Hospitality Lending: Whose Market?
As the economy continues its upward trajectory, hotels are enjoying the benefits of strong demand from both personal and business travel. Despite these solid operating fundamentals, many lenders are apprehensive about the record length of the current economic expansion and the impact that a future downturn may have on room rates and occupancy levels. In response to these growing fears, many capital sources have either tightened their lending criteria or decided to cease hospitality lending all together. As traditional sources of financing retreat, hospitality owners have had to look far and wide for lenders that remain receptive to this asset class. This has created opportunities for lesser-known sources of capital, like Chicago-based Alliant Credit Union, to finance high quality properties.
By going against the trend and utilizing internal specialization, Alliant has been able to exercise a level of selectivity that a more crowded field prevented until recently. This has resulted in loans on well-located properties with demonstrable operating results that are run by highly experienced owners with the financial resources to withstand a downturn. The emergence of non-household name lenders has enabled an accomplished subset of borrowers to access needed liquidity and obtain favorable loan terms in light of the broader market circumstances.
Overcoming the Risk
Hotel financing is typically seen as a higher-risk asset class, resulting in higher margins and lower leverage, although lenders historically earmark less of their lending portfolio to the hospitality sector. These factors, combined with many lenders tightening their structure criteria in hospitality, have created opportunities for some.
“Alliant, like most lenders, has a percentage of capital allotted for hospitality lending,” says Tim Madigan, commercial loan originator at Alliant. “So, we’re highly selective when it comes to partnering with a borrower.”
The current nature of the hotel lending market, combined with the types of hotels that Alliant focuses on — higher-end flags in strong destination locations — allows the credit union and other venturesome lenders to choose from the best financing prospects to capitalize on higher margins and successful loans, Madigan says.
Even though hospitality lenders will pass on underperformers and outlier hotels, Alliant still has a robust underwriting process to ensure a successful loan partnership. The credit union’s due diligence includes performing expense and revenue analyses to ensure adequate reserves are available for continued property upkeep and maintenance, a break-even analysis to determine the property’s resilience if occupancy takes a hit, as well as evaluating the property’s upside.
Being highly knowledgeable in the hotel sector is crucial to originating and underwriting loans, and Alliant’s nationwide experience and expertise in the marketplace gives it the competitive edge to understand many of the niche markets across the country; in particular, how the hospitality sector is affected by economic cycles and performance. With short-term guests, hotels are usually one of the first markets to experience the effects of an economic downturn with drops in occupancy.
Although Alliant typically looks for higher-end flagged hotels in good locations operated by owners and managers with vast track records of success, its flexible financing and research-intensive approach allows it to explore unique properties with particular structure needs. For example, Alliant recently provided financing for a unique hotel located within the Disney corridor of Orlando in which the hotel is branded as an economy flag.
Flexibility for Borrowers
While hotel financing is considered a higher-risk asset class, Alliant’s underwriting process gives the credit union confidence in providing lending for hotels that meet its standards and benchmarks. The credit union uses due diligence and research coupled with a borrower’s resume to understand the potential risks and success of any proposed financing partnership.
This approach also enables the credit union to have the confidence to offer more flexible loan terms for borrowers who pass its underwriting criteria. Madigan notes that Alliant offers flexible multi-year financing packages; the ability to get out of a loan, if needed to sell; and the option for additional earn out financing for property improvements or other needed funding, if necessary.
The Borrower’s Advantage
The current lending environment for the hospitality sector is fragmented, but borrowers and lenders still want to lend in this asset class. However, with money from traditional lenders decreasing, institutional and non-traditional lenders are investing more and more into the sector because it continues to show its viability and resilience, even though the hotel market is typically the first to see the effects of an economic downturn.
This combination means it can be competitive to garner financing, so being prepared is key to finding a financing partner. Alliant is currently doing more non-recourse loans in part due to lower leverage, and looking to invest in the hospitality market by competing on the best opportunities, explains Madigan.
For example, earlier this year the credit union placed a loan for a boutique hotel that had recently come online in Detroit. Madigan says that even though the hotel was new, the property was performing on a stabilized basis with a sponsor that had a successful track record of developing and managing hospitality assets, and was also willing to stand behind the property.
“The track records of the operator and manager and property’s location and performance are critical pieces to the financing puzzle,” Madigan says.
Tips for Hospitality Borrowers
Alliant Credit Union and Madigan offer the following tips for hospitality developers and operators seeking financing.
Tip #1 – Tell your story
Share your successes, future plans, concerns, etc. For most lenders, the more information, the better. The good, bad and ugly will come out during due diligence, and lenders prefer borrowers to be upfront and honest.
Tip #2 – Knowledge is power
Choose a lender with a proven track record of execution and experience in the hospitality sector. Financing partnerships with lenders who understand the market will ultimately ensure a more successful lending experience.
Tip #3 – Flexibility
What type of flexibility do you need or want with the loan? Is the asset a short-term or long-term hold? Carefully consider these factors before partnering with a lender.
Tip #4 – Property Improvement Plans (PIP) and Maintenance
Is there a PIP currently required by the franchisor and how intrusive is it? How much deferred maintenance?
Tip #5 – Location and Performance
If looking to invest in the hospitality market, lenders are typically more favorable to hotels in good locations with strong metrics that can weather a downturn in the market. How did the asset perform during the last downturn?
— By Amy Bigley Works, staff writer. This article was written in conjunction with Alliant Credit Union, a content partner of REBusinessOnline.