Hotel loans get special attention from lenders
Hotel loans outlined
- Underwriters look closely at a hotel’s historical performance, location and competition.
- The financial strength of a hotel is measured by its occupancy level and the revenues generated by the guest rooms.
- A hotel’s high occupancy levels may lower its room-revenue projections, as lenders may worry new hotel construction will occur.
- Lenders may require a right to refuse changes to franchise and management agreements, and may require oversight of the annual operating budget.
Hotels are a specialized property type and, as such, underwriters evaluate hotel loans differently.
For one thing, hotels are considered riskier than most other commercial asset types because they are more susceptible to market changes and fluctuations in the economy. Probably more so than other major property types, lenders are closely evaluating a hotel’s historical performance, its location and competitors.
The financial strength of a hotel is primarily measured by room-occupancy rates and the revenues generated by the guest rooms — measured through the average daily rate (ADR) and the revenue per available room (REVPar).
Quirks with hotel underwriting
Underwriters can draw surprising conclusions about a hotel’s numbers, however. You might assume, for example, that lenders want to see the highest possible occupancy level – the higher, the better. This isn’t necessarily the case.
If the hotel occupancy climbs above 75 percent, underwriters tend to assume the market has a shortage of rooms and could soon see a boom in hotel construction. This will lower the hotel’s outlook for ADR and REVPar. Lenders also tend to underwrite hotel loans by assuming higher operating expenses than may be shown on the books.
Among the first things that lenders look at is the hotel’s flag, franchise agreement and location. If the franchise agreement is expiring, lenders may require the borrower to try to renegotiate the pact early. Lenders also commonly require what is known as “a comfort letter” that will enable the lender to easily take over the franchise agreement or transfer it to a new purchaser in the event of a default. Lenders also usually require that the borrower make no major changes to the franchise agreement, including terminating the pact, without the lender’s consent.
Other possible conditions
Lenders also often require some control and oversight authority over the hotel management company — particularly if there needs to be a management change. A lender also may require the borrower to set aside money into a reserve account and also may require the right to approve a borrower’s annual hotel operating budget.
The debt-service coverage ratio also is a big factor in hotel-loan underwriting. This ratio compares the property’s income stream to the amount needed to service the debt. Underwriters want to see that the borrower has a healthy cushion to cover the debt payments.
Hotel underwriters look at numerous other factors in weighing risk and a hotel’s operating income and expenses, down to fine-grained details such as the condition of the furnishing and fixtures and the seasonal changes in occupancy.
The bottom line is that borrowers can expect a thorough vetting before the lender will sign on the dotted line.