Hotel Lending in 2011 and Beyond
The current inactivity on the commercial real estate lending front is less the result of a lack of funds on the part of banks than the lack of optimism on the part of hoteliers. What can be done to end the stalemate and reinvigorate hotel transactions and development?
by Russ Rivard
As we prepare for the 2011 U.S. Hotel Appraisals Hospitality Conference, one question comes to the forefront: What is the state of lending for commercial real estate projects? I hear almost every day from both lenders frustrated with increased FDIC regulations and hoteliers concerned about the strength of the economy. In the following, we’ll examine the pressures that lenders face in the current environment, especially with regard to smaller regional and community banks, as well as the state of mind among hoteliers concerning economic progress and the demand for rooms.
Regulation, Interest Rates, and the Fed
Today’s lending environment, which was forged in the turmoil of the Great Recession, presents a tough set of obstacles. Increased FDIC regulations in the recession’s aftermath along with borrowers’ damaged credit status have made progress toward securing multi-million-dollar development loans a very tough affair. But the difficulties the industry is experiencing now have their roots in some policy changes that date back ten years.
In 2001, the Federal Reserve began lowering the Federal Funds Rate from 4% to 1%. This resulted in an unparalleled proliferation of both cash and credit into the U.S. economy, so-called “cheap money” that resulted in years of subsequent expansion. The dark lining of this silver cloud, however, was the tremendous increase in consumer debt. The demand for these low interest residential loans from 2001 to 2008 was shared by small business owners as well. As demand increased, lenders’ loan volumes became bloated. According to The Daily Capitalist’s Jeff Harding, “banks were happy to accommodate this debt explosion. Total bank loans spiked from $3.8 trillion in 2001 to about $7.2 trillion in 2008.1
The tipping point came shortly after as real estate values plummeted and loans went into default, leaving everything from homes to hotels skating on thin ice.
The Banking Crisis
The blame for the sub-prime banking crisis can arguably be leveled in equal part at players in the private and public spheres who exhibited short-sighted influence over the commercial real estate markets, especially through aggressive lending and mortgage deals. The fallout from these events has landed heavily on both hoteliers and lenders in today’s marketplace.
Throughout the recession, many smaller community banks found themselves struggling with bad commercial real estate (CRE) loans. Whether banks were too aggressive in growing their CRE lending portfolios and/or ill-prepared to manage the consequences, the outcomes have been alarming. The following chart illustrates the number of bank failures from 2007 through the first half of 2011.
According to the FDIC, the number of failed and troubled banks has only recently begun to decline, even though the recession officially ended over two years ago.
The Local and Regional Banking System
The bulk of the failed lending institutions have consisted of local and regional banks, or LRBs. These smaller and mid-sized banks play a critical role in financing small businesses, including limited- and select-service hotels. The table below illustrates the number of loans made by a lending institution relative to the institution’s total asset holdings.
Of the 6,453 banks in America, the overwhelming majority—the LRBs—have fewer than $1 billion in total assets. These banks provided a significant amount of credit to limited- and select-service hoteliers throughout the pre-recessionary boom and now are struggling to deal with the fallout from many of their residential loans, which have been sold and securitized.
Although large, full-service, “prize” hotel properties are often the exclusive domain of national lenders, which account for 78% of CRE loan volumes, the majority of limited- and select-service hotels are financed by the LRBs. The smaller banks are also more attuned to the specific needs of these hoteliers. Of course, the eagerness of these smaller banks to support CRE development has come at a high price; the high percentage of CRE loans on the books of LRBs reportedly has grown from 60% in 2003 to 74% today.2 Defaults on these loans, combined with the depreciated value of hotels and other assets over the past three years, have caused a disproportionate number of LRBs to hold off on further lending.
The Potential of Hotel Loans: Supply and Demand
On the supply side of lending we have the banks, which despite the continued resolution of the recent crisis are now in a much stronger position to make CRE loans. On the other side we have U.S. hoteliers, many of whom are less than inclined to seek out new loans at all. The chart below, which shows confidence levels among U.S. small-business owners from 1986 through 2010, illustrates why.
The fall in optimism since the downturn is striking. The National Federation of Independent Businesses (NFIB) Optimism Index dropped another 1% in June of 2011, and remains in what the NFIB has termed "recession territory." Without vigorous economic activity generating demand, business owners aren’t willing to start new ventures. It is not therefore surprising that high unemployment rates and the explosive U.S. government debt level have hotel owners frozen in their tracks.
Conclusion
It’s true that some banks are still struggling. But the dearth in CRE lending, which has affected everything from new hotel development to hotel transactions nationwide, reflects in greater part the current cautiousness among hoteliers. Limited- and select-service hoteliers, like so many small-business owners, are deciding to sit tight until the dust settles. The uncertainties in the economy are enough to give pause when it comes to reaching out for capital.
Nevertheless, hotel performance has been trending upward in markets across the country, and it doesn’t pay to sit on the sidelines when you have a hotel venture that’s worth pursuing. One of the goals of the U.S. hotel Appraisals Hospitality Conference is to jump start movement by putting active lenders and active loan-seekers in the same room, providing a forum for discussion that can get viable hotel projects off the ground. We hope you join us as we work to make the process less daunting and more fruitful in all courts.
______________________________
1 - Harding, Jeff. The Small Bank Problem. The Daily Capitalist. Retrieved August 15, 2011. http://seekingalpha.com/article/282616-the-small-bank-problem-why-we-are-40-000-properties-away-from-recovery
2 - Harding, Jeff. The Small Bank Problem. The Daily Capitalist. Retrieved August 15, 2011. http://seekingalpha.com/article/282616-the-small-bank-problem-why-we-are-40-000-properties-away-from-recovery
The current inactivity on the commercial real estate lending front is less the result of a lack of funds on the part of banks than the lack of optimism on the part of hoteliers. What can be done to end the stalemate and reinvigorate hotel transactions and development?
by Russ Rivard
As we prepare for the 2011 U.S. Hotel Appraisals Hospitality Conference, one question comes to the forefront: What is the state of lending for commercial real estate projects? I hear almost every day from both lenders frustrated with increased FDIC regulations and hoteliers concerned about the strength of the economy. In the following, we’ll examine the pressures that lenders face in the current environment, especially with regard to smaller regional and community banks, as well as the state of mind among hoteliers concerning economic progress and the demand for rooms.
Regulation, Interest Rates, and the Fed
Today’s lending environment, which was forged in the turmoil of the Great Recession, presents a tough set of obstacles. Increased FDIC regulations in the recession’s aftermath along with borrowers’ damaged credit status have made progress toward securing multi-million-dollar development loans a very tough affair. But the difficulties the industry is experiencing now have their roots in some policy changes that date back ten years.
In 2001, the Federal Reserve began lowering the Federal Funds Rate from 4% to 1%. This resulted in an unparalleled proliferation of both cash and credit into the U.S. economy, so-called “cheap money” that resulted in years of subsequent expansion. The dark lining of this silver cloud, however, was the tremendous increase in consumer debt. The demand for these low interest residential loans from 2001 to 2008 was shared by small business owners as well. As demand increased, lenders’ loan volumes became bloated. According to The Daily Capitalist’s Jeff Harding, “banks were happy to accommodate this debt explosion. Total bank loans spiked from $3.8 trillion in 2001 to about $7.2 trillion in 2008.1
The tipping point came shortly after as real estate values plummeted and loans went into default, leaving everything from homes to hotels skating on thin ice.
The Banking Crisis
The blame for the sub-prime banking crisis can arguably be leveled in equal part at players in the private and public spheres who exhibited short-sighted influence over the commercial real estate markets, especially through aggressive lending and mortgage deals. The fallout from these events has landed heavily on both hoteliers and lenders in today’s marketplace.
Throughout the recession, many smaller community banks found themselves struggling with bad commercial real estate (CRE) loans. Whether banks were too aggressive in growing their CRE lending portfolios and/or ill-prepared to manage the consequences, the outcomes have been alarming. The following chart illustrates the number of bank failures from 2007 through the first half of 2011.
According to the FDIC, the number of failed and troubled banks has only recently begun to decline, even though the recession officially ended over two years ago.
The Local and Regional Banking System
The bulk of the failed lending institutions have consisted of local and regional banks, or LRBs. These smaller and mid-sized banks play a critical role in financing small businesses, including limited- and select-service hotels. The table below illustrates the number of loans made by a lending institution relative to the institution’s total asset holdings.
Of the 6,453 banks in America, the overwhelming majority—the LRBs—have fewer than $1 billion in total assets. These banks provided a significant amount of credit to limited- and select-service hoteliers throughout the pre-recessionary boom and now are struggling to deal with the fallout from many of their residential loans, which have been sold and securitized.
Although large, full-service, “prize” hotel properties are often the exclusive domain of national lenders, which account for 78% of CRE loan volumes, the majority of limited- and select-service hotels are financed by the LRBs. The smaller banks are also more attuned to the specific needs of these hoteliers. Of course, the eagerness of these smaller banks to support CRE development has come at a high price; the high percentage of CRE loans on the books of LRBs reportedly has grown from 60% in 2003 to 74% today.2 Defaults on these loans, combined with the depreciated value of hotels and other assets over the past three years, have caused a disproportionate number of LRBs to hold off on further lending.
The Potential of Hotel Loans: Supply and Demand
On the supply side of lending we have the banks, which despite the continued resolution of the recent crisis are now in a much stronger position to make CRE loans. On the other side we have U.S. hoteliers, many of whom are less than inclined to seek out new loans at all. The chart below, which shows confidence levels among U.S. small-business owners from 1986 through 2010, illustrates why.
The fall in optimism since the downturn is striking. The National Federation of Independent Businesses (NFIB) Optimism Index dropped another 1% in June of 2011, and remains in what the NFIB has termed "recession territory." Without vigorous economic activity generating demand, business owners aren’t willing to start new ventures. It is not therefore surprising that high unemployment rates and the explosive U.S. government debt level have hotel owners frozen in their tracks.
Conclusion
It’s true that some banks are still struggling. But the dearth in CRE lending, which has affected everything from new hotel development to hotel transactions nationwide, reflects in greater part the current cautiousness among hoteliers. Limited- and select-service hoteliers, like so many small-business owners, are deciding to sit tight until the dust settles. The uncertainties in the economy are enough to give pause when it comes to reaching out for capital.
Nevertheless, hotel performance has been trending upward in markets across the country, and it doesn’t pay to sit on the sidelines when you have a hotel venture that’s worth pursuing. One of the goals of the U.S. hotel Appraisals Hospitality Conference is to jump start movement by putting active lenders and active loan-seekers in the same room, providing a forum for discussion that can get viable hotel projects off the ground. We hope you join us as we work to make the process less daunting and more fruitful in all courts.
______________________________
1 - Harding, Jeff. The Small Bank Problem. The Daily Capitalist. Retrieved August 15, 2011. http://seekingalpha.com/article/282616-the-small-bank-problem-why-we-are-40-000-properties-away-from-recovery
2 - Harding, Jeff. The Small Bank Problem. The Daily Capitalist. Retrieved August 15, 2011. http://seekingalpha.com/article/282616-the-small-bank-problem-why-we-are-40-000-properties-away-from-recovery
About the Author:
Russ Rivard is Managing Partner for U.S. Hotel Appraisals, overseeing the firm’s hotel consulting and appraisal activity across ten offices nationwide. Russ graduated from the University of Arkansas with a Master’s degree in Operational Management and is a veteran of over 1,000 consulting and appraisal assignments for limited- and select-service hotels, including single assets and portfolios in markets across the U.S. Russ is a state-certified appraiser and an associate member of the Appraisal Institute. Contact Russ at (214) 766-5394 or rrivard@ushotelappraisals.com.