8 Key Factors When Financing Your Hotel

As the economy continues to improve, hoteliers have many more options when it comes time to finance their property; though lenders still have their qualms and are slightly more reserved with hotel assets versus other income producing properties. There are 8 factors to be aware of when it comes time to finance your hotel.

What are the hotel demand drivers?
This is often the lenders first question. Unlike an office building or a retail property with leases in place, a hotels income is purely derived from the demand for its existence. Many factors can impact a hotels demand, whether it be located in a major MSA, along a highway, near a college or university, or driven by tourism; these factors along with others immediately affect the revenue a hotel generates. Demand is also impacted by the number of hotels in the immediate area.

How does your property perform on the STAR Report?
How well your hotel performs relative to its competitors is very important to the lender. Smith Travel Research, Inc., (STR) provides supply and demand data and market share analysis for all branded hotels in a report commonly referred to as the STAR Report. The STAR Report provides daily and monthly property performance for a specific hotel versus its competitive set. It allows you to track trends in occupancy (ADO), average daily rate (ADR), and revenue per available room (RevPAR). If the STAR report reflects weak performance a lender may find it reason enough to deny the finance request upfront. Therefore, a hotel owner should aim to have an Index for ADR, ADO and RevPAR above 100 on the STAR report; indicating to the lender that the hotel is operating equal to or better than its competitors.

How much time is remaining on the franchise agreement?
This is probably one of the most important factors to a lender, with regards to a flagged hotel. A franchise agreement is like a lease; the longer the term the less risk to the lender. If a hotel only has 3 years remaining on the franchise agreement, but the owner wants a 10 year loan term, we will have to find a way to mitigate the risk of losing the flag at expiration. One way to mitigate the risk would be to collect a reserve at closing to ensure the owner can complete the requirements of the brand to renew the flag or reposition the property with an equally acceptable flag. A long-term franchise agreement is very important to the lender as they feel that a hotel is more valuable if it is operated as a branded property.

Why is a Comfort Letter important?
Prior to loan closing, almost all lenders will require a Comfort Letter from the franchisor. The Comfort Letter is merely an assignment of the franchise agreement that allows the lender to operate a hotel property under the current flag in the event of a loan default, receivership or foreclosure. It is often a lead time item in the refinance process and can be frustrating to the hotel owner because it essentially has no direct impact on them.

Why does it matter to the lender if a PIP (Property Improvement Plan) is due soon?
In addition to demand drivers, franchise agreements and comfort letters, franchisors require the operator to complete a PIP or Property Improvement Plan in specified years. A PIP keeps the property in compliance with brand standards and could be a minor upgrade to the property or a major renovation depending on the physical condition of the hotel. Though PIPs can be costly, they are important to the hotel’s overall operating performance and ultimately, its market value. A lender will want to know when the last PIP was completed, if one is coming up, the total cost and what the plan includes. If you have a PIP coming up the lender may hold money in a reserve account at closing that you can draw down upon when it comes time for it to be completed.

What is your overall Cost Basis?
The lender will want to know what your overall cost basis is in the property. In other words, what is your all-in investment in the property – what was your purchase price (inclusive of closing/finance costs) and/or development costs? How much have you invested into the property since you purchased or developed it? As a rule of thumb, your cost basis should at least be equal to your loan amount; however, ideally, it is 30% more than the amount you are looking to borrower.

Analysis of the Hotels Operating Statements
A lender asks many questions to get comfortable with the property and to determine if they want to provide a loan to the hotel owner. In addition to the STAR report, we will analyze the hotels operating statements. In general, for a limited service hotel, the owner/operator should try to bring anywhere between 30%-40% to the bottom-line whereas, a full-service hotel should strive for 20%-25%. If your limited service hotel is only bringing 18% to the bottom-line, there may be something fundamentally wrong with hotel operations and you might want to think about making a change.

What is most important to you when securing financing for your property?
Despite all the questions a lender may ask, you need to determine what is most important to you. Are you looking for a non-recourse loan at maximum leverage? Or do you follow more of a conservative business model and prefer a more streamlined process at a lower leverage point? Those questions, along with the property’s operating performance, will determine which lender would best fit your current needs. The chart below indicates two different options for refinancing your hotel. Where do you fit?

The chart above is a limited example of possible financing options for hotel owners. We work with hoteliers across the United States and Canada to meet their finance needs, whether it is financing an entire hotel portfolio, a PIP in conjunction with the refinance, an acquisition, or to reposition a property in the market. Largo is in the market every day and will strive to obtain the most competitive financing terms available for you and your property.

By Lori Tirado, Managing Director, Largo Hospitality Finance Group