Commercial Lending and

Limited-Service Hotels

It’s been a long drought for commercial lending, but conditions are looking more fertile. What resources do hoteliers have—and where should they turn—when seeking out and securing a loan?

By Russ Rivard

October 5, 2010

Speaking with hotel owners and brokers, one question keeps coming up: Who is making loans? It’s a question that’s become increasingly hard to answer as the recession forces more and more lenders to the sidelines. The FDIC continues to close troubled banks, and bank failures in 2010 are outpacing those of last year. Even some of the remaining players are on infirm ground, with more banks on the FDIC’s “troubled” list than any time since 1993.

Some of these banks will fail—it’s inevitable. But others will strengthen. While a vast majority of bank failures over the past two years have been due to bad loans, existing banks, REITs, and other lending agencies are in a position to fortify themselves by making loans to viable commercial real estate ventures. Many of the larger lenders are starting to report profits. This is good news for hoteliers, but to capitalize in the “new normal” lending environment, we need to understand why commercial lending volume has dwindled.

A Stalemate

One reason is more restrictive loan underwriting requirements. Despite some loosening of credit, many hotel owners find that under these stricter standards they do not qualify for a loan. Lending agencies scrutinize the finances of potential borrowers like never before, and today’s lenders will not take a chance on a venture that’s too high risk.

Strangely enough, another reason that commercial loan activity continues to suffer is the lack of demand for loans. Many business owners are focusing on revenue management and trimming expenditures, reluctant to expand or hire until a firm recovery takes place. The idea of adding more debt in this scenario seems unrealistic. Hence, the banks in a strong position to make loans are hunting to find hotel owners willing and able to take or even discuss the terms.

As bad as the past 18 months have been for the financial industry, there seems to be some light on the horizon for U.S. banks. FT.com recently reported that U.S. bank profits have returned to “pre-crisis” levels—though the slow recovery of their coffers has not yet translated into a sizable offering of new loans.[1]

Opportunities for Hoteliers

With lending criteria so strict, how does a hotelier make the strongest case possible for a loan? A well-supported appraisal report is a good place to start. As with any commercial real estate parcel, valuation is critical to procuring a loan for a hotel. Lenders want to know both what a hotel is worth now and what projections can conclude about its future value before releasing thousands or millions of dollars. Hence, a credible value for a hotel property—one produced by an appraiser whose expertise is geared toward evaluating hotel performance and revenue potential—is fundamental to making a case for a loan.

There’s another piece of collateral that lenders prize in limited-service hoteliers: experience. According to Ed Fitzgerald, President of National Republic Bank of Chicago, in today’s tough lending environment, experience is a necessity. “Borrowers need to have at least three to five years of hotel operational experience before our bank seriously considers making a loan. We’ve found that most problems occur with an inexperienced first-time operator.”  A hotel’s brand carries weight with lenders as well. According to Mr. Fitzgerald, the high risk associated with lending on an independent hotel has led National Republic Bank of Chicago to focus on loans for brand-affiliated properties.

Certain programs can benefit limited-service hoteliers in obtaining loans. Among the most important is  the U.S. Small Business Association’s 504 Loan Program, a partnership between a borrower, a bank, and a Certified Development Company to produce financial backing for real estate projects. “The 504 program offers an opportunity for a borrower to gain a loan with only an approximate 10-20% down payment, while the lender also benefits from a less risky position,” said Mr. Fitzgerald. The government-backed 504 program allows lenders to loan on hotels with a lower risk position due to a 50% loan-to-value ratio.

Perry Espie of the U.S. Small Business Administration (SBA) concurs that most small business owners find financing for capital improvements and operations elusive. This includes owners of limited-service hotels. Yet lending is active, if subdued, even in today’s economic climate. “Meeting lenders and understanding their requirements is a challenging first for many small businesses,” said Mr. Espie. “The SBA invites small business owners and new entrepreneurs to meet and talk at the ‘Small Business DEAL DAY,’ an SBA/SBDC (Small Business Development Center) partnership event that has proven to be an effective forum to introduce business owners to active SBA lenders.”

Conclusion

Limited-service hoteliers seeking loans are encouraged not to lose faith. Industry performance is improving, and hotel demand in many U.S. markets was up by double digits in the first half of 2010. As the economy continues to record modest gains, the commercial lending picture should regain focus. Poise yourself to take advantage by evaluating the costs, income, and integrity of your hotel asset or proposed development, and get in touch with a professional hotel appraiser to ensure that you have an objective value to present to lenders when you go to make your case for a loan.

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