Perspectives on Hotel Financing
|The cost and availability of capital have an enormous affect
on the hospitality industry, with far-reaching implications for property
liquidity, values and new supply. Given the importance and recent shortage
of financing to the industry, GHG Chairman Jim Butler interviewed two of
the most consistently active players in hotel finance to hear their perspectives
on hotel financing in 2001, critical issues today, and case studies on
deals that are still getting done. Here is that interview with Jerry Earnest
of GMAC Commercial Mortgage and Frank Anderson of Westdeutsche Landesbank
Jim Butler: In October 1998 Criimi Mae - the buyer of the riskiest portion of securitized loans - filed bankruptcy and withdrew from participation in new financings. Securitization of hotel and other real estate loans bogged down and major Wall Street firms gagged on billions of loans they intended to pump out to investors through conduits. While commercial real estate lending has generally recovered, hotel lending is still operating at a greatly reduced pace. There are now dramatically fewer hotel lenders, hotel loan rates are higher, more equity required, tougher underwriting apply, and construction financing is particularly difficult to find.
Jerry, your firm has been one of the few to be consistently in the market for years. Where does it go from here for the next 12 months or so?
Jerry Earnest: At GMACCM, we agree with the widely held view that the economy is finally slowing. Weaker economic growth will ultimately translate into reduced growth in demand for hotels as we move into 2001. The impact will vary considerably from market to market. Notwithstanding the softening hotel operating environment in many markets, we believe that there will be numerous good lending opportunities for hotel properties in 2001.
Lenders will continue to use the slightly more conservative underwriting criteria of the past year. Stabilized hotel properties will remain more attractive than properties with limited or no operating history, including development properties. Full service hotel properties will continue to be received more favorably by lenders than limited service (although this trend has been too indiscriminate - both ways!). Experienced, well-capitalized hotel operators will continue to be important to discerning hotel lenders. GMACCM will continue to be active across-the-board with permanent loans, interim loans, forward commitments for interim loans, construction mini-perm loans and mezzanine loans in 2001.
Butler: Frank, WestLB is another one of the few players that has been consistently in the market for years as a serious hotel lender and one that remains committed to significant hotel development projects. Where do you see this going and tell us about the "silver lining."
Frank Anderson: Liquidity continues to be very tight for development transactions. Debt providers for financing project loans are limited. Not too many new players are entering the market. Existing players - including Westdeutsche Landesbank Girozentrale - are seeing concentration issues in select markets, limiting the ability to increase exposure and some institutions are saying that they are pretty full on hospitality. And that means that larger transactions are struggling as a number of failed syndications have resulted from a lack of lending capacity.
On the equity side, there seems to be an increasing number of equity
players reviewing packages. However, we hear on a second-hand basis that
the money is so expensive and opportunistic that not very many deals are
Our exit strategy on development deals depends on low leverage. As we are admittedly late in the economic cycle and refinance markets are tighter as the conduit players seem to have a lower appetite for hospitality product than in the past. And due to execution problems, the prevailing attitude is that many sponsors are reluctant to do business with conduit players.
Butler: Frank, our Global Hospitality Group is working with select developers of major hotel projects in gateway cities and destination locations all over the country. You and WestLB are one of the first we think of and recommend to our clients when we think it might be of interest to you. But even with great demand for construction lending, WestLB is very selective in the handful of credits it accepts. What does it take to get a deal done and what is your appetite for 2001?
Anderson: Well Jim, first it really helps when we get a referral from a quality source we have confidence in, like you and your Global Hospitality Group. We have to make an intelligent and effective use of our limited resources, and that is a little easier when you know the source is knowledgeable and won't waste our time.
In development deals, the transactions that will get done will have relatively short tenures maxing out at about five years including construction and mini-permanent phase. They will have minimum equity of 40 to 50%. It will be essential to have the equity raised before approaching syndication markets. This is difficult because the equity, with a classic "chicken or egg" problem, want to know the debt is there. But you need strong sponsorship with good banking relationships. It is very helpful if sponsors can provide a least one local line bank to the syndication group.
WestLB has decided to target hotel financing opportunities on a very selective basis. For the year 2001, WestLB may lead up to six financings, of which four or five might be development projects.
Butler: Jerry, when you look into your crystal ball, where do you see hotel financings going from here?
Earnest: Financing for hotels probably gets slightly, but not materially, more conservative over the next year. The type of loan, most likely, will determine the general availability of capital. The securitization market should remain reasonably friendly to permanent and interim loans on full service hotel properties. Many lenders are active in this area. Limited service hotels should continue be in disfavor in the securitization market, as well as with other capital market sources.
The risk of potential downgrades to previously issued securities because of the declining performance of hotel loans, remains a risk that could make the capital markets more unfriendly to hotel loans in 2001. While most of the bad news in this area is probably out already, the likelihood and effect of further bad news is unknown.
Development loans will remain difficult to obtain, with more conservative criteria imposed on such properties, particularly in the "wrong" markets. Large development projects, already extremely difficult to finance, will most likely continue to be hard to finance.
Butler: Jerry, I can't remember a time since 1993 when such massive equity and strong sponsorship - the people behind the deal and the credit request - have been so critical in hotel financing. Frank mentioned these factors too. How do you see these issues?
Earnest: Sponsorship is the single most critical factor for GMACCM in making new hotel loans. The sponsorship issue consists of the track record, operating capabilities and credit considerations of a potential client. In order to illustrate that point, for many of our repeat clients, the equity and recourse requirements are no different today than two or three years ago, despite the more restrictive lending environment.
After sponsorship, the issues of equity, recourse, brand, location, market and others, depend on the overall structure of the transaction. For example, while we have a preference for hotel properties with strong brands, we continue to lend actively on high quality, independent hotels with a good history of performance, and of course strong sponsorship.
However, some markets may be too soft for new loans at levels that make sense for the hotel owners, particularly development loans. Some firming in these markets may be required before liquidity returns in a major way. A number of major hotel markets will remain out-of-favor with many mainstream hotel lenders in the current environment.
Butler: Frank, what do you look at in evaluating your loan applications?
Anderson: We look to the following criteria:
Butler: JMBM's GHG has seen the inside of about a dozen successful hotel finance deals in the last year, and we are working on several right now. While every deal is different, please give us a representative example or two from your current or recent transactions.
Anderson: Consistent with the criteria listed above, WestLB has recently arranged a couple of representative transactions. One is a development transaction and one a refinance.
St. Regis Monarch Beach is an approximately $240 million development in Dana Point, California where WestLB arranged $125 million in debt for a 400-key five-star hotel and spa on the water, approximately 65 miles south of the LA airport. Starwood, as operator, has an excellent strategy to market the triad of the Los Angeles St. Regis, the Phoenician and the St. Regis Monarch Beach Hotel to large business groups. The development team includes Capital Pacific Holdings, an AMEX traded luxury residential and commercial developer. Given the difficulty with development along the California coast, it would appear that there are significant barriers to entry and the market has significant name recognition as a result of the existing luxury project in the market, the Ritz-Carlton Laguna Niguel.
In November 2000, WestLB arranged the refinancing of the Lowell Hotel in New York City. The Lowell is a 68-key 124-room hotel that based on physical characteristics would appear to be a boutique hotel, yet based on its competitive set and high RevPar, it truly is a luxury hotel competing with the likes of the Pierre and Four Seasons. The sponsors have consistently favored low leverage and therefore enjoy significant cash flow after debt service to grow their real estate activities.
The project is characterized by a very high level of service. The most impressive amenities include as a conversion of a residential project the high number of suites and rooms with working fireplaces. The conversion took place in 1984 and WestLB had a trailing 72 months to look at when the loan was originally closed and it has been refinanced on several occasions representing a rare case where we have made a relatively long-term investment.
Earnest: We have had a steady increase in all types of hotel loans since early this year. In fact, our volume for fixed rate, permanent loans now exceeds 1997 and 1998 levels by a substantial margin. We also continue to provide considerable short term, floating rate loans and development loans in a variety of different vehicles. Overall, the quality of the properties financed and the sponsorship has improved from prior years.
A recent notable transaction is a $43 million construction mini-perm loan for the renovation of the historic Humble Oil building in downtown Houston. The client is a venture between Historic Restoration, Inc. and Kimberly Clark Corporation. Marriott International also assisted with the project financing. This adaptive reuse project provides for the conversion of the office building into a 191-room Courtyard by Marriott, a 171-room Residence, an 82-unit luxury rental complex and a 249 vehicle-parking garage. The project employs historic tax credits and other creative forms of community support. Besides the obvious complexity, the deal attracted us with the strength of sponsorship, brands and urban location. Hibernia Bank felt the same and is a participant in the loan.
Butler: Frank, in part, this reflects on what you were saying earlier, about liking to work with good referral sources, because if you have the right team, you will take the right steps. But please summarize for us a few tips on how to best pursue hotel financing.
Anderson: First, make sure you have the right people on your team from the outset - pros who know the hotel industry and have plenty of experience with hotel deals. Make sure that your financing package is complete, concise and organized. Have the equity in place.
Focus all your attention on the leading financing players and avoid "shopping" the deal. First look deals get the most attention and give the appearance of freshness that give lead arranger banks comfort that the secondary market have not been adversely impacted. Seasoned transactions are nearly impossible to get placed today.
Check out your arranging bank thoroughly. Retrading continues to be an issue. Best indicator is the desire of the arranger bank to keep a large percentage of the loan on balance sheet.
Postpone leverage strategies until after stabilization. Be prepared to step up with recourse. At today's leverage this should be largely symbolic, as the likelihood of a guarantee call is low.
And be prepared for some sticker shock - these deals are all priced
north of 300 bps.
The Global Hospitality Group(r) is a registered servicemark of Jeffer, Mangels, Butler & Marmaro LLP
Jeffer, Mangels, Butler & Marmaro LLP
web site: http://www.jmbm.com
Email Jim Butler at [email protected]
Jim Butler at the Firm
Jeffer, Mangels, Butler & Marmaro LLP
2121 Avenue of the Stars
Los Angeles, CA 90067
The premier hospitality practice
in a full-service law firm
|Also See:||Outlook 2000 - A Roundtable Discussion / Also: '90s Trends That Didn't Make It - JMBM / December 1999|
|Annual Review of the Mexican Lodging Market / JMBM / March 2000|
|Kleisner on the New Wyndham / Jim Butler Q & A / JMBM / Oct 1999|
|Robert J. Morse: Millenniumís New President / Interview with GHG Chairman Jim Butler / Nov 2000|
|Straight Talk from KPMG's Nardozza / JMBM / Dec 1998|
|Special Reports / Jeffer, Mangels, Butler & Marmaro LLP|