In an ALIS Summer Update online panel, hotel lenders said they are still willing to work with hotel owners, but with the pandemic, they are shying from construction and giving extra scrutiny to transactions.
REPORT FROM THE U.S.—With the coronavirus pandemic disrupting plans and changing the situation day by day, hoteliers and their lenders are trying to figure out how they can plan ahead and whether they are comfortable with the debt necessary for construction or deals.
On the online panel “Capital for development” during the ALIS Summer Update—Dallas, industry experts outlined what they are seeing and how they are planning for the future.
Atlantic Hotels Group has an extended-stay property currently in development, said company CFO Arzu Molubhoy. The company worked with a bank it has an established relationship with and the project was well-capitalized, so executives decided to move forward on it. Construction began in June 2019.
“We were already in the middle of the project; we couldn’t really stop or put it on hold, so it is slated to open in about Q4 of this year,” she said. “With that project, we’re confident that we have enough reserves set aside.”
The company has worked with the bank to get deferments and is having ongoing conversations to stay ahead of the game, she said.
Other development projects in the pipeline are on hold for now as the company has shifted gears to trying to survive with what it already has, Molubhoy said. That said, while the company is pausing development, they will keep an open mind toward acquisition opportunities that make sense, she said.
Access Point Financial CEO Dilip Petigara said his company has about $110 million to $120 million in construction loans on the books for projects in various stages of construction. Some of them, depending on their location, have been able to continue unimpeded while others have had to slow or stop work until local jurisdictions gave permission to return to normal.
“Certainly, that impacts the delivery timeframe of it,” he said. “It also impacts the interest reserves that were available to service the debt for that duration.”
That could create some lingering effects on what his company can do to accommodate a loan, he said.
There are still opportunistic inquiries and people reaching out to Access Point Financial with projects they want to move forward on, Petigara said. However, there haven’t been any pressing requests, particularly for development requiring new money, he said.
Stonehill Strategic Capital has more than $150 million in construction deals on the books in nine projects spread across the country from Washington, D.C., to California, said company President Mathew Crosswy. The company likes taking on the risk of new assets with a great brand in a strong market where it can underwrite the demand drivers as their viewpoint is new always beats old when entering new markets, he said. Unfortunately, the company was ramping up its construction pipeline when the pandemic started.
As the depth of the crisis unfolded, those conversations with potential borrowers changed to shoring up existing portfolios, he said. Only one of the construction deals in its pipeline closed, and it closed in the middle of March.
“It was far enough along,” he said. “We also knew that it was going to be a longer construction period, and that was a pretty low basis and it was in a market that we can easily underwrite in our backyard.”
Those factors along with having 24 months of interest structured into a deal with the ramp-up period and it being a Residence Inn property in Decatur, Georgia, with demand drivers from Emory University and the U.S. Centers for Disease Control and Prevention, helped the deal along, Crosswy said.
There was a lot of competitive pressure toward the end of 2019 in terms of compression on rate and available leverage, but that has all but evaporated, Petigara said. His company is looking at transactions, but the ones they’re quoting on today aren’t new-build transactions. They are seeing more opportunities in repositioned assets, however.
Leverage is lower than they have historically seen, and their rates have gone up marginally, he said. While their rates have been a little higher than banks, they made up for it by being focused solely on the hospitality industry and being integrated in all sectors, allowing it to deliver faster.
Historically, the company could stretch leverage to 75% of cost or even 70% of cost on an existing asset, Petigara said. Now they will share money probably from 15% to 25% basis points lower than that, he said.
“People are approaching us, and they have an acquisition of an asset,” he said. “We'll tell them if we can delay a little bit … until we all kind of see what the end of the tunnel looks like, but if you need to press forward, then this is kind of what it’s going to look like.”
Groups are still coming forward with projects and while Stonehill will quote a construction deal, executives are also evaluating the entire playing field because there’s little to no capital available to hotels right now, Crosswy said. There are a lot of deals and a lot of capital that must come into the space, and the company has had to determine whether construction is the right play right now, he said.
At the same time, construction costs are expected to come down, with some thinking it could happen early 2021, he said. There should be savings of anywhere from 10% to possibly 20%.
“We’re quoting deals, but we’re really trying to build up and quote our pipeline for Q1 in next year where we think that the cost savings are baked in,” Crosswy said.
Private capital is more expensive than banks, so being able to pencil a deal and make it work for the cost of private debt requires creating savings elsewhere in the underwriting, he said. The deal must model in size to a return that works for both the borrower as well as the lender where they think they can underwrite to a definite takeout in 24 to 48 months when capital markets are healthier, he said.
Atlantic Hotels has its sights on an 18% to 22% levered return, Molubhoy said. It all depends on the type of opportunity it is, though. Some projects, because the basis is so low or they can pick it up for pennies on the dollar, the return is much higher, she said. Other times, it might be an incredible project in an irreplaceable location and while it’s priced higher than desired in the current environment, they might go ahead and take it.
“It’s hard to just give a blanket statement,” he said. “It would have to be a project-by-project basis, but we are confident that if we stay in that little niche in limited- and extended-stay service, then you’re able to give projects that give that investor the return that they’re looking for.”
In those cases, the rooms are controllable and aren’t big boxes that are difficult to fill, she said. They’re also not banking on international travelers or guests flying in; instead, they have a drive-to market providing gusts or overspill from whatever demand driver is in the area, such as a convention center, she said.
This is where models become extremely interesting by adjusting and manipulating the models to make different assumptions, Crosswy said. While his company would not take on debt from a construction project assuming it’s going to place debt for six or 12 months from now, it would look at some acquisitions, he said.
Without having good debt assumptions, it’s difficult to come up with the right levered internal return rate, he said. He wouldn’t touch a deal unless it had a safe 10%-plus return on costs, and there are few deals out there like that, he said.
If a borrower has cost savings and might hit those numbers, they could start today with the assumption knowing they’re going to whittle away at their debt and value engineer their project, he said. Then, hopefully by 2021, they could finance that project at 50% to 55%, which would get them to a levered 18% or 10% to 12% unlevered, he said.
“Those numbers feel safe, they make sense,” Crosswy said. “It might not be that 20%, 20%-plus, but you don't have as much debt either. So, from a risk-adjusted perspective, I think it still does kind of pencil, and it makes sense for a group like us.”