel loans. That number has now dropped to 37 percent. Conduit lending for commercial mortgage-backed securities (CMBS) for hotels, which for the most part were nonexistent for the past two years, are now beginning to start up. Insurance companies are also financing hotels again basically because they perceive the bottom of this recession has passed.

 

Presently, government agencies are originating a very small fraction of hotel loans. The government is providing some guarantee for investors buying pools of first liens in front of 504s. As that market develops, and if it becomes a healthy market to sell those loans, then lenders will certainly get back into the 504 market. There are some costs to investors to get that government guarantee and those costs will have an impact on the prices they’re willing to pay for those loans.

 

Government guarantees will be crucial for the 504 program; however, it will be interesting to see if costs to investors will trickle back to the borrower in the form of higher rates.

 

One of the most dramatic changes of the last few years is the significant decline in the number of lenders originating hotel loans. Some lenders have chosen not to do so, others were deemed by Federal Bank regulators to be too heavily exposed to that property type, and still other lenders are simply out of business or were taken over by the FDIC, or forced to be sold to another bank by the FDIC. Reduction in the number of lenders making new hotel loans means those who are still active in hotel financing are being presented with many more loans than they can take through underwriting and close. This puts lenders in the unique position to cherry pick only the loans with the strongest borrowers, or hotels with strong debt service coverage ratios and those loans where all parties including borrower, seller and brokers are totally co-operative.

 

The underwriting process has become more thorough with an expectation to have your paperwork complete and in order. Would-be borrowers or sellers need a responsive, cooperative attitude. They may get frustrated with all of the lender’s requirements for well written, organized and detailed documentation, but this is the new reality in hotel financing. Key information parties seeking hotel funding should have in hand includes: who is in the partnership group, a clear understanding of the group’s hotel experience – good hotel experience is big plus in today’s market, personal financial statements and tax returns for each of the group’s partners, financial statements and tax returns for other businesses in which the partners have ownership. Overall financial strength and experience are very important to lenders today.

 

Lenders and advisors are working harder today than ever before to make a deal work and close on new loans for hotels.

 

In short, things have changed dramatically. There are far fewer lenders with much stricter underwriting documentation requirements. Capital markets are operating under closer government scrutiny and tighter regulations. There are fewer loan programs available and often requiring more cash down. With fewer lenders and fewer loan programs there are fewer dollars available for hotel financing. To achieve success in this new reality of hotel financing, borrowers should work with only very experienced hotel funding professionals – whether a hotel mortgage broker or a direct lender.

 

 

CAPEX is Set to Exceed Recent Record

Hotel CAPEX is Up for '13

 

The Epicurean, a new 137 room hotel in Tampa by Marriott



The U.S. hotel industry is expected to spend $5.6 billion on capital expenditures this year, exceeding the most recent record of $5.5 billion set in 2008.



The information comes from research by Bjorn Hanson, the divisional dean of the Preston Robert Tisch Center for Hospitality, Tourism and Sports Management at New York University.  Hanson estimates that one-fifth of hotels will receive improvements this year, up from 15 percent in a typical year.

Investors and management companies that waived spending to offset lower profits in a weak economy are now looking at projections showing a much healthier outlook. Occupancy this year is expected to be at its highest level since 2007, while industry profits will be a record $46 billion.  

The MGM Grand in Las Vegas just spent $160 million and 11 months to completely redo 4,200 rooms and suites. The renovation added sustainable features such as LED lights, more efficient thermostats, solar shades, upgraded faucets and showers, and 100 percent biodegradable bath amenities. That staggering cost does not include the many other elements of the resort’s “Grand Renovation,” including the addition of a five-story nightclub, a new restaurant by celebrity chef Michael Mina, major casino upgrades, a new comedy club, and much more.

In a recent survey, 57 percent of travelers said they often make eco-friendly travel decisions. To meet this growing demand, hotels, airlines and rental car companies are working to implement strategies that take the environment into consideration, according to a report in HotelManagement.com.

Two of the world’s urban grand hotels, London’s Savoy and Paris’ Ritz, both have undertaken renovations so dramatic they require closing completely for two to three years.

Closer to home, the Ritz-Carlton Laguna Niguel on the Pacific coast in Los Angeles is marking its 30th year with all new pale blue and white guestrooms and more. The hotel’s location was the source of inspiration for the new design.

Hotel Pipeline

The ten largest hotel brands are on the move: with more than 10,000 new hotel rooms Hilton has the strongest growth, which is even higher as the growth of the industry leader Holiday Inn/Holiday Inn Express with just 7,700 new hotel rooms. This data has been revealed by a current analysis of TOPHOTELPROJECTS (http://www.tophotelprojects.com), the worldwide leading provider of global b2b hotel data.

Holiday Inn/Holiday Inn Express by InterContinental Hotels Group (IHG) remains at the first place of the ten largest hotel brands in the world with a large distance. Follower Best Western grows as quick as Holiday Inn - 4,700 hotel rooms arise internationally but with currently 311,000 existing hotel rooms Best Western is clearly behind the first place.

Hilton, the large and strong brand by the same named US hotel company (which will be brought back to the stock exchange in 2014) is going to pass the brand Comfort Inns & Suites by Choice Hotel and it will reduce the distance to Marriott. Hilton Worldwide is the second largest hotel group so far and therefore is ahead of Marriott International and just a bit behind IHG. A second hotel brand by Hilton which is growing also very strong is Hampton Inn by Hilton.

Place - Hotel Brand - Hotel Group - new hotel rooms at hotel construction projects - number of existing hotel rooms/hotels 
1 - Holiday Inn/Holiday Inn Express - IHG - +7,719 rooms/23 - 424,612/3,392
2 - Best Western - Best Western - +4,775/30 - 311,611/4,024
3 - Marriott - Marriott Int. - +7,050/53 - 204,917/558
4 - Comfort Inns & Suites - Choice Hotels Int. - +196/1 - 194,262/2,509
5 - Hilton - Hilton Worldwide - +10,098/60 - 191,199/551
6 - Hampton Inn by Hilton - Hilton Worldwide - +3,901/29 - 184,765/1,880
7 - Ibis/Ibis Style/Ibis Budget - Accor - +1,978/18 - 182,496/1,667
8 - Home Inns - Home Inns - 0/0 - 164,325/1,438
9 - Sheraton - Starwood Hotels - +5,574/25 - 14,784/427
10 - Days Inn of America - Wyndham Hotel Group - 0/0 - 147,808/1,826
(Source: tophotelprojects.com/MKG Hospitality)

 

If you have a hotel construction project that needs funding then contact me - info@targetsearchgroup.com or 954.439.0612

Top 4 Hotel Financing Obstacles

Do You Have Upcoming Hotel Financing Needs?

Hospitality Net recently posted this blog by Brian Holstein:

Do you have upcoming hotel financing needs? Whether you are in the market for a simple refinance or acquisition financing, a discounted-payoff (DPO) financing or a PIP-induced recapitalization, the same rules apply.

The hotel loan market has been on a good run for the last twelve months with competition among lenders heating to a point not seen since prior to the financial crisis. Lenders are beginning to focus increasingly on areas outside of pricing and leverage in order to preserve loan profitability and keep mortgage leverage below the aesthetically pleasing 70% loan-to-value level.

Simply Put, What This Means For Hotel Loan Borrowers Is That Lenders Are Willing To Listen To Your Story, Now More Than Ever, To Win And Close Your Business.

The following list identifies the top 4 hotel financing obstacles and advice on how to approach them:

1. NOI UNDERWRITING ADJUSTMENTS Unfortunately, the borrower's NOI doesn't aways look like a lender's NOI. Lenders implement a series of underwriting adjustments to determine an "underwritten" NOI. Below are the most common adjustments.

• Occupancy Adjustment– Lenders are reluctant to underwrite occupancy levels above 75%. There are certain markets, particularly those with high barriers-to-entry (New York City), where this rule may not apply or carry a higher threshold. The reason for the threshold is because hotels operating at or above 75% occupancy are typically in markets that have latent demand which may lead to future new supply and pressure on market-wide occupancy.      

It is in an owner's best interest to push ADR in lieu of occupancy prior to a financing. Lenders will not adjust ADR upward to offset a downward occupancy adjustment, so be prepared to do that yourself. Lenders will correspondingly drop variable expenses associated with the lower underwritten occupancy to help offset the downward adjustment.

• FM&M (Franchise, Marketing and Management) Adjustment– Some lenders will underwrite a minimum FM&M expense as a percentage of revenue. For full-service hotels, the minimum is approximately 12.0% and for limited/select-service product, the minimum is approximately 14.5%. Included in the FM&M calculation is the management fee which most lenders will underwrite at a minimum of 3.0%. The FM&M adjustment typically comes into play on owner-operated and un-flagged hotels. A case can be made to waive the adjustment if the historical FM&M expense has been consistent over the years, the hotel is performing near the top of its competitive set and there is no new supply anticipated in the market.
• FF&E (Furniture, Fixtures & Equipment) Adjustment – The standard FF&E adjustment made by lenders today is 4.0% of revenue. Lower adjustments can be made for new or recently renovated hotels. There is a difference between underwritten FF&E and the amount of actual FF&E reserve that will be collected by the lender. It is often easier to negotiate a lower actual FF&E collection than it is to negotiate down the underwritten FF&E for the purposes of loan sizing and pricing. Presenting and explaining a detailed schedule of recent capital improvements is important ammunition to effectively present your case for lower reserves.

2.   RECESSIONARY BATTLE SCARS It has become commonplace for borrowers to have at least one, or multiple, instances of default, workout, foreclosure or bankruptcy as a result of the most recent recession. Prior to the recession, most lenders would avoid such borrowers. Nowadays, if lenders took that same stance, there wouldn't be a whole lot of qualified borrowers.

The foremost question that arises when underwriting the above situation is whether or not the sponsor "played nice" in such times of distress. It is our job to help craft an explanation in a manner that is easily digestible and viewed favorably in the eyes of a lender. Almost every financing we have worked on post-financial crisis included one or more of these stories. We have been successful, without exception, at telling that story and getting credit approval.

3.   LOAN TERM FRANCHISE EXPIRATIONS With an exception for recently constructed hotels, it is often difficult to execute franchise agreements with term in excess of ten years. This poses a problem when seeking five or ten-year permanent financing. Lenders are reluctant to take on the risk that their collateral will be down-flagged or become un-flagged during the term of the loan or at the time of maturity.

A cash flow sweep structure can solve this problem. The sweep is triggered by a non-renewal of the franchise agreement prior to the franchise expiration. The sweep is a temporary mechanism, with all swept cash returned to the borrower once the franchise agreement is renewed and there are sufficient funds available to pay for an associated PIP.

4.   PREPAYMENT PENALTIES Prepayment penalties typically come in the form of yield maintenance or defeasance. Prepayment penalties make it more difficult to take advantage of cap rate declines, as the penalties become more costly as interest rates decline. Below are the most effective ways to mitigate prepayment penalties:

• Loan Assumption – A loan assumption option allows the borrower to sell the hotel encumbered by its existing debt. Although slightly lower leverage and a higher than market loan interest rate may detract from a hotel's value, it is less costly than paying a prepayment penalty to sell a hotel unencumbered. This is almost always true, as yield maintenance and defeasance penalties are discounted at the risk-free rate (U.S. Treasury Rates), whereas a loan interest rate includes additional spread above treasury rates.
• In a rising interest rate environment, a loan assumption will add value to an encumbered sale by allowing a new buyer to take advantage of a lower than market interest rate for the remainder of the existing loan term.
• Additional Debt– Lenders are beginning to allow for the ability to add additional debt post-closing, usually in the form of mezzanine financing. In an encumbered sale scenario, as discussed above, this allows a new buyer to assume the senior financing and "right-size" the loan by adding additional debt at closing. This minimizes or eliminates the discount to market value a seller would otherwise have to accept, particularly in a declining interest rate environment.
• Lengthening the "Open Period"– Most non-recourse hotel loans include a 90-day period at the end of the loan term with which loans can prepaid without penalty. Lenders have the ability to price in longer open periods, with the cost varying amongst lenders. A borrower can think of this structure as having a loan with a shorter term and built-in, prepaid extension options

 

New Hotel Construction Financing

Experience Counts 

There are 20% more rooms under construction today than there was a year ago, 90% of them are in hotels with 200 rooms or less, and 65% of them are in the upscale or upper-midscale segments. 

Money is available for hotel/ development construction for borrowers who have experience in the business and a solid track record of performance.  Newcomers to the industry need to team-up with experienced owners or operators to improve their chances of securing financing. 

Favorable financing is available for nearly any kind of hotel/ development project—conversions or new construction, branded or unbranded, gateway city or secondary market—but if you don’t have solid experience and a strong track record in the business you still may be able to secure financing, but at a much higher rate.  

Lenders really like hotels again. As an asset class, hotels have outperformed every other major class in commercial real estate in the past 18 to 24 months, and it continues to outpace even what some had considered being lofty expectations.    

Lending is loosening for a number of reasons, the most important of which might be the performance of the hotel market.  

The industry is realizing some of the strongest margins experienced in a long time because operators are able to push (average daily rates), and occupancies are at an all-time high. The fundamentals are strong, so from a (hotel) owner’s standpoint it’s an awesome time to be in the market.
 
While money is plentiful, most lenders still want to deal with borrowers who have experience in the business or can partner with a seasoned hotel veteran.

Lenders want to work with people they know are going to be successful, and there are too many other opportunities to place (financing) to bother with a developer who may not be able to make a successful project.  A newcomer to the industry is advised to team up with someone who has developed or operated hotel assets previously. It’s the best way to cut your teeth in this business.

NEW DEVELOPMENT
Developers looking to build new hotels should be able to attract financing, even for projects in secondary and tertiary markets and for boutique and unbranded hotels.

We have sourced two major lending sources that are providing up to 100% non-recourse financing that can include the acquisition of the real estate. A 10% deposit of the loan amount is required and is refunded upon completion of the construction. 

Contact Us Today for Free Suitability Assessment of Your Project

To keep our underwriters happy we have to be selective for whom we will source loans. The key driver is the experience of the sponsor and or his team. We have spent a lot of time trying to get developers first hotel deals bought; the odds improve greatly with two or three under their belt.

A lay up for us is a strong, flagged project in a heavy business demand generator market.

While branding is important to most lenders, not all projects need to be chain-affiliated. At one time many lenders only considered projects with top-tier brands, but recently we are seeing a number of successful non-branded hotel loans.

There are some other secondary markets where the barriers are low, but this is a whole different kind of animal. More hotels are opening all the time, as are apartments, where many of the people who live in hotels today are moving.

Lenders are very prudent with the deals they’re doing and the sponsors they’re lending to. Many of the deals that we are getting done are typically big, landscape-changing projects, not deals done by local lenders. The market is very discriminating as to what will get built.  We submit to underwriting only about 20% of the new hotel development projects that we review. Approximately 80% of those packages will get financed. These deals take a lot of time, and some (developers) may not realize the scrutiny involved. Many people don’t understand that construction documents need to be about 70% done before a lender will issue a term sheet.

We would be glad to provide a free review your project today to determine suitability for our underwriters. Call or email me at 954.439.0612 - tstidham@targetsearchgroup.com