Finance Column: Checking in on Hotel Construction Financing

By Barbara Morrison, Founder & President, TMC Financing

Across the U.S., the hospitality industry is riding a wave of recovery. According to the latest STR Pipeline Report, hotel rooms under construction are up nearly 22 percent year-over-year. Demand, however, is still outpacing supply and is predicted to do so for at least two more years, according to a May 2015 report by HVS Global Hospitality Services. Occupancy rates, RevPAR and other key performance indicators continue to grow at record levels.

This optimism aside, we see two factors that will continue to affect hotel construction financing through 2016:

1. Tight financing will continue to cause hotel construction to lag behind other commercial real estate sectors. While the availability of hotel financing has grown significantly since the economic downturn, the number of lenders active in the hotel construction sector remains limited. Because hotel properties are not easily converted to other uses, they are classified as “special properties,” making conventional financing more difficult to find. Many commercial lenders continue to operate with tight underwriting standards, requiring hotel owners to come up with a down payment of 35 to 50 percent. We’re seeing renewed interest in the U.S. Small Business Administration 504 commercial real estate loan program because it reduces both a commercial lender’s risk and the down payment required from the hotel owner. Typically, SBA 504 loans are structured with a first mortgage from a commercial lender for as much as 50 percent of the total project cost, an SBA 504 second mortgage of as much as 35 percent, and at least 15 percent down from the hotel owner. While SBA 7(a) financing maxes out at $5 million, the SBA 504 program can finance larger projects because there is no maximum total project cost.

2. Projects that meet market trends and are backed by strong management will have the best chance of gaining loan approval. While the hotel industry certainly rewards economies of scale, properties that offer a special experience are increasingly in demand. Millennial travelers value green, healthy, local and authentic, and franchise brands have responded with new property improvement plans, often requiring franchisees to reinvest in renovations. About two-thirds of our recent SBA 504 hotel construction loans are for renovations vs. ground-up construction and 80 percent are flagged properties. Energy-efficiency improvements, particularly solar, are gaining in popularity. Many hotel owners with existing SBA loans have utilized the $5 million SBA maximum; however, under the SBA 504 “green energy” program, owners can finance additional projects. To qualify, at least 10 percent of the property’s energy needs must be generated on site. This is easily accomplished with energy-efficient lighting or the addition of solar panels, which play very well when marketing the property to travelers. While some lenders recommend removing FF&E costs from the overall construction loans, the SBA 504 loan allows FF&E, PIP and other soft costs to be rolled into the loan. This flexibility is what makes the SBA 504 program so attractive for hotel projects right now. It allows hotel owners to take advantage of today’s hot market with a competitive, customized financing package.